Detroit: From ‘Heat Wave’ to deep freeze
Detroit has made any number of contributions to the national popular culture, including the Red Wings, Tigers, Lions, Pistons, Kid Rock and Eminem, along with the priceless treasures now housed at the Detroit Institute of Arts, about which my colleague Andrew Moylan and I recently authored a modest paper. But Motown probably remains the most enduring. The transformation of a fledgling record company into an industry ground-breaker and powerhouse is also highly illustrative of Detroit’s squandered chance to remain a major American city.
Detroit filed for bankruptcy July 18, 2013. This surprised no one, since the person picked by the governor to manage the city and correct its fiscal instability is a bankruptcy lawyer. The move also capped more than a half-century of decline. By 1980, Detroit’s property values had dropped 67 percent from what they had been in 1960, before the 1967 riots that killed 43 people. The population has likewise fallen by more than half since the mid-20th century.
The city’s debt was downgraded to junk bond status in 1993, although Mayor Kwame Kilpatrick got the ratings ratcheted up to investment grade with a complicated 2005 Wall Street deal to sell pension obligation certificates and buy interest rate swaps. Because of a subsequent credit downgrade, the deal had to be renegotiated, and the city now owes $2.8 billion in principal, interest and insurance over the next 22 years. These instruments today represent about 19 percent of total city debt.
There have been many factors in the city’s decline, including bad economic decisions made by a series of mayors, erosion of the once-dominant American auto industry in a competitive global market, a ferocious crime rate and, ultimately, widespread abandonment of entire neighborhoods. In more recent years, Republican domination of the state Legislature certainly plays some role, although Detroit still gets about half of Michigan’s statutory revenue sharing (excluding sales tax), despite representing only about 7 percent of the population.
Some of the key factors contributing to the city’s fiscal imbalance can be laid at the doorstep of former Mayor Coleman Young, who lead the city from 1974 to 1994. During his tenure, crime rates tripled and the city saw one of the most dramatic cases of “white flight” to the suburbs of any city in the country.
His major mistake was authoring Public Act 312, requiring mandatory binding arbitration to settle union compensation fights when he was a state legislator. The elected management of the city never really had a chance to exercise control after that, because the city regularly lost arbitrations and was limited in its ability to curb any costs. If this isn’t fixed, then I don’t see how Detroit can be.
To pay for the union benefits awarded by arbitrators, Detroit instituted three new taxes — on utilities, casino gaming and income. Today, Detroit has more revenue sources, higher tax rates and less revenue to show for it. The state provides about 16 percent of the city budget.
Coleman and nearly every mayor who followed him gave nearly $1 billion in “13th check” bonuses to both city workers and retirees from the mid-1980s through 2008. Actuaries estimate that if the money has been invested instead, there would be an extra $1.9 billion in the city treasury now.
According to Andrew Biggs, former principal deputy commissioner of the Social Security Administration, who now chairs a group looking at unfunded public pension obligations across the country, Detroit employees who put in a full career of 30 to 35 years with the city can expect a pension that pays out about two-thirds of what they earned. Police and firefighters pay nothing into the plan. When added to Social Security benefits, these employees secure retirement pay equaling 95 percent of what they were paid as public servants, which averages about $100,000 a year in salary and benefits.
Plainly, the taxpayers are paying out benefits to government workers that they cannot themselves afford. In 1960, Detroit had 26,386 employees supporting 10,629 pensioners. When Young was mayor, that ratio dipped to one to one. By 2012, 10,525 Detroit employees are each carrying two retirees in the pension system.
New York City had a brush with default and bankruptcy in the 1970s, after following some of the same fiscal patterns seen in Detroit. A succession of mayors used the same solutions. They borrowed for expanded city services. Overgenerous contracts to public employee unions were granted to prevent labor unrest. State aid was also extracted, because Albany realized what could happen to everybody else if the Big Apple rotted. Even the leaders of Germany and France expressed concern at a New York bankruptcy. Matters came to a head in 1975, when the nation’s largest city literally ran out of money and could not pay operating expenses. At the time, New York had $14 billion of debt outstanding.
One difference is that New York didn’t attempt to walk away from its debts. Bonds were sold through the newly created Municipal Assistance Corporation, carrying a hefty 11 percent interest rate in a market where the index of high-grade municipals carried a coupon of 6.89 percent. The city also transferred debts to the state and federal governments. State aid for all purposes was accelerated to help keep the city afloat. The feds chipped in $2.3 billion in short-term loans, a plan that only passed the U.S. House by ten votes. In exchange, the city accepted changes in its governance and financing. After all this, for years, the city was seriously constrained in how it could borrow money.
In Detroit, the real concern is that, while the city offers the appearance of talking tough to pensioners, the real plan is to short the other debt holders or win additional support from the state. Depending on how it all goes down, this could have a ripple effect on future municipal bankruptcies.
While there are other municipal bankruptcies in progress in California, most eyes these days are on Chicago. The city is making balloon payments on its debt which, according to Mayor Rahm Emanuel, could require an unprecedented hike in the property tax. The pension shortfall in Chicago is reported to be $7,100 per resident, or roughly eight times the size of Detroit’s unfunded liability. True to form, the Chicago Teachers Union is promising protests that will look a lot like those generated in Wisconsin when Gov. Scott Walker and the Legislature worked to address the problems of funding imbalances and sustainability of state services and employee benefits.
There will be a very interesting exchange of views in these matters for the next couple of years, and public managers will not be as popular as they are when they give bonus checks out of the public treasury. But the laws of economics are not so easily repealed.
