Detroit Goes Bankrupt: Reax

Jul 19 2013 @ 12:08pm

Population Decline

Yglesias provides an overview:

This is the largest city to ever file for bankruptcy, and obviously no large city goes bankrupt without a complicated array of problems. But the basic reason Detroit needs to do this is pretty simple. In 1950 there were 1.85 million people in Detroit. In 1970, it was 1.5 million. In 1990, it was a million flat. By 2010, it was down to 710,000. When your city is shrinking like that, you end up with a tax base that’s inadequate to maintain the fixed infrastructure or to pay off pension costs that were incurred in more prosperous times. Shedding legacy obligations is a necessary part of the fix. You can shed legacy obligations without filing for bankruptcy by just stiffing pensioners. But the scale of Detroit’s fiscal problems are so enormous that doing it entirely that way would be cruel and pointless—bondholders need to take a hit and this is the way to do it.

Plumer notes some of the city’s other problems:

— The official unemployment is now 18.6 percent, and fewer than half of the city’s residents over the age of 16 are working. Per capita income is an extremely low $15,261 a year, which means there’s not all that much tax revenue pouring in.

— Low tax revenue, in turn, means that city services are suffering. Detroit has the highest crime rate of any major city, and fewer than 10 percent of crimes get solved. The average response time for an emergency call is 58 minutes. Some 78,000 buildings are abandoned or blighted and there are an estimated 12,000 fires every year. About 40 percent of the city’s streetlights don’t work.

— High crime and blight are driving even more residents out of the city. It’s also driving down property values, which means many residents have stopped paying property taxes. The city collected about 68 percent of the property taxes owed in 2011. Both of those things put a further strain on Detroit’s finances.

Soltas zooms out:

Detroit’s dependence on cars … wasn’t exactly the problem. It was dependence itself. Cities should never go all in on any industry, cars or otherwise. It didn’t realize that until it was too late.

Rob Wile explains what happens next:

Assuming the case goes forward — some creditors may try to object to the filing — the court will now determine which entities — corporations, pension funds, employees and anyone else Detroit owes money to — will actually see the money they were promised by the city.

According to the American Bankruptcy Institute Journal, Detroit technically gets to do all of the proposing for how that works out. It will submit a restructuring plan to the court, and if the plan doesn’t violate any sections of the federal bankruptcy code, it will be voted on by the creditors.

The creditors don’t get to propose their own plan, and the court can issue a “cram down” order to force objecting creditors to accept parts of the plan. But there will be negotiations going along the whole way where creditors will have their say.

John Cassidy expects this process to take time:

Having seen General Motors and Chrysler both emerge from bankruptcy leaner and with much less debt, [Detroit’s mayor, Dave Bing,] and other officials are evidently hoping for a similar outcome for the city. But even assuming that the bankruptcy filing does survive a legal challenge, it’s far from clear how a case of this size, complexity, and political toxicity will work its way through the courts; the process could take years. Municipal bankruptcy cases are invariably complex. With Detroit’s debts standing at an estimated twenty billion dollars, this is by far the largest such case in U.S. history. And Detroit is still a city of more than seven hundred thousand people. Can an unelected official like [Kevyn Orr, Detroit’s emergency manager,] govern such a city for years on end with no democratic mandate? A mayoral election is due to take place later this year. So long as Orr is effectively running the show, its result won’t mean much.

Tim Fernholz offers three reasons why Detroit filed yesterday instead of in September or October as expected. One theory:

[Orr] feared lawsuits from pension funds seeking to stop the bankruptcy. In Chapter 9, the city’s promise to spend billions paying for retiree health care is likely to be shifted to the federal government, and the pension funds themselves are likely to take significant cuts. Their managers have been filing lawsuits seeking to prevent the city from entering bankruptcy, but the filing stays them all.

Lydia DePillis looks at who Detroit owes money:

Detroit is about $18 billion in debt, and will only be able to pay out a fraction of that in the short term. The two main groups of creditors arguing they’re entitled to that money are public employees and retirees, and bond holders. The investors are likely to make out better, since more of that debt is secured; the city will continue to pay water and sewer bondholders. Most of the pension debt has no similar backstop.

City residents will likely suffer a lack of anything other than the most rudimentary public services for a long time, but the impact is likely to be felt most keenly by those who lost a large chunk of the retirement they were counting on.

Barro wishes the public sector pension system was designed differently:

If a federal court approves Detroit’s bankruptcy plan, its retired workers will see their pension benefits cut drastically.

It shouldn’t be this way.

When a company goes bankrupt, most of its workers’ pension benefits are insured through the Pension Benefit Guaranty Corporation, a federal government entity established under the Employee Retirement Income Security Act of 1974.

Congress should extend ERISA or a similar set of rules to municipal and state governments. This would force governments to manage their pension systems in a safe way, and would protect workers from destitution in the event of a state or municipal insolvency like Detroit’s.

Sommer Matthews also considers the pensions:

Michigan’s constitution technically prohibits the accrued pension benefits of public employees from being reduced retroactively. But Detroit Emergency Manager Kevyn Orr has previously indicated that bankruptcy would mean pension cuts for both current and former city workers would be on the table. The city’s pension funds currently face an estimated shortfall of about $3.5 billion. For (hopefully obvious) political reasons, it’s unlikely that current retirees would see their checks disappear entirely, but smaller checks are a (frightening) possibility. Future retiree benefits would be the big area for cuts, though. Plenty of states and local governments have already slashed pensions even without going bankrupt.

The above map, on Detroit’s population loss, is from Nate Cohn, who rounded up various maps on Detroit’s decline.