That’s not really fair or practical. For one, bondholders agreed to some cuts voluntarily some time ago, but for another, the city does have resources and a couple decades ago was on reasonable financial footing. It wasn’t that long ago that the idea of a municipal bankruptcy was seen as inconceivable. But the biggest problem is this: Detroit needs the bondholders at least as much as the bondholders need Detroit these days. The city cannot function without bonds, to the extent that defaulting on the bonds means in effect an immediate default on the pensions as well.
I agree with Exapno Mapcase that to really explore the issue it’s a political, and thus GD type discussion. But you can get some of the basic nuts and bolts.
Bankruptcy is governed by Federal bankruptcy laws, there is a specific section for municipalities. Municipality bankruptcy is covered under Chapter 9 of the bankruptcy code. Different types of bankruptcy have different technical aspects, most of which I don’t know about and thus won’t go into here.
But the basic concept of bankruptcy is similar regardless. Any entity, be it an individual, a business, or a local government can incur debts. I won’t get into the different types of debts that cities can incur, but assume that a city must pay interest on its debts from revenues. Revenues from cities come almost entirely from taxes and fees. Things like property, sales, income and B&O taxes as well as fees for all kinds of permits, parking fees, sometimes cities operate attractions like parks or zoos that charge entrance fees etc.
As debts go up, two things can happen to the city. If the city is vibrant and growing, such that it gains population and tax base faster or as fast as its debt grows, then it can continue to make payments on its debts without raising existing tax rates or increasing fees. If the city is not those things, and the population is stagnant or worse decreasing as debts increase, then you have a larger debt burden that must be serviced by a smaller tax base. The only way to meet those payments is to increase taxes and fees.
However, that only works so much. City populations are semi-captive; people won’t move or change jobs over minor tax changes. But if a city loses a large amount of population (as Detroit has), and many jobs are leaving the city, then the tax increases necessary to fund the debt payments would be very large. Those increases would lead to people deciding it is indeed worth it to leave their homes and jobs to get out of that tax regime, thus putting even more burden on an even smaller population. Services eventually must be cut, dramatically. This leads to things like more dangerous neighborhoods as urban blight takes over, and absolute basics like fire and police protection go below acceptable levels. This will lead to even more flight.
So basically at a certain point, a declining city has to stop raising taxes to pay for its debts. Because it reaches a point where those taxes would effectively kill the city. If it can’t raise taxes any longer, and it can’t cut services any further, much like a company that is unable to pay its creditors the municipality really only has one option left: seeking bankruptcy protection.
Bankruptcy is a process by which you can legally discharge debts to your creditors without paying them back what they are owed. It is overseen by a Federal court and judges specializing in bankruptcy law. Creditors have some rights in these proceedings, and they usually end up getting “some” of their money back. Some creditors get nothing, some get small portions of their money back, some might get larger portions of their money back. In general in a bankruptcy most creditors will lose significant portions of the money they had lended.
I was wrong when I said a city in such a situation has one option, they do have another option. State governments can choose to bail out failing cities, and use State tax revenues to buoy municipal balance sheets and take over paying down those bonds. But the decision on whether or not to do that is governed by State law and politics. States also can often (as a matter of State law) take over the day-to-day running of a municipality. There is no constitutional right to exist as a city, at the Federal level. So cities are protected only by their State constitutions. Some States provide very strong protections for the rights of cities, but some make cities basically entities that exist at the “whim” of the legislature or governor. In Michigan it’s somewhere in between that, the Governor can take over a city but there is State law governing how he’s allowed to do that and in what circumstances. This has happened to Detroit, that is why people often talk about Detroit’s “Controller.” He is an unelected individual, appointed by the Governor of Michigan, to run Detroit. Detroit’s elected representatives have very little legal say in what goes on there now.
It was the Controller who made the decision to seek Federal bankruptcy protection, but most observers whatever their political affiliations agree that was almost certainly necessary for Detroit.
That thus means Detroit’s status is that its day to day government is overseen by an appointed official. He has made the decision to seek bankruptcy protection. Various entities who are stakeholders in this process will and have opposed taking Detroit into bankruptcy, and there is most likely going to be ongoing litigation that will determine how and if Detroit fully goes through the bankruptcy process.
So that is Detroit’s current status. As to how it got there, probably the most neutral way to present that is to only go through the “proximate causes” which most people will agree on, but not get into the “root causes” which many people will debate:
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Detroit’s tax base decreased and its debts either did not decrease or continued to grow.
