DETROIT’S BANKRUPTCY

ABSTRACT: Detroit’s bankruptcy is the result of a long term decline with many contributing factors. Detroit’s bankruptcy proceeding will favor the big financial corporations because of federal bankruptcy laws, which give priority to paying off financial firms’ interest rate swaps before paying pensions or bond holders. If Detroit ends up cutting workers’ pensions and defaulting on its municipal bonds, it will create dangerous precedents. Other financially ailing cities and municipalities may consider filing for bankruptcy, too, to relieve pension and debt costs.

It will be interesting to watch how the state and federal governments respond. Many precedents will be set. We will learn whether our big corporations and their executives and employees are more important from the federal government’s perspective than our cities, their residents and municipal workers, and their municipal bond holders.

FULL POST: Detroit’s bankruptcy is the result of a long term decline with many contributing factors. Since the financial system collapse of 2008, the federal government has done little to help municipalities that took a double hit from the loss of tax revenue due to the recession itself, as well as from the decline of property tax revenue due to falling property values and homeowners in distress. Certainly, state and federal policies for urban America and trade agreements that let manufacturing jobs, especially in the auto industry, move out of the country played a role. Mismanagement by and corruption of Detroit’s elected leadership played a role as well.

Detroit’s bankruptcy proceeding will favor the big financial corporations because of the 2005 changes in federal bankruptcy laws. Those changes, lobbied for heavily by Wall Street, give priority to paying off financial firms’ interest rate swaps before paying pensions or bond holders. (These interest rate swaps are sold by the big financial firms to cities as insurance to protect them from increases in interest rates. However, unlike insurance, they are really interest rate speculation because they require the cities to pay the financial corporations if interest rates fall. And they have fallen dramatically in the wake of the 2008 financial collapse, which was caused by the big financial corporations.) So the financial firms that speculated on interest rates with Detroit will get paid first and its bondholders and employees’ pensions will get whatever is left over. [1]

If Detroit defaults on its municipal bonds, in other words pays less than it owes, it would set a dangerous precedent for the municipal bond market. Other financially ailing cities and municipalities may consider filing for bankruptcy too, to reduce what they owe bondholders. And it is likely to make borrowing more expensive for states, municipalities, and school districts as municipal bonds will no longer be viewed as virtually risk-free. [2]

Similarly, if Detroit ends up cutting workers’ pensions, it will create a scary precedent for other municipal and government employees. (The average pension owed to Detroit municipal workers, incidentally, is less than $23,000 per year. [3]) Other cities, municipalities, or even states could declare bankruptcy as a way to reduce pension costs. [4] In the private sector, declaring bankruptcy has become a standard tactic for cutting pensions and other benefits for retirees. The airline industry has done this and it has been a standard tactic in leveraged buyouts of private companies. (This was a tactic used by Bain Capital, Mitt Romney’s firm, and became an issue when he ran for President.) In many cases, when a corporation declares bankruptcy, the pensions of its workers become the responsibility of the federal government’s Pension Benefit Guaranty Corporation (PBGC). In 2012, PBGC paid for monthly retirement benefits for nearly 887,000 retirees in 4,500 pension plans that could not pay promised benefits. However, it does not cover state or municipal pension plans. [5] (This is another example, along with bailouts, of how the federal government picks up the pieces when corporations fail to meet their commitments.)

It will be interesting to watch how the state and federal governments respond. Here are two interesting tidbits:

• While the Michigan state government is doing little to help the city itself, it has approved $450 million in bonds to build a new arena for the Red Wings hockey team and its billionaire owners (who also own Little Caesars Pizza and the Tigers baseball team). Decades of studies have shown that sports facilities’ subsidies are massive wastes of taxpayer money. There is no evidence of a return to the public (as opposed to the private owners of the teams) and they are not an efficient way to create jobs. [6]
• The federal government has been providing about $100 million a year to Detroit under a variety of federal programs. By way of comparison, US aid to Columbia (the South American country) is about $323 million a year to combat drug trafficking and violence. However, Detroit’s homicide rate is 81% higher than Columbia’s. [7]

Many precedents will be set as Detroit moves through the bankruptcy process. It will be interesting to see who the big winners and losers are, as well as whether the federal government steps in to help out the city as it did the big financial corporations and the big auto companies. We will learn whether our big corporations and their executives and employees are more important from the federal government’s perspective than our cities, their residents and municipal workers, and their municipal bond holders.