Lecture 25 - How about Detroit

Sources: http://archive.freep.com/interactive/article/20130915/NEWS01/130801004/Detroit-Bankruptcy-history-1950-debt-pension-revenue, http://www.freep.com/story/news/local/detroit-bankruptcy/2014/11/09/detroit-bankruptcy-rosen-orr-snyder/18724267/ http://www.freep.com/story/money/personal-finance/susan-tompor/2015/02/27/detroit-orr-pension-checks-cuts/24144513/ https://news.artnet.com/art-world/detroit-institute-of-arts-reaches-100-million-grand-bargain-goal-212785

Be a little

carefulRevenue is a flow

Debt is a stock

Wilbur Thompson (1965)

… tremendous amounts of fixed capital have been sunk in social and private overhead in the very large urban area – streets, sewers, schools, water mains, electric power line, stores and housing – so that even if the area’s productive facilities for export are worn out or technically obsolete, public service and utility costs are low enough to make it uneconomic to abandon so much immobile capital. No nation is so affluent that it can afford to throw away a major city. (A Preface to Urban Economics, P. 23, emphasis added).

much immobile capital. No nation is so affluent that it can afford to throw away a major city. (A Preface to Urban Economics, P. 23, emphasis added).

Facts

• In 1970 the City of Detroit had 497,748 occupied dwelling units.– In 2010 it had 269,445 occupied units, a

fall of 45% in 40 years.

• In 1970 City of Detroit had 529,012 total dwelling units.– In 2010 it had 349,170 total units, a fall

of 34%, again in 40 years.

Table 1 Changes in Total Units - 1970-2010 1970-1980 1980-1990 1990-2000 2000-2010 Sum % Change Detroit -57,784 -61,381 -35,383 -25,294 -179,842 -34.00% St. Louis -36,467 -7,209 -18,911 171 -62,416 -26.18% Cleveland -24,716 -15,316 -9,024 -7,557 -56,613 -21.43% Buffalo -9,689 -4,525 -6,567 -11,876 -32,657 -19.66% Pittsburgh -10,658 -9,394 -7,264 -6,323 -33,639 -17.72% Newark -6,046 -18,931 -2,399 9,503 -17,873 -14.03% New Orleans 18,088 -1,998 -11,422 -22,789 -18,121 -8.71% Rochester -2,882 -1,553 -1,495 -2,413 -8,343 -7.91% Cincinnati 116 -3,813 -3,361 -4,318 -11,376 -6.60% Baltimore -2,623 1,001 -4,421 -2,360 -8,403 -2.75% Chicago -32,881 -43,140 17,431 46,018 -12,572 -1.04% Philadelphia 11,908 -11,162 -13,941 10,003 -3,192 -0.47%

Every decade, Detroit lost more units than any other city, although itwas not unique.

So …

• How did this lead to bankruptcy?• How did we get out?• What was the “Grand Bargain”?• What will happen next?

How did things get so bad? – 1

• Taxing higher and higher– Despite a new income tax in 1962, a new utility

tax in 1971 and a new casino revenue tax in 1999 — not to mention several tax increases along the way — revenue in today’s dollars fell 40% from 1962 to 2012.

– Higher taxes helped drive residents to the suburbs and drove away business. Today, Detroit still doesn’t take in as much tax revenue as it did just from property taxes in 1963.

http://archive.freep.com/interactive/article/20130915/NEWS01/130801004/Detroit-Bankruptcy-history-1950-debt-pension-revenue

How did things get so bad? – 2

• Downsizing — too little, too late– The total assessed value of Detroit property — a

good gauge of the city’s tax base and its ability to pay bills — fell 77% over the past 50 years in today’s dollars.

– Through 2004, the city cut only 28% of its workers, even though the money to pay them was drying up.

– Not until the last decade did Detroit, in desperation, cut half its workforce. The city also failed to take advantage of efficiencies, such as new technology, that enabled enormous productivity gains in the broader economy.

How did things get so bad? – 3

• Skyrocketing employee benefits– City leaders allowed legacy costs — the tab for

retiree pensions and health care — to spiral out of control even as the State of Michigan and private industry were pushing workers into less costly plans.

– That placed major stress on the budget and diverted money from services such as streetlights and public safety.

– Detroit’s spending on retiree health care soared 46% from 2000 to 2012, even as its general fund revenue fell 20%.

How did things get so bad? – 4

• Gifting a billion in bonuses– Pension officials handed out about $1 billion in

bonuses from the city’s two pension funds to retirees and active city workers from 1985 to 2008.