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Detroit’s tax base largely decreased because of population decline and business decline. As has been mentioned Detroit lost over 1m residents. Further, despite GM and Ford continuing to have significant operations in Michigan, almost none of it is within the city limits of Detroit. This compares to in the past when significant auto industry activity occurred within city limits. This means all the taxes businesses pay to cities, and the taxes their workers can pay to cities are no longer available to Detroit.
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Detroit is not geographically compact. As many neighborhoods have become vacant or blighted, Detroit has ended up with a very large (relative to its total population) area to provide services for. This means those services are basically guaranteed to be less efficient. It is harder to continue covering the same geographic area with decreased revenues and population. [Some have recommended part of reforming Detroit would be to cut off parts of the city that are basically “rotten” or depopulated to make it a more geographically compact entity.]
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A bigger city requires more workers. When those workers retire they collect pensions and other benefits. Since Detroit used to be much larger, it used to have more employees, now it has a situation where its ratio of pensioners to its city workers is in a bad place. Most pensions are funded by a combination of employee paycheck deductions as well as general revenue from taxpayers. With a larger number of retired employees and fewer current employees and taxpayers this creates a large unfunded obligation gap that can sap a large portion of revenue that could otherwise be used to pay debts or fund current services. [It should be noted pension and other employee obligations are an “obligation” and can be viewed as a liability, but they aren’t necessarily the same thing as an actual “debt.” Pension obligations are creatures of Statute and in some cases can be written off or decreased with no recourse to the pensioner. Governments are loathe to do this, but this ability means they are not like actual debts, which can’t typically be written off or discharged without going through a bankruptcy proceeding.]
About taxes, it’s worth noting that Detroit is one of only a few cities in Michigan which have a city income tax. In practice, this isn’t a very good idea, because many people refuse to work in Detroit precisely because they don’t want to pay the city income tax. And since most cities don’t levy an income tax, Detroit is at a disadvantage in trying to attract employment. They really should dump the city income tax, but at this point they probably can’t afford to lose the income. It’s a Catch-22.
Good summary, Martin. Let me add one more neutral point from this morning’s newspaper.
The reason that bankruptcy cases get so difficult is that everybody walks in knowing they are going to lose money. Nobody gets what they think is a fair share. Worse, many of the claimants have contractual guarantees for that money. Michigan state law, from what I’ve read, guarantees pensions, and the financial deals that Syncora was involved in moved money around to do this. The rest of that Times article details how every single piece of the deals went wrong after the financial meltdown in 2008.
Now the bankruptcy judge has to decide who loses how much money up against lawyers whose fiduciary duty is to get the most for their clients. It’s a mess but one that evolved out of good intentions ruined for a lack of precognition.
So Detroit is in the same situation as a bankrupt with a steady income, the “orderly payment of debts” situation.
Usually, for individuals or Chapter 11(?) companies, this results in a schedule of payments and an agreement for the creditors to take a reduced payout. (I.e. I owe you $5000 instead of $10,000 and I’ll pay you $100 a month).
The fatal flaw in a lot of pension schemes is relying on ongoing revenue to finance pensions - or failing to pay up for the fund that should finance them. The USA is far more lax than Canada in this regard. Politically, it is easier to put off payments to the fund and promise to pay tomorrow when things get better - but of course, they never do. Even more reckless is to commit future revenue to pay out non-productive (ex)employees.
Another issue is that not only are there blighted, effectively abndoned areas but there is no money for cleanup or remediation. Are they, for example, producing water and pumping it into aras where only a few houses are occupied but various breaks and ground heaves may mean they are making expensive clean water that goes out into the ground or down the sewers? Abandoned buildings are a hazard and a nuisnace and a place for pests and other problems. etc.
This will be decided by the courts, probably more than one. Logic has little to do with it.
It’s the Michigan State Constitution, not just State law. See here for the actual text.
However, this is being decided in federal court, not state courts. Michigan’s constitution isn’t particularly relevant.
Having recently read Shadow over Innsmouth again, I couldn’t help but think of Detroit. I wonder if there are any Old Ones nearby…
Strange cults? Inhuman chanting? People with very strange common features not previously seen in Humans?
