Go to Top

A Slow Slide To A Hasty Bankruptcy

Detroit’s long march to bankruptcy took nearly a half-century to complete before it ended last week in a race to a courthouse.

Kevyn Orr, the city’s emergency manager, scrambled to file Detroit’s Chapter 9 bankruptcy petition just minutes before a state judge said she would have issued a temporary injunction to block the maneuver, Bloomberg reported. Municipal unions had asked County Circuit Judge Rosemarie E. Aquilina to prohibit the bankruptcy because, the unions contend, it would result in a reduction in retiree benefits in violation of Michigan’s constitution.

Aquilina ordered Orr on Friday to withdraw the bankruptcy petition, ruling that the state law authorizing it was unconstitutional. Michigan officials promptly challenged Aquilina’s order, sending the question of whether Detroit can avail itself of the federal bankruptcy process to the Michigan Court of Appeals.

Actually, nobody knows how the bankruptcy case – assuming it proceeds at all -- will play out, though it is a pretty safe bet that the city’s current and future retirees will see benefits slashed and that municipal bondholders (or their insurers) are going to recover relatively little of what they are owed.

Even though city and county bankruptcies occur, on average, about once or twice a year, and even though we have seen several recent filings in California alone, there is no road map for what will happen in Detroit’s case.

It’s not just that there has never been a city bankruptcy so big in this country - with around 700,000 residents, today’s greatly diminished Detroit still has twice the population of previous record-holder Stockton, Calif. The real problem is that most cities go into bankruptcy when their obligations become too big for their population and tax base to sustain, so they need to lighten their debt load. Once this adjustment is complete, such cities can resume normal operation.

In Detroit, at least within its current boundaries, it is not clear that there is a viable city to save.

I can recite some of the sad statistics here, but you probably already know the basics. Detroit’s population has shrunk by more than 60 percent from its 1950 peak. Around 90 percent of its manufacturing jobs are gone; while the city continues to host General Motors’ headquarters, Chrysler and Ford are based in the suburbs, and Detroit-labeled cars are built practically everywhere except Detroit.

Around one-third of the city’s property parcels are either vacant or abandoned. Half the street lights don’t work, nor do more than half the ambulances. There are two retired city workers drawing pensions and health benefits for every active worker who is supposed to serve the city’s residents. Despite a small, renascent downtown core, city residents are far poorer, and thus needier, than in most other places. These are not the sorts of problems that a federal bankruptcy judge can fix.

So what happens after the bankruptcy court scales down Detroit’s obligations? What is there about Detroit, apart from its professional sports teams (who obviously derive most of their revenue from fans living outside the city and the advertisers who want to reach them), that will attract new industry, new jobs and new residents? How can a city this decrepit, this hollowed-out - a city that exists more on the map than in real life - become self-sustaining?

At a minimum, I suspect it will take substantial state and federal guarantees before Detroit will even have access to the credit markets again. One of the biggest controversies in Detroit’s bankruptcy will be the amount that private municipal bond insurers will be allowed to collect from the city’s assets or its future revenues. My guess is that Detroit’s future debt issues are now uninsurable absent backing from higher authorities.

So far those authorities seem prepared to offer little more than warm words of encouragement. In what may be a new low for empty political verbiage, the White House issued a statement - not on behalf of the president, or even of his press secretary Jay Carney, but over the signature of spokeswoman Amy Brundage. “While leaders on the ground in Michigan and the city’s creditors understand that they must find a solution to Detroit’s financial challenge, we remain committed to continuing our strong partnership with Detroit as it works to recover and revitalize and maintain its status as one of America’s great cities,” Ms. Brundage wrote. This is what happens when there is some really bad news and the boss says, “Keep it as far away from me as possible.”

And while Michigan’s Gov. Rick Snyder authorized Orr to file the bankruptcy case, that is a long way from declaring that taxpayers in places like Ann Arbor and Dearborn and Grosse Pointe are ever going to be part of Detroit’s financial solution.

This is the intractable problem that Detroit faces, and the one that a bankruptcy court also lacks the power to solve. American cities are designed to grow; they are not engineered to shrink. Beginning in the 1950s, and at a much faster pace following the 1967 race riots and the U.S. automakers’ long decline thereafter, all of the things that once made Detroit a major city moved outside the city limits. Most of the people followed. The folks that moved did not want to remain part of Detroit back then, and they certainly don’t want to be part of it now. If Detroit is viable, it is only as part of a larger region, but its political boundaries are fragmented and ossified. Detroit cannot grow to recover its tax base.

If it cannot grow, the only other option is to shrink. On the old frontier, settlers sometimes had to be recalled within the walls of the nearest military post when the farms they occupied were too hard to defend. But how do you recall the handfuls of residents who are scattered across the empty spaces of the former urban landscape, one or two households to a block? How do you offer police, fire and sanitation services at a sustainable cost?

These are the problems Detroit has laid before the bankruptcy court. They are unlike any other municipal bankruptcy in living memory.

If Detroit were a corporation, it would either be reorganized or liquidated. In a reorganization, the creditors would actually take over most of the equity in the enterprise. The analogy here would be to give creditors most of the city’s assets, probably beginning with large swaths of vacant land and abandoned property. Creditors would also get management control, so they could put those assets to work in whatever way they chose. The bankruptcy court may not have this power in a municipal Chapter 9 case.

The other corporate analogue would be liquidation. The enterprise - in this case, the city of Detroit - would cease to exist as a corporate entity, and its assets would be sold off to pay creditors. This does not seem to be an option in Chapter 9 either. At least not yet.

Detroit is an extreme case, even given the woeful state of government finance across much of America. I expect there will be quite a few additional bankruptcies in the years to come, most of them with issues more similar to those of Stockton (centering on the cost of unfunded retirement obligations) than to those of Detroit. Eventually, a state may need relief, which will be an even bigger problem because bankruptcy law does not cover states.

Just because Detroit is extreme does not mean it is unique, however. There are other cities on similar paths, many in the old Rust Belt. Detroit will just show us the limits of the tools we have to fix these places. If we’re smart, we will get ourselves a better toolkit ASAP.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us,” and Chapter 4, “The Family Business.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

The views expressed in this post are solely those of the author. We welcome additional perspectives in our comments section as long as they are on topic, civil in tone and signed with the writer's full name. All comments will be reviewed by our moderator prior to publication.

, , , , ,