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Thursday
Jul112013

Bankruptcy

After decades of sad and spectacular decline, it has come to this for Detroit: The city is $19 billion in debt and on the edge of becoming the nation’s largest municipal bankruptcy.

So begins a recent story in the Washington Post, summarizing the tragic state of Detroit. It's a story we're all familiar with by now. The reason it's back in the news is that the decline may be reaching it's ultimate, symbolic end:

An emergency manager says the city can make good on only a sliver of what it owes — in many cases just pennies on the dollar. A decision about whether to file for bankruptcy is widely expected this month.

At Strong Towns we talk about the financial health of cities every day. We talk about a city's debt versus it's tax base, and what happens when the tax base is overwhelmed by debt. In Detroit, that's what's playing out:

The city’s population has plummeted by 26 percent since 2000, while the unemployment rate has jumped from 7.3 percent to 18.6 percent. Property tax collections are down 20 percent and income tax collections are down by more than a third in just the past five years — despite some of the highest tax rates in the state. Even casino taxes, a bright spot in recent years, are projected to decrease because of increased competition from nearby Toledo.

All of that has led to an alarming erosion of municipal services. The city is home to nearly 80,000 abandoned and blighted structures. It recently announced plans to close 50 of its remaining 107 parks. Police response times are up to nearly an hour, and 40 percent of the city’s street lights do not work. Meanwhile, Detroit has the highest violent crime rate among the nation’s big cities.

The consequences of this decline of municipal services is made even more clear in a New York Times article this week:

If you suddenly found yourself gravely ill, injured or even shot, would you call 911?

Many people here say the answer is no. Some laugh at the odds of an ambulance appearing promptly, if ever. In Detroit, people map out alternative plans instead, enlisting a relative or a friend.

So now Detroit is near rock-bottom, presumably going to declare bankruptcy shortly. Many people are worried about what this means. Again, from the NYT article:

They say they fear that bankruptcy would add more stigma to a city that has contracted alarmingly in the decades since it was the nation’s fourth largest, starting in the 1920s, and that it might worsen already bare-bones services.

The notion that assets like Coleman A. Young International Airport, Belle Isle Park and the collections of the Detroit Institute of Arts might be sold — either in a formal bankruptcy proceeding or in a huge city reorganization outside of the court system — has fueled outrage.

“Bankruptcy scares me,” said LaTanya Boyce, a nurse practitioner.

For these reasons and more, the resistence to the idea of Detroit going bankrupt is significant. It may not be rational, though.

In modern law, Bankruptcy is a process specifically designed to fix badly broken organizations. From Wikipedia:

The principal focus of modern insolvency legislation and business debt restructuring practices no longer rests on the elimination of insolvent entities but on the remodelling of the financial and organisational structure of debtors experiencing financial distress so as to permit the rehabilitation and continuation of their business.

Clearly, Detroit is a broken organization that needs radical change if it wants to survive. From the NYT:

“The city is past being a city now; it’s gone,” said Kendrick Benguche, whose family lives on a block with a single streetlight, just down from a vacant firehouse that sits beside a burned-out home. The Detroit police’s average response time to calls for the highest-priority crimes this year was 58 minutes, officials now overseeing the city say. The department’s recent rate of solving cases was 8.7 percent, far lower, the officials acknowledge, than clearance rates in cities like Pittsburgh, Milwaukee and St. Louis.

“I guess I’ll be glad if someone else takes over and other people run this thing,” Mr. Benguche said. “The way I look at it, the city is already bankrupt.”

This is the key - like it or not, the city is already bankrupt. The court proceedings would merely be a formality. Bankruptcy is the rational response to an unsolvable problem; and for Detroit, it is likely the only option. This option is scary, but at this point, what isn't scary for Detroit?

Yet, the fears are much greater outside of the city. At a state and national level, the municipal bond markets are spooked by what's going on in Detroit. From Bloomberg News:

Emergency Manager Kevyn Orr’s plan to suspend payments on $2 billion of Detroit’s debt threatens a basic tenet of the $3.7 trillion municipal market: that states and cities will raise taxes as high as needed to avoid default.

...

Paying less than 100 cents on the dollar would “rock the market,” said Tamara Lowin, director of research for Belle Haven Investments in White Plains, New York.

What happens when the municipal bond market gets "rocked?"

“It definitely sets a precedent, and there’s definitely going to be a penalty going forward for the city and the state,” said Dan Solender, director of munis at Lord Abbett & Co. in Jersey City, New Jersey. The company oversees $19.5 billion of local debt.

...

“It will certainly affect all the debt of struggling governments in Michigan, if not nationally,” Belle Haven’s Lowin said.

When the bond markets get spooked, the cost of debt rises for everyone. Even in the artificially low interest environment we've been living in, interest rates will increase with the perception of risk.

For our Strong Towns audience, we want you to understand that the bankruptcy in Detroit is simply a notable milestone on the long road to the collapse of the Growth Ponzi Scheme. Part of the national level fear caused by the impending bankruptcy in Detroit comes from the fact that Detroit is in many ways the model of suburban growth. This is the world headquarters of Motordom, and more than any other city has embraced, and suffered the consequences of, the unproductive growth pattern. This was supposed to be the best city, not the bankrupt city.

The truth is, people everywhere are afraid of what's happening in Detroit, because to one extent or another we're all Detroit. In every part of the country we've spent trillions of dollars on infrastructure to promote unproductive places that will be dead weight on our backs. The question before us is how to rationally respond to this crisis. Finding rational responses, and making difficult decisions, will be the ultimate work of this generation. The bankruptcy of Detroit is only the beginning.

 


As a postscript, if you want to be part of the solution, we'd love for you to join our community of problem-solvers over at StrongTowns.net. None of us, individually, have answers for these crises. There are no silver bullets. But, at Strong Towns, we believe that if we all work together we can and will find ways to move forward.

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Reader Comments (4)

Great analysis Andrew.

The thing that sticks in my mind as silly is the idea that selling the airport is a scary prospect. Worse than inefficient motoring infrastructure, of which some will certainly remain in the cores of successful places, air facilities are likely to become a massive liability as depletion of crude oil resources keeps prices trending higher.

July 11, 2013 | Unregistered CommenterBob Williams

There's been a handful of municipal bankruptcies over the last 2-3 years already, such as San Bernardino and Stockton, CA, Harrisburg, PA, and Boise County, ID. Detroit would certainly be the biggest by a large margin, but how have these others played out? We hear about them when they're impending, but has there been any lasting aftermath? Some bankruptcies, like Harrisburg, were dismissed because their state laws do not allow for it. Granted that's just semantics, and the remedies are likely similar, but I just want to see what has come out of these other bankruptcies that we can learn from.

July 11, 2013 | Unregistered CommenterJeffrey Jakucyk

The pain you know, vs the pain you don't know. It's still pain. They'll have little choice, but to proceed through, and then find what remaining options exist after. This is a valid demonstration of the confluence of the growth ponzi scheme, and the longest-lived boomtown in history.

July 11, 2013 | Unregistered CommenterDennis

Sad news for Detroit. However, municipal bankruptcy doesn't entail the same emotional dilemmas consumer bankruptcy poses. For cities the decision is rooted in a pragmatic economic decision, as it should be.

July 15, 2013 | Unregistered CommenterAdan Garcia
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