Detroit Files Largest Municipal Bankruptcy In History
Late today, the City of Detroit filed the largest bankruptcy by a municipality in American history:
DETROIT — Detroit, the cradle of America’s automobile industry and once the nation’s fourth-most-populous city, has filed for bankruptcy, an official said Thursday afternoon, the largest American city ever to take such a course.
The decision to turn to the federal courts, which required approval from both the emergency manager assigned to oversee the troubled city and from Gov. Rick Snyder, is also the largest municipal bankruptcy filing in American history in terms of debt.
Not everyone agrees how much Detroit owes, but Kevyn D. Orr, the emergency manager who was appointed by Mr. Snyder to resolve the city’s financial problems, has said the debt is likely to be $18 billion and perhaps as much as $20 billion.
For Detroit, the filing comes as a painful reminder of a city’s rise and fall.
Founded more than 300 years ago, the city expanded at a stunning rate in the first half of the 20th century with the arrival of the automobile industry, and then shrank away in recent decades at a similarly remarkable pace. A city of 1.8 million in 1950, it is now home to 700,000 people, as well as to tens of thousands of abandoned buildings, vacant lots and unlit streets.
From here, there is no road map for Detroit’s recovery, not least of all because municipal bankruptcies are rare. Some bankruptcy experts and city leaders bemoaned the likely fallout from the filing, including the stigma it would carry. They anticipate further benefit cuts for city workers and retirees, more reductions in services for residents, and a detrimental effect on future borrowing.
But others, including some Detroit business leaders who have seen a rise in private investment downtown despite the city’s larger struggles, said bankruptcy seemed the only choice left — and one that might finally lead to a desperately needed overhaul of city services and a plan to pay off some reduced version of the overwhelming debts. In short, a new start.
The decision to go to court signaled a breakdown after weeks of tense negotiations, in which Mr. Orr had been trying to persuade creditors to accept pennies on the dollar and unions to accept cuts in benefits.
All along, the state’s involvement — including Mr. Snyder’s decision to send in an emergency manager — has carried racial implications, setting off a wave of concerns for some in Detroit that the mostly-white, Republican-led state government was trying to seize control of Detroit, a Democratic-held city where more than 80 percent of residents are black.
The nature of Detroit’s situation ensures that it will be watched intensely by the municipal bond market, by public sector unions, and by leaders of other financially challenged cities around the country. Only slightly more than 60 cities, towns, villages and counties have filed under Chapter 9, the court proceeding used by municipalities, since the mid-1950s.
The debt in Detroit dwarfs that of Jefferson County, Ala., which had been the nation’s largest municipal bankruptcy, having filed in 2011 with about $4 billion in debt. The population of Detroit, the largest city in Michigan, is more than twice that of Stockton, Calif., which filed for bankruptcy in 2012 and had been the nation’s most populous city to do so.
Other major cities, including New York and Cleveland in the 1970s and Philadelphia two decades later, have teetered near the edge of financial ruin, but ultimately found solutions other than federal court. Detroit’s struggle, experts say, is particularly dire because it is not limited to a single event or one failed financial deal, like the troubled sewer system largely responsible for Jefferson County’s downfall.
Instead, numerous factors over many years have brought Detroit to this point, including a shrunken tax base but still a huge, 139-square-mile city to maintain; overwhelming health care and pension costs; repeated efforts to manage mounting debts with still more borrowing; annual deficits in the city’s operating budget since 2008; and city services crippled by aged computer systems, poor record-keeping and widespread dysfunction.
All of that makes bankruptcy — a process that could take months, if not years, and is itself expected to be costly — particularly complex.
“It’s not enough to say, let’s reduce debt,” said James E. Spiotto, an expert in municipal bankruptcy at the law firm of Chapman and Cutler in Chicago. “At the end of the day, you need a real recovery plan. Otherwise you’re just going to repeat the whole thing over again.”
The municipal bond market will be paying particular attention to Detroit because of what it may mean for investing in general obligation bonds. In recent weeks, as Detroit officials have proposed paying off small fractions of what the city owes, they have indicated they intend to treat investors holding general obligation bonds as equal, in essence, to city workers — a notion that conflicts with the conventions of the market, where general obligation bonds have been seen as among the safest investments.
Leaders of public sector unions and municipal retirees around the nation will be focused on whether Detroit is permitted to slash pension benefits, despite a provision in the State Constitution that union leaders say bars such cuts.
Officials in other financially troubled cities may feel encouraged to follow Detroit’s path, some experts say. A rush of municipal bankruptcies appears unlikely, though, and leaders of other cities will want to see how this case turns out, particularly when it comes to pension and retiree health care costs, said Karol K. Denniston, a bankruptcy lawyer with Schiff Hardin who is advising a taxpayer group that came together in Stockton after its bankruptcy.
“If you end up with precedent that allows the restructuring of retirement benefits in bankruptcy court, that will make it an attractive option for cities,” Ms. Denniston said. “Detroit is going to be a huge test kitchen.”
Brad Plumer lays out some of the reasons Detroit got where it is today:
— Since 2000, Detroit’s population has declined 26 percent. There are now just 700,000 people in the city, way down from 2 million during its industrial heyday in 1950.
— The official unemployment is now 18.6 percent, and fewer than half of the city’s residents over the age of 16 are working. Per capita income is an extremely low $15,261 a year, which means there’s not all that much tax revenue pouring in.
— Low tax revenue, in turn, means that city services are suffering. Detroit has the highest crime rate of any major city, and fewer than 10 percent of crimes get solved. The average response time for an emergency call is 58 minutes. Some 78,000 buildings are abandoned or blighted and there are an estimated 12,000 fires every year. About 40 percent of the city’s streetlights don’t work.
— High crime and blight are driving even more residents out of the city. It’s also driving down property values, which means many residents have stopped paying property taxes. The city collected about 68 percent of the property taxes owed in 2011. Both of those things put a further strain on Detroit’s finances.
— Detroit is sagging under decades of bad governance. ”The city’s operations have become dysfunctional and wasteful after years of budgetary restrictions, mismanagement, crippling operational practices and, in some cases, indifference or corruption,” Orr wrote in May. “Outdated policies, work practices, procedures and systems must be improved consistent with best practices of 21st-century government.” (For the record, Detroit has been a one-party city run continuously by Democrats since 1962.)
— Meanwhile, Detroit owes around $18.5 billion to its creditors. That includes about $6 billion in health-care and life insurance obligations, plus billions more in pension costs racked up over the years. Given its ever-worsening economic slide, Detroit was in no position to pay off all its obligations.
As Plumer notes, Kevin Orr, the financial manager that Governor Snyder appointed to manger the city’s finances last year has spent much of his time in office trying to negotiate deals with those creditors, and with the public employee unions and pension funds that constitute such a huge part of the city’s financial load but those negotiations have been unsuccessful. Perhaps that lack of success was due to the fact that creditors didn’t actually think that Orr and Snyder would actually pull the trigger and file for Bankruptcy protection, but that’s not entirely clear. In any event, the matter will not go before a Bankruptcy Court Judge who, assuming he accepts the filing as required under the rules that govern a Chapter 9 petition, will manage perhaps one of the most complex cases that has ever been in a U.S. Bankruptcy Court and, no doubt, one that is likely to be watched by other struggling cites across the country. As noted above, if Detroit is able to successfully renegotiate its obligations under Chapter 9, then the odds are fairly high that we’ll see other cities make the same attempt. It won’t be pretty, but it may be what’s best to save cities that never really managed to find a way to reorient themselves as the American economy has reoriented itself from the industrial economy that they came to rely upon.
Here’s the initial petition filed by the City of Detroit: