If cities can’t be free to fail, they shouldn’t be free in the first place

Were Detroit declared ineligible for bankruptcy, it would be too bad for the city and its residents, but not necessarily bad for other cities. Municipal bankruptcy is an expensive, uncertain process that will never serve as a satisfying policy remedy to local governments’ fiscal troubles. If Judge Stephen Rhodes creates a precedent that not even Detroit can count on access to Ch. 9 (unlikely but possible), other cities and states would have to get serious about preventing and managing distress through non-federal avenues.

But Detroit needs bankruptcy. If its petition is denied, “The city would almost certainly be besieged by lawsuits, triggering an even deeper financial downward spiral that could lead right back into bankruptcy with even fewer assets to divvy up among creditors.” The list of creditors stiffed by Detroit grows longer every month. Without bankruptcy, all would lawyer up, if they haven’t already, and demand full repayment. Detroit would face years of litigation and legal fees that could run into the hundreds of millions.

To avoid that outcome, as well as bankruptcy, the liberal think tank Demos proposes a state bailout (“emergency revenue enhancement”). Demos argues that Detroit suffers from nothing more than a “short-term cash flow shortfall,” not a structural crisis. The city’s troubles have been overhyped and, to the extent they haven’t, their roots lie in inadequate state aid and Wall Street hucksterism. Detroit has a revenue problem, not a spending problem, and bankruptcy is unnecessary.

The report’s a good, if not great, read. Though ideologically indistinguishable from the recent offerings by David Sirota and Matt Taibbi, it far surpasses them in detail and depth. But its argument that Detroit doesn’t need bankruptcy rests on shaky assumptions.

One simple argument for why a city should go bankrupt is that current generations should not be punished for past mismanagement. Over the decades, Detroit unwisely continued to expand government even while its population and tax base were declining. Those decisions left the city poorly-positioned to respond to its recent loss of revenues from the Recession and state aid cuts.

Yes, Wall Street bankers indeed profited handsomely from a terrible pension-borrowing and swaps deal in 2005-6, modified in 2009, that now consumes an astounding 5 percent of annual general fund revenues for the swap payments alone. But to say these were “urged” on hapless local officials…Look, only because Detroit was in search of a shortcut to fund its pension system did it become susceptible to bankers’ pitches. The historical record shows that Detroit went into the deal eyes wide open and after forthright public debate. The city’s former CFO remains defiant. Though Demos goes to great length trying to demonstrate the unusually risky character of the deal, it fails to mention that the Bond Buyer, the voice of conventional wisdom in public finance, gave Detroit a “Deal of the Year” award for the swaps deal.

Demos denies Detroit has a pension problem, arguing, with others, that emergency manager Kevyn Orr employed overly conservative standards to evaluate the liabilities. There are three responses to this. One, “most cities’ and states’ general practice” with regard to pension assumptions, also favored by Detroit’s retirement systems, are indefensibly rosy and no government should ever rely on them. Two, governments won’t be relying on them for much longer. As the new GASB standards come online, Orr’s assumptions will seem perfectly conventional. Three, given Detroit’s well-documented record of pension mismanagement and fiscal weakness, it cannot afford the luxury of using pension funding assumptions of minimal strictness. Because it has so much to prove, Detroit should be held to higher pension management standards than other governments.

Reduced to its essence, the Demos argument is that Detroit could avoid bankruptcy were state government to get more involved, through providing more aid (though Detroit already receives far more aid than any other city in the state on a per-capita basis) and credit guarantees in the case of those few debts which Detroit cannot negotiate away or fund itself. But Demos seems to suggest that the state expect nothing in return. To revive Detroit without bankruptcy, Michigan should grant a bailout with no strings. Measured against past practice, this recommendation makes no sense.

Bankruptcy’s a crude solution, but a respect for local autonomy must acknowledge the freedom to fail. Are liberals willing to embrace enhanced state intervention and oversight policies? If not, they should reconcile themselves with bankruptcy.

Comments (4) Add yours ↓
  1. joshv

    I think a bailout could work, but string must be attached, and Detroit should lose most, if not all, of it’s fiscal autonomy as a condition of the bailout.

    November 26, 2013 Reply
    • Tough Love

      Another part of that “string” is that a bailout should be contingent on the promised pensions being reduced to a level no greater than what the typical Private Sector Taxpayer receives in retirement benefits from their employer. EVERYBODY knows that these pensions were grossly excessive from the getgo. There is ZERO reason for taxpayers to honor such excessive promises.

      THAT means AT LEAST a 50% reduction in the promised pensions for non-safety workers, and closer to a 75% reduction for safety workers & judges with the most egregious pensions.

      November 26, 2013 Reply
  2. John Say

    No Bailouts, Just bankruptcy.
    No oversite, no strings.

    Failure is a part of learning.

    November 27, 2013 Reply
  3. 10x25mm

    In Detroit’s case, bankruptcy is certainly preferrable to a bailout from any source. At the conclusion of a bankruptcy, there is a full accounting of the banrupt’s financial status and this can be used as a benchmark going forward. Bailouts tend to go on for indefinite periods of time and lead to sufficiency arguments if things go bad later on.

    The major issue going forward in Detroit is leadership. In a corporate bankruptcy, new management is usually brought in and new shareholders enfranchised. The old management and shareholders lick their wounds and move on, having no real control over the reformulated entity. In Detroit, on the other hand, many of the same political actors will resume authority and the same voters will select the leadership. While there was a massive sea change in the recent Detroit election, it remains to be seen whether this is an anomaly.

    November 28, 2013 Reply

Your Comment