What happened to Detroit?
What does it mean to have a city declare bankruptcy? Some of the issues Detroit faces are unique,
but others could be repeated in other cities.
Altogether, it's well worth our time here at Ways of the World. We'll give some background and comment in a
conclusion about two factors generating broader caution for some of you.
Do Weak Economies Automatically Lead to Poor City Finances? No.
We've often heard it said that Detroit is a poor city. Pictures of abandoned property and
dilapidated buildings frequently accompany press reports on the financial
developments.
This is so, and some of the numbers are striking. Median household income was a mere $25,193 in
2011, just half of the national number of $50,502, which many argue is barely
adequate itself. The share of the
population with incomes below the federal statistics measure of poverty is
40.9%, compared with the nationwide 15.9%, and as you can imagine, well more
than half of the children live in poverty-stricken households. Also in 2011, the latest data we could locate
for the city, the unemployment rate was 29.3%, compared to a national total
then of 10.3%.[1] Good grief.
But such challenging economic conditions by themselves don't
automatically push the local government into a bankrupt condition, we
learned. Clearly, much of Detroit's
trouble comes from the poor state of the U.S. auto industry until fairly
recently. It occurred to us to look at
some other upper Midwest city with heavy industrial involvement to see what
that might mean elsewhere. Cleveland
doesn't have as much concentration in one sector as Detroit, but back in 2000,
both cities had a sizable 18%-plus of their residents employed in total manufacturing,
a noticeably larger amount than the nation's 14% at that time. By 2011, Detroit's share in manufacturing had
fallen to 11.4% and Cleveland's to 12.1%, close enough for us to use it for
comparison.
Household incomes in Cleveland in 2011 were nearly the same,
$25,371, as in Detroit. Unemployment was
not as high, 19.5%, but still "awful" compared both to the national
total and to anything we might deem desirable.
Same with poverty: people in poverty-stricken households were 34.3% of the
population then. So the economy of
Cleveland too has suffered with outsourcing of manufacturing and the severe
recession.
However, the government of the City of Cleveland is quite
solvent and in fact carries a bond rating from Moody's of A1. This is not at the high end, but it's certainly
adequate, described by Moody's as "upper medium grade and subject to low
credit risk"[2], and thus, far from a condition of bankruptcy.
A Financial Tale of Two Cities
We're hardly experts at municipal budgets and finance, but
we've read a lot of press reports and looked at recent financial reports for both
cities.
1. The most obvious
fact is that Detroit has a lot of debt.
Kevyn Orr, the emergency manager of the city government appointed by the
governor of Michigan, says the debt is about $18 billion. We identified $8.4 billion of long-term bonds
as of June 30, 2012, equivalent to $11,942 per resident. There are other obligations related to
pension and health-care funding. We'll
comment more on those. For Cleveland, to
give some context, long-term bonds totaled $2.7 billion on December 31, 2011,
or $6,862 per resident of that city, just 60% as much as Detroit. It handles its pensions differently, as we'll
see below.[3]
2. Detroit was
spending more per resident than Cleveland.
Over the last few years, Detroit spent about $2,500 per resident; it began
to cut this back in 2010 and was down to $2,261 in its fiscal year 2012, which
ended June 30, 2012. As its financial
condition deteriorated, it reduced its employees from 13,420 in 2009 to 10,525
in 2012. Cleveland's city government has
been spending right at $2,000 per resident each year from 2007 through 2011
(its fiscal year coincides with the calendar year). It has also reduced the number of its
employees, from about 8,500 through 2009 to 7,700 in 2011.
3. The two cities
have different mixes of taxes. About 42%
of Cleveland's revenue comes from income taxes and only 8% or 9% most years
from property taxes. The heavy use of an
income tax means it can reach the incomes of non-residents who work in
Cleveland, and the "Notes" to their financial statements indicate
that the vast majority of the income tax receipts indeed come from
non-residents. Detroit's revenues consist
of just 13% to 15% income tax and 12% to 14% of property tax. The greater reliance on property tax makes
their revenues more dependent on local property values, which have been
falling, eroding the tax base. Detroit also
collects a sizable chunk from a wagering tax and both cities have other fees
and proceeds from leases and other business-type activities. But we are struck with Cleveland's outreach
to its suburban population for revenue, a source that on the face of it, might
well be utilized more effectively by a city like Detroit too.
