This article was first published at The McAlvany Intelligence Advisor on Monday, July 22nd, 2013:
The city of Detroit is living proof that Herb Stein is right: if something cannot go on forever, it will stop. For Detroit, it stopped last week when its emergency financial manager appealed to Michigan Governor Rick Snyder for permission to file for Chapter 9 bankruptcy. It will be the largest filing by a municipality in the country. It won’t be the last.
Snyder said Detroit’s “problem” is six decades in the making. In the 1950s, Detroit was known as Motor City, the center of an economic powerhouse in the northeast, with nearly 2 million inhabitants enjoying one of the highest per capita incomes in the country. The home of The Big Three automakers, jobs were easy to find and hard to fill.
But then the storm clouds of negatives began to gather on the horizon: Automakers built new facilities out in the suburbs, away from Detroit’s taxing authorities. Japanese automakers began ravaging the industry with high quality automobiles. And, as taxes rose, the population began a migration that continues today.
If there was one signpost on the highway to disaster for Detroit, it would be the riots of 1967. What began as a small disturbance in the city’s Near West Side erupted into the deadliest and most destructive riot in American history, leaving 43 people dead, 1,200 injured, 7,200 arrested, and 2,000 buildings destroyed.
That was soon followed by another disaster: the election of Coleman Young as mayor in 1976. For 19 years, he ran the city as his own private charity, enlisting the willing help of his cronies to rape and ravage the city. Several members of his administration went to jail, though Young managed to escape punishment.
Another contributor to the problem was Mayor Kwame Kilpatrick, who enjoyed extreme illegal largesse at the expense of taxpayers, and who is now residing behind bars, having been convicted of 38 – 38 – felony counts of fraud, racketeering, extortion, bribery, and self-dealing during his reign from 2002 to 2008.
The aftermath of those influences isn’t pretty: With a population of barely 700,000 – a third of them living below the poverty level – the city can’t afford itself. It has a cash flow deficit of $162 million and a deficit this fiscal year of $368 million. The city of Detroit is the largest employer, larger even than General Motors and Chrysler put together, with 9,500 employees on the payroll and another 20,000 retirees expecting their pension checks and health care benefits to continue to flow unimpeded.
They are in for a shock.
When Kevin Orr, the interim emergency financial manager, took office in March of this year to see if the city could be saved from bankruptcy, he reviewed the books. He found catastrophe after catastrophe: computer systems that were woefully inadequate, accounting standards that weren’t being followed, pension plans that greatly overstated their expected returns, half of taxpayers owing real estate taxes weren’t paying them, half the streetlights not working, two-thirds of the city’s ambulances out of service, violent crime the worst in the country, police response times to 9-1-1 calls an unbelievable 58 minutes, unemployment approaching 20% – the list goes on. He found that Detroit owes $18 billion and can scarcely service the interest on it. He was forced to forgo making a pension plan payment in June.
When he designed a plan to save Detroit, it was just plain ugly. Pensioners and bondholders would have to take a 90 percent haircut. Let’s put this into perspective: a retiree expecting to get a monthly check of, say, $3,000 a month would instead get $300. And as far as health care benefits? None. Sorry. Do the best you can with the new Obamacare healthcare exchanges. We don’t have the money.
When the bondholders and unions sued, Orr ran out of options. Herb Stein was right.
Detroit isn’t alone. It’s just the first on the list. And the list is very long. Chicago’s shortfall is $44.8 billion. New York City’s is $122 billion. Philadelphia’s is $9 billion. Boston’s is $7.5 billion.
Pew released a study in January that looked at 61 of the largest cities in the country and discovered that the total pension plan shortfalls are $99 billion and another $118 billion in health care, for a total of $217 billion. The cities most likely to follow Detroit are Charleston, West Virginia, Omaha, Nebraska, and Providence, Rhode Island. Right behind them are Atlanta, Georgia, Boston, Massachusetts, and Chicago, Illinois, according to Pew.
Ken Noble, a New York bankruptcy lawyer specializing in municipal bankruptcies, said:
If Detroit comes out of this [bankruptcy as] a decent credit risk, other municipalities are going to absolutely want to follow [its] lead. This is a … watershed moment for municipal finance.
Detroit’s difficulties were encapsulated in one single unguarded moment when Herbert Jenkins, a city employee who has been filling potholes for the past 25 years, was asked about his retirement plans. He responded: “I was planning on retiring in October, but now I’m not sure. I have a lot of questions.” Jenkins is 50.