Detroit City Bankruptcy

Just under one week has passed since the City of Detroit filed for Chapter 9 Bankruptcy on July 18, 2013, making it the largest municipal bankruptcy in the history of the United States with an estimated $17-$20 billion debt burden. After taking some time to let the dust settle, let us take stock of this landmark event.

Detroit’s Emergency Manager, Kevyn Orr, was given the task in March of this year to manage the city’s finances. Since then he has commented on the fact that Detroit has been operating on an insolvent cash flow basis (more going out than coming in) and has recommended this drastic action of bankruptcy as a last resort.

Before looking at the implications that may arise, it will be prudent to consider some of the facts. This bankruptcy, though large in scale, does not come as a surprise. Detroit has been suffering greatly not just through the financial crisis which shook the foundations of “Motor City’s” automotive industry, but also because its population base of 1.8 million in 1950 has shrunk to somewhere in the 700,000 range. What this means is the base of people that may be taxed in order to raise revenue for the city is greatly diminished and local government is not able to turn the faucet on to easily or quickly solve the problem.

In addition to the population whittling away considerably, there are many other unresolved issues in the city. Detroit has an exorbitant amount of vacant buildings in the ballpark of 70,000-80,000. Basic functions within the city have suffered as well with an estimated 40% of the streetlights being out. Issues such as these are serious fundamental problems that are only likely to be exacerbated as Detroit enters bankruptcy proceedings.

What is at stake?
Everyone with a financial stake in the city of Detroit can be expected to be pursuing their claims. I have heard estimates of pensioners potentially facing cuts of up to 90%, though I would suspect that number to be far too drastic. Nevertheless, with the city’s future so incredibly uncertain, more and more of the residents with the means to do so can reasonably be expected to pack up and move on. At the same time, less people will be encouraged to make the move to call Detroit home.

Bondholders and other investors may find the risk/reward proposition unfitting and take their dollars elsewhere as Detroit suffers the fallout of bankruptcy. Without new money flowing in, the city will continue to decay.

Will we see a bailout?
I will be watching most closely at any actions the federal government takes to bolster Detroit. On the face of it, it may appear to be a straightforward solution to this problem, but it can be a slippery slope. If Detroit gets bailed out by the government with an influx of money, what would stop other struggling cities or states from likewise filing bankruptcy and asking for a handout? Further, what if one lump sum is not enough? Supposing the federal government clears Detroit’s debts, this still would not necessarily address the cash flow situation and the city may once again find itself in need of further handouts until this underlying issue is addressed. It can indeed be a bottomless pit. All the same, if the bailout does get fully approved by the courts and things move forward, I do expect a bailout on some level to take place. Governments cannot seem to help themselves but to print money as a short-term fix to their problems at the cost of their constituents and future generations alike.

One suggestion to aid matters has been for the city to put its art collection up for sale. At an estimated $15 billion, this would all but clear Detroit’s debts while leaving a void in the cultural soul of the city. Additionally, these art works are tourist attractions which generate revenue. A one-time sale, again, would not solve the cities structural issues, but rather buy time.

The bankruptcy of a city is, in my view, a more interesting proposition than that of a corporation (which can be sold off in pieces and cease to exist) or a person (creditors take what they can and the individual is left to rebuild from ground zero). A city must, in the midst of trying to regain its financial footing, continue its day-to-day operations such as hauling waste, providing public transport, and so on.

Domino effects also exist in a municipal bankruptcy. For instance, if pensioners (many of whom likely still reside in Detroit) have their incomes cut, they will have less disposable income to spend within the city and businesses will feel the ripples as their sales decrease, leading to further layoffs which force people to apply for social assistance, deepening the problem.

A call to action...
If anything, this case may serve as yet another example to demonstrate that individuals absolutely must take their financial futures into their own hands. When we have cities going bankrupt and once-rock-solid government pension funds being called into question, everyone should have their eyes wide open to what is happening. The world is reaching a critical mass with its debt load and the troubling part is that there are no signs of slowing. People continue to use their credit cards as ATMs with no thought to the cost. Governments are facing the stark reality that they may not be able to cash the cheques they have written in the past as demographically, aging populations pose a serious threat to social assistance and systemically important pension plans.