Detroit, Detroit It's a Helluva Town...

Detroit's bankruptcy filing today is obvious grabbing some headlines. It's not clear, however, how much bankruptcy can do to fix Detroit. Bankruptcy is really good at dealing with problems created by overleverage.  If there's too much debt, a debtor, municipal, corporate or consumer, can use bankruptcy to slough it off.  Similarly, if the problem is some bad contracts outstanding, bankruptcy's got that covered too.

But bankruptcy can't fix everything.  If a business doesn't have a viable operating model, well, bankruptcy doesn't solve that.  At best, it buys a business some breathing room to fix its operating model. But not every business can be fixed. Slide rules, whale oil, and ice delivery just aren't winning business models these days.  Same goes for a consumer.  Bankruptcy can take care of the debt, but it can't get the consumer a job.  

This principle also applies to municipalities.  It isn't clear at this point whether Detroit would be able to operate in the black going foward even if it were delevered and lowered its labor costs.  Put another way, it isn't clear at this point that there is an effective reorganization possible. The city is straddled with a much larger footprint than its tax base can easily support, and to the extent it increases the costs of the services it provides or decreases service provision, it risks losing the more affluent and therefore more mobile part of its tax base.  Basically, Detroit needs to have its population consolidated in about a quarter of the city's square mileage. I don't know how that can be accomplished. It's one thing to consolidate operating divisions of a company to effectuate cost savings from reduced overhead. But that move just doesn't work with municipalities.  

Similarly, Detroit does not seem to have been well managed, even in spite of its problems.  The emergency manager represents a turnaround team at the very top of the city, but the management problems appear to go much, much deeper. I don't know how bankruptcy can fix this problem either. 

So what does this mean for Detroit? My guess is that we see both bondholders and labor making (or being forced to make) concessions during the bankruptcy. But don't expect to see a revitalized city coming out of Chapter 9. Instead, Detroit will continue to be a deeply troubled city, irrespective of what happens in bankruptcy. I hope I'm proven wrong, but I just don't see how bankruptcy will fix Detroit.   In the meanwhile, we can all sing along:  Detroit, Detroit, it's a helluva town...the attorneys are up, but the bondholders down...

Comments

[Jason Kilborn]

My relatively uninformed sense is that pension and health care obligations are a major drag that Detroit hopes to reduce or eliminate. Won't that represent a major delevering that could mean a big turnaround for Detroit? Here in Chicago, we costantly hear about the unsustainable burden of pensions, and I thought Detroit had a similar problem. Mismanaged or not, escaping or reducing pension and health costs could mean lots more money for servicing the city on a sustainable ongoing basis, no?

[Christopher]

Second line of the song could presumably be something like, "Warren's up and Windsor is down." Just geographically of course. Windsor is going fine.

[As a note to Christopher--the lead story on the Canadian Broadcasting Corp. National newscast last night was the Detroit bankruptcy, and Windsor's need for a strong]

When casinos came to Detroit, and gave a source of extra revenue to the city in taxes, the state offset its revenue-sharing to the city on a dollar-for-dollar basis, effectively depriving the city of a new source of revenue. The state government needs to consider things like a regional metropolitan government, or a regional sales tax to get the city back on its feet. Otherwise, the city can't recover from (1) the loss of 60% of its population over the last 60 years, and (2) 40 years of decline in the auto industry, since the Arab oil embargo of 1973, with opposition to increased gas taxes and increased corporate-average-fuel-economy (CAFE) standards resulting in bankruptcies for GM and Chrysler, and Ford restructuring itself as it did, and (3) decades of financial corruption by Mayors Young and Kilpatrick and their cronies. If the state government doesn't act, all of southeastern Michigan is in trouble, and other local governments will similarly fall like dominoes.
As a note to Christopher, the Canadian Broadcasting Corp. nightly newscast led with the Detroit bankruptcy story, and Windsor's need for a financially solid Detroit.

[mt]

That was an insightful post. Thank you.

During the Depression, FDR literally moved entire towns as one of his many trial-and-error approaches. It seems to me from afar admittedly that Detroit needs to consider doing something similar and moving people into consolidated spaces that can be better managed, by eminent domain if need be.

But in any case the legacy debt has to go to the greatest extent possible. And that is what bankruptcy is good for.

[David]

The more affluent of Detroit's tax base left during the last century....

[MacCruiskeen]

"ice delivery just aren't winning business models these days"

Really? Around here, every supermarket and convenience store has a freezer with bags of ice for sale. Presumably those bags aren't walking to those freezers by themselves. Not in this weather!

[Adam]

OK, smarty. Let me be more precise: Home ice delivery. As in the ice & coal man. And yes, I am aware of the venerable Brookline Ice & Coal: http://brooklineice.com/

[Ep3]

Ya know what would solve detroit's problems? Having those 1 million jobs back that disappeared over the last 50 years. Some went cross country. Some went to Mexico.
The Foxconn plant in china employs 400,000 persons making apple products. Why can't Apple be required to build iPhones in America? I think 400k jobs in Detroit, with giant factories on all that vacant land, would fix everyone's problems.
Finally, welcome to capitalism everyone. Corrupt govts working with greedy companies. Sucking up all the natural resources of an area. building vast environmentally destructive factories spewing chemicals into our air and water. And then abandoning all that to move to another area to do it again. What they leave behind is Detroit.

[GMPierce]

"My relatively uninformed sense is that pension and health care obligations are a major drag that Detroit hopes to reduce or eliminate."

There is a definite lesson here. If your pension or healthcare is controlled by government or by unions, you are at the mercy of deadbeats.

In theory, that pension was part of your compensation. It was deferred because the company could pay it into some kind of investment where the money would be available when it was needed. In the meantime, the miracles of compound interest would allow the company to pay a smaller amount.

Unfortunately, too many business and union managers wee able to avoid making an honest contribution to the pension plan. Their pension and bribes payed out, while the people who trusted them will get whatever minimal amount will be funded by ERISA.

No doubt, paying their honest bills will be a drag on a lot of cities. Once they have successfully welshed on their obligations, the people who should have received those pensions get to welsh on their own obligations to someone else (hopefully a banker or a credit card company).

I guess you could call this a "turnaround" for Detroit if you are unable to see the misery that will be inflicted on the people of Detroit.

Maybe Goldman Sachs can manage to sell Lake Michigan to the Chinese in anticipation of the day when they run out of water.

[May]

http://bettercities.net/news-opinion/blogs/charles-marohn/20313/detroit-american-autopsy
Detroit: An American autopsy

Paying heavy price of ignoring advice that state monitor debt
See:
http://www.crcmich.org/PUBLICAT/2000s/2000/rpt329.pdf
AVOIDING LOCAL GOVERNMENT FINANCIAL CRISIS:
THE ROLE OF STATE OVERSIGHT

[Matthew Bruckner]

I recently learned that Cleveland has a suburban tax (http://www.ritaohio.com/). Based on my (admittedly limited) understanding, this tax operates as an incentive to live in the center city and discourages suburban growth. The tax seems enormously complicated because it varies by slight amounts on a suburb-by-suburb basis and some credit is given against taxes paid to Cleveland proper as well.

Nevertheless, this seems to be a way to nudge people back to center cities..