Bloomberg News

Detroit’s Bankruptcy Reveals Dysfunction Common in U.S. Cities

July 21, 2013

Detroit’s Bankruptcy Reveals Dysfunction Common in U.S. Cities

Graffiti covers an abandoned building in Detroit, Michigan, on February 24, 2013. Photographer: J.D. Pooley/Getty Images

No city was hit as hard by the recession as Detroit, America’s one-time industrial capital whose decades-long decline cut its population in half and left $18 billion in debt it can’t afford to pay.

Even so, the pressures that pushed Detroit into the largest municipal bankruptcy in U.S. history are playing out on a smaller scale around the nation. Diminished tax revenue and rising labor costs have left four cities insolvent since 2007. Service cuts were made by others such as Detroit, where street lights are dark and police are scarce.

“None of the other cities are as far along, but there are dozens, if not hundreds of cities that have similar issues,” said Alan Mallach, a senior fellow at the Brookings Institution, a public-policy research organization in Washington. “Every other industrial city has problems that could send them down the same path.”

U.S. municipalities have recovered slowly from the 18-month recession that ended four years ago, depressing property-tax revenue and leading to investment losses for pensions that many cities haven’t fully funded for years. Projected pension and health-care obligations for the 61 biggest cities will top assets by about $217 billion, according to a study by the Pew Charitable Trusts, a Philadelphia-based research and public-policy group.

Not Unique

“Detroit is a very high-profile example of some of the challenges our cities continue to face, but it’s by no means unique,” said Kil Huh, an analyst who tracks local finances for Pew. “Detroit is indicative of governments living beyond their means -- and they are going to eventually have to pay the piper.”

Detroit’s bankruptcy capped a decades-long slide for a city that once symbolized U.S. industrial might and the union-covered manufacturing jobs that propelled the growth of America’s middle-income families.

The Motor City’s fortunes ebbed along with the nation’s automotive industry. The tax base dwindled starting in the 1950s as more than 1 million residents left, an unprecedented exodus that left about 40 percent of the city’s lots vacant or unused. In the decade through 2010, Detroit lost a quarter of its population, dropping it to about 700,000.

On July 18, the city sought court protection, a step Emergency Manager Kevyn Orr said was the only way to deal with $18 billion in long-term obligations, including more than $3 billion owed to its retirement system. Detroit borrowed, skipped pension contributions and put off paying bills, deepening its insolvency, Orr said at a news briefing last week.

Upends Assumptions

The bankruptcy challenges a long-held assumption in the $3.7 trillion municipal-bond market that large cities will take whatever steps necessary, including raising taxes, to cover their debts. The move is opposed by unions seeking to protect retiree benefits from cuts so other obligations can be paid.

Since the beginning of the recession, three cities in California -- Vallejo, Stockton and San Bernardino -- and Central Falls, Rhode Island, all sought court protection because they couldn’t cover their bills. Last year, a judge approved cutting pension payments to Central Falls retirees by as much as 55 percent as part of the city’s debt reorganization plan.

Municipal bankruptcies are rare. There were 54 from 1970 to 2009, only four of which were cities or counties, according to the Washington-based National League of Cities. Analysts said they don’t expect many to follow Detroit.

No Trend

“We view Detroit’s default and subsequent bankruptcy filing as idiosyncratic, and not as a symptom of a wider issue in the municipal market,” Jane Hudson Ridley, a credit analyst with Standard & Poor’s, said in a July 19 statement. “Although we have seen isolated pockets of distress across the country, we do not view bankruptcy filings or defaults as a trend.”

Detroit’s situation is being watched closely by investors, who’ve pushed borrowing costs higher for Michigan relative to similarly rated states, and by union leaders concerned that its bankruptcy may inspire other cash-strapped cities.

“It’s more than troubling,” said Harold Schaitberger, the president of the International Association of Fire Fighters union in Washington. “If they can see that a major city in this country can simply use the bankruptcy code as a way to walk away from all of its obligations to thousands of workers and tens of thousands of retirees, we’re very concerned about what signal that sends.”

No Panacea

Prices in the broader municipal debt market were little changed after Detroit’s bankruptcy, with benchmark 10-year yields rising 0.02 percent to 2.79 percent on July 19, according to Municipal Market Advisors Inc.’s indexes.

Bankruptcy isn’t a cure-all. Both Vallejo and Stockton had difficulty dealing with crime after reducing their police forces. Jefferson County, Alabama, scaled back hospital services, fired hundreds of employees, and curbed road clean up, leaving dead animals to rot on the street.

“If you’re a community, you don’t want to go into bankruptcy,” said Chris Mier, the chief municipal strategist for Loop Capital Markets in Chicago, a bond underwriter. “It’s expensive. It’s lengthy. It’s a black eye.”

Some localities, including Providence, Rhode Island, have taken steps to shore up pensions by paring employee benefits. Last year, San Diego and San Jose, California, voters approved measures to bolster pensions and steer new workers into 401(k)- style savings plans, which don’t offer lifelong payments like those in Detroit. Baltimore, struggling to reverse years of population declines, is pressing for similar steps.

Higher Contributions

Costs for some cities will keep rising as they make up for years of failing to contribute enough to pensions. In April, the California Public Employees’ Retirement System said it may need to raise municipal pension contributions by 50 percent.

In Syracuse, New York, a $30.1 million pension bill in fiscal 2013 was twice what it paid five years earlier, according to city budget documents. Mayor Stephanie Miner told reporters last year that she hired outside legal help for advice on the municipal bankruptcy process, though she didn’t expect to have need of it.

In most cities, revenue is stabilizing as home prices rise, increasing real-estate tax receipts, said Donald Boyd, a senior fellow at the Nelson A. Rockefeller Institute of Government in Albany, New York.

“A lot of cities have more robust economic foundations that are more likely to rebound,” compared with Detroit, Boyd said. “To say bankruptcy is the new norm or the new widespread phenomena, it’s just too soon to say.”

To contact the reporter on this story: William Selway in Washington at wselway@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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