4. Pensions. Two years ago, we wrote about state and local
governments
here
and, among other issues, emphasized the continuing use of defined benefit
pension plans by many of them. We said
then that these were problematic, burdening cities and states with payment
obligations if the plans' investment results were weak, requiring added funding
from the governments' current budgts.
Sure enough, this is one of the main factors for Detroit, which has both
pension and retiree health plans. We
identified $640 million of unfunded pension liability and $5.7 billion of
unfunded health care liability. These
are just the numbers we found in one financial statement and press reports
suggest that at least the pension amount is much greater. In addition, some of Detroit's funding
payments in recent years were made by issuing bonds, not using current revenue,
so they are still a debt overhanging the city's finances. Cleveland, by contrast, has enrolled its
employees in the Ohio Public Employees Retirement System, a state-wide plan
that includes both defined benefit and defined contribution [401(K)-type]
aspects and ties its health benefits to Medicare. Some of its retirees are not included
directly in the health plan. Similarly,
in 2011, just weeks after our own article on these topics, the City of Atlanta negotiated
and enacted reform of its pension system, adding defined contribution elements;
they also increased employees' own contribution rates to the defined benefit
plan.
Detroit's Bankruptcy: Pensioners and Bondholders Face Same Unpleasant Outcome
Overall, we can see Detroit's issues: greater spending,
albeit at a slowing pace; greater reliance on an eroding tax base with less
appeal to a potentially more generous revenue source; a huge debt load that was
allowed to grow; and a huge pension and health burden it tries to shoulder on
its own.
Municipal bankruptcy is, fortunately, rare. However, this means that there's little precedent
for how to handle a city in such dire straits.
In a bankruptcy proceeding, the debts – the pension benefits and the
bond obligations – would be reduced, and the bankruptcy court's work is meant to help
this occur in as orderly a fashion as possible.
Still, Mr. Orr, the emergency manager, has rankled both unions and
bondholders by proposing that both pensions and bonds be reduced markedly in the
settlement plan. We surmise that both
unions and bondholders – stakeholders not usually on the same side of issues
like this – expected that tax increases could simply make up any shortfalls. Or at least that their particular item was
safe from any reduction.
In this case, there also remains the very basic issue of
whether Detroit is eligible to file for bankruptcy. In a trial currently expected in October, Mr.
Orr must show that the city is "insolvent" and that it has negotiated
with unions and other contractors in good faith on its own already. As you can see, both unions and others
believe they have not been dealt with in this fashion. The court will have to decide.
Take-Aways for Us as Citizens and Retirees
Is there a take-away for you readers? We'd call two points to your attention. First, on Tuesday this week, there was a
primary election for the next government of the City of Detroit. New York City is in the midst of an election
campaign season. In Detroit, a business
leader actually got the most votes for mayor and the second candidate is in the
union camp; these two gentlemen will vie in a general election in
November. The good showing of a business
leader in that city is surprising; we suspect there will be other surprises
before it's over. In New York, several
of the candidates for mayor and for comptroller have been involved in
scandals. The Detroit situation should
show us how important it is to have trustworthy, responsible officials and it
should give us pause about electing people who have given evidence otherwise,
even if it's in an unrelated field.
Second, to offer a bit of advice that follows out of these issues:
plan and commit for your own retirement.
Take on that responsibility.
We're going to talk more about health care here soon with ObamaCare on
the horizon, but it's important to pay attention now to plans and
coverage. We can be busy arguing the
justice of various structures for both pensions and health care, but that
shouldn't divert our focus from making sure our own needs are covered to the
best extent we can. Cities have
"Rainy Day Funds" – Cleveland has one; there's no mention of the word
in the Detroit financial report – and we should too.
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[1] Our economic data for cities come from the U.S. Census
Bureau's American Community Survey, a massively detailed annual survey that
replaced the old "long-form" on the Decennial Census. The coverage and timing vary somewhat from
the regular monthly unemployment data and those figures for the total U.S. do
not match. Find the American Community
Survey at http://factfinder2.census.gov/faces/nav/jsf/pages/wc_acs.xhtml. Accessed August 9, 2013
Labels: Economy, Government Policies, Personal Finance