– That money — mostly in the form of so-called 13th checks — could have shored up the funds and possibly prevented the city from filing for bankruptcy.

– If that money had been saved, it would have been worth more than $1.9 billion today to the city and pension funds, by one expert’s estimate.

How did things get so bad? – 5

• Borrowing more and more– Detroit went on a binge starting around 2000 to

close budget holes and to build infrastructure, more than doubling debt to $8 billion by 2012.

– Under Archer, Detroit sold water and sewer bonds. Kilpatrick, who took office in 2002, used borrowing as his stock answer to budget issues, and Bing borrowed more than $250 million.

How did things get so bad? – 5

• Kilpatrick’s gamble– Borrowed $1.44 billion in a flashy high-finance deal

to restructure pension fund debt. That deal, which could cost $2.8 billion over the next 22 years, now represents nearly one-fifth of the city’s debt.

– Detroit sold pension obligation certificates of participation and shoved the money into its pension funds, making them nearly 100% funded. Separately, the city also bought so-called swaps, or derivatives, a complex Wall Street financial deal to permanently lock in steady interest rates in the range of 6%, a comparatively good rate at the time.

The Deal

The Deal

Bankruptcy

• It means that people cannot discharge debts.

• Bankruptcy makes some arrangements to pay something, and then the rest of the debts are discharged.

• Bankrupt party often cannot get credit cards, or mortgages for houses.

Bankruptcy

• I means something different for governments than it means for families or businesses.

• One asset that governments have is the ability to tax a defined tax base.

• In the 1950s Michigan used to have “payless paydays” because the (Republican) legislature would not agree with the (Democratic) governor – even though the resources were there.

City’s response

• The state (over the years) had withheld about $250 M that they had promised. “We want it now.”– Didn’t happen. – It would only be a one-time fix anyhow.

• Michigan Constitution protects pension liabilities. They have to support our obligations.– Didn’t happen

So …

• The Dilemma• Creditors want money and want to

liquidate whatever they need to liquidate to get it.

• Pensioners want what they think was owed to them.

Creditors

• Bondholders and those who insured the bonds

• Proposed liquidating whatever they could to get money, including:

Grand Bargain – 1

• Foundations “monetize” art collections• Among the donors who helped the DIA

raise the necessary funds: – Andrew W. Mellon Foundation and the J. Paul

Getty Trust, which pledged a combined $13 million

– Detroit's automotive giants, who collectively put $26 million toward the cause. Various other companies, foundations, and wealthy individuals also pitched in (including Toyota).

Grand Bargain – 2

• Pensioners accept cuts– A group of retirees who are giving back some

interest earned as part of an annuity savings fund, dubbed as a clawback, will see their pension checks reduced by up to 20% each month. Some retirees agreed to pay a lump sum of several thousand dollars upfront to cover the clawback and would avoid the deeper cuts. They will still see the 4.5% cut.

– Uniform retirees who served in the police force or as fire fighters do not receive the across-the-board cut to the pension checks but instead take a smaller cut involving annual cost of living adjustments.

Grand Bargain – 3

• Creditors accept cuts– Detroit reached a deal in September to pay

Syncora, one of its largest creditors, a fraction of what it was owed and provide rights to city property and an extension on the firm's lease to operate the Detroit-Windsor Tunnel.

– Financial Guaranty Insurance Co., owed more than $1 billion as the last big holdout creditor, struck a settlement for 13 cents on the dollar plus rights to develop the Joe Louis Arena waterfront into a massive hotel development.

Grand Bargain – 4

• State comes in– Republicans and others were finally sold on the

idea that the grand bargain would protect state government from being sued over city pension cuts or having to increase spending on welfare and health care programs to save impoverished retirees.

– On May 22, the state House overwhelming approved an 11-bill package authorizing a $195-million up-front contribution. The state Senate followed suit on June 3, and the governor signed the bills into law..

Will it Work?

• Analogy– Guy overeats, smokes, doesn’t exercise

heart attack quadruple bypass– Will it help?

• NOT if the guy goes back to overeating, smoking, etc.

Long Term Solutions – 1 ?

• Increase tax base• How? • Regionalization

•Detroit/Wayne County?•Wayne/Oakland/Macomb Metroplex

• Problems•Suburbs don’t seem to want it.•City doesn’t seem to want it.

• Break it up!• It’s hard to

argue that economies of scale are occurring at the current city size. Viable districts will

survive. Others will not.

Solutions – 2 ? City Council Districts, for example

Bogus Solutions

• Increase/decrease taxes• Urban Farming• More Casinos

Thoughts?