10 Facts about the Detroit Chapter 9 Bankruptcy

10 Facts about the Detroit Chapter 9 Bankruptcy

“They (outsiders) think Detroit is a dump. No respect. It’s a dump now. Detroit can’t even handle its own business? That’s sad.” — Detroit resident Everett Cottrell, 52.

1. The largest Chapter 9 Bankruptcy to date

Since 2008 there have been ten incidences of municipal bankruptcies in the United States: Gould, Arkansas (2008) due to spending money withheld to pay employee income taxes. Vallejo, California (2008) due to an inability to pay pension obligations. Westfall Township, Pike County, Pennsylvania (2009) due to losing a lawsuit. Prichard, Alabama (2009) due to an inability to pay pensions, especially state mandated pension increases. Central Falls, Rhode Island (2011) due to and inability to pay obligations, especially pensions. Jefferson County, Alabama (2011) over $4 billion in debt (largest Chapter 9 bankruptcy until 2013 Detroit bankruