Last Tuesday, a federal judge declared that Detroit met the specific legal criteria to receive protection from its creditors, making it the largest city in U.S. history to enter Chapter 9 bankruptcy.
What does this mean for Detroit and its citizens?
Well, literally it means the city of Detroit cannot meet its financial obligations to its creditors. But it also means that it has not been able to meet the obligations to its citizens, in terms of services provided and promises made. For current and former municipal employees, this almost certainly means that they will get pennies on the dollar for pensions and retirement benefits. And the city as a whole will continue to lose population, which has already dropped from 1.8 million in 1950 to just over 700,000 now, because Detroit cannot provide basic sufficient services, such as policing, fire and healthcare assistance. And as a result of people leaving, the city will lose tax revenues and businesses, and real estate values will drop. So this has a lot of negative ramifications for the city. But if there is a silver lining, this might give the city an opportunity to shed its debt, restructure its finances, restore its services and reinvent itself without the baggage of the past 50 years.
What will the fallout be? How much of a stigma will this carry?
There is certainly going to be a lot of focus on this being the largest Chapter 9, or municipal, bankruptcy in U.S. history, both in terms of the size of the city and the size of the liabilities. We are talking about nearly $20 billion dollars in debt. With all of this hanging over the city, there will certainly be those that choose not to invest in Detroit, which will cost the city revenues. More importantly, this stigma will be very apparent in the higher borrowing costs for the city in the future. However, in the long term, I think it will be less of a factor, as Detroit has dealt with a negative perception for at least a decade. Perhaps this will allow the city to break out of the doldrums and reinvent itself.
Do you think this means we’ll see even more people fleeing the city after this?
I think that’s a pretty good bet. In the decades between 1950 and 1970, there was a lot of flight to the suburbs, but in recent years we have seen a different kind of exodus, based on the lack of services, from policing to parks and recreation. For example, in the last 10 years, Detroit has closed over 100 schools, eliminated the city’s Department of Human Services, cut funding for police and firefighters, and abandoned maintenance of numerous parks and other facilities. The restructuring might help turn this around, but in the short term, I think it is likely that more people will leave, particularly those retirees who will lose the most in the bankruptcy.
So is this a partial victory for Detroit? Will it help the city face its financial problems? What’s next?
It should help the city get its finances in order, but it will take time. The next step is to for the city to seek to pay out secured debt holders and then deal with the unsecured debt, including the retirement benefits, which are not protected under Chapter 9 filings. This process will take months, if not years, and be tied up in court. And no one can say that this will break the cycle of population loss and therefore revenue loss that has played such a large part in the city’s troubles up to this point. But it should certainly help to shed the debt burden on the city.
How about the fact that Detroit approached the White House for a bailout and was denied? What kind of precedent did that set for other troubled cities?
Not coming to the assistance of Detroit was certainly controversial in some sectors, especially after the bank bailouts during the last 5 years. We have to remember that the government gave AIG a bailout worth more than $180 billion, and over $45 billion to Citibank, not including the nearly $300 billion of guarantees on bad assets. And now unions are getting the cold shoulder and having their pensions slashed, so this will certainly be a very hard pill to swallow for many, many residents of Detroit. However, in terms of precedent, it is probably a good one, considering the scope of financial issues that are confronting states and municipalities across the country. One bailout for a city would have justified other cities in thinking that they could simply go that route as well.
What about other states and municipalities? What’s the scale of the bankruptcy problem for them?
It’s pretty significant, and it has clearly gotten worse since the economic downturn, as revenues fell, demand for social safety nets rose and the national and state governments had to cut resources for cities. Since 2010, 23 cities, municipalities and municipal utilities have files for Chapter 9 bankruptcy in the US. This obviously does not count the many that are very close to the edge but have not yet been forced into a decision. But there will certainly be more, due to the rising liabilities. One economist estimates that the public pension shortfall in this country is nearly $1 trillion dollars.
Mellody is President of Ariel Investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts. Additionally, she is a regular financial contributor and analyst for CBS News.