Yes. However, there’s a legal difference between a public right-of-way (a parcel of land owned by a political subdivision of some kind, reserved for access to and between parcels of land which may be publicly or privately owned) and a street (a physical path used to facilitate travel by vehicles, and ideally pedestrians and cyclists). A public right-of-way does not necessarily need to be a paved street with sidewalks, lights, and utilities. It doesn’t even need to be a dirt road with ditches. Consider “paper streets” and “ghost subdivisions”. Many American cities, including Detroit, had large areas that were platted and subdivided decades before development took place. The roads only went in just before the lots were sold, and houses built.
Most cities, towns and counties in the US have standards of some kind for street construction. However, they can be waived under varying circumstances.
Until a judge decides, and appeals play out, you don’t know that. The emergency manager, appointed by Michigan governor Snyder, filed for bankruptcy, so the state of Michigan can’t really say they are not involved.
Well, OK. Maybe it’s better to say that the state consitution is as relevant as the federal judge says it is.
As a practical matter, the judge will almost certainly disregard the clause in the state consitution about not being able to cut pensions, and the pensions will end up taking a haircut along with everyone else, although probably not as severe a haircut as bondholders or other creditors will take.
Well of course. If you hold a cheque from X, and X goes bankrupt - where your money comes from, if at all, is up to the court. Or a promissory note, or a contract, or a debt. they promised the money, and don’t deliver, well, sucks to be you.
However, welching on that bargain to the working stiffs, whatever the excuse, is a particularly nasty convenience that seems to appeal to politicians and MBA’s and does much to define the reputation of capitalism.
Bankruptcy is complicated. Although it’s a federal matter, the bankruptcy statutes require the courts to apply state law to the case in a lot of areas. I have no idea how it affects a municipal bankruptcy. But it’s definitely not as simple as “it’s a federal question so state law is irrelevant.”
The issue is that you’re only seeing the obvious; a facile concept of “fair”. The put osebof bankruptcybisn’t to be nice. It’s a recognition that the debtor cannot pay and an attempt to manage things as best as practical. Generally, nobody gets stiffed entirely. In this case, the city needs loans and can’t function without them. Further, guess who owns a huge amount of muni bonds in this country? Yep - retirees and institutional investors, especially IRA funds and pensions.
But further, there is the serious question of whether the pension guarantees were rationally or honestly made in the first place.
I’m well aware of the “legal” vs. “fair” issue.
When the German government, for example, helped bail out Greece - they weren’t worried about the Greeks, they were bailing out (stupid) German bankers.
Your last point is the most important - what’s the old saying? “If things can’t go on this way… they won’t.” Anyone who could do a modicum of math can see the dnagers of the immediate future - yet we’ve seen a plethora of organizations, like Detroit and many other municipalities, like the Detroit Auto makers, etc. - commit to policies (including pension promises) that were patently unsustainable in the medium term, let alone the long term. We can debate the causes - corruption? Stupidity? Willful blindness? Excessive optimism? Ostrich syndrome? The mess had been coming for years, and unless there was an incredible change in circumstances, the only question is “when”?
Another interpretation would be “suicide”. If one problem is the state law/constitution forbids one obvious remedy, then all you can do is enjoy the ride until you hit a brick wall and let someone else sort out the consequences.
“Detroit’s municipal pension fund made payments for decades to retirees, active workers and others above and beyond normal benefits, costing the struggling city billions of dollars and helping push it into bankruptcy, according to people who have reviewed the payments.”
http://dealbook.nytimes.com/2013/09/25/undisclosed-payments-cost-detroit-pension-plan-billions/?_r=0
Anyone surprised?
Yeah, I’ve got to say I’m surprised.
Bankruptcy ought to be a great opportunity,for Detroit to reinvent itself-start over, with a clean slate. If I were Dave Bing, I’d invite in Chinese and Korean automakers-give them the abandoned factories for $1.00. The whole city could become an enterprise zone.
But this will never happen.
Why would the Chinese want a US factory? They want to make stuff in China, and just sell it here.
As for Korea, they already have plants … down South. Automakers of every nationality love to build plants down South, because they’re not union-friendly down there. Even the Detroit automakers do it; the plants up North are mostly “legacy” facilities that were built many years ago.
This is the infamous “13th check” by which the pension fund distributed whatever money was left over at the end of the year.
Yes, the pension fund is managed by morons who apparently have never imagined that it might be better to re-invest the extra money for a rainy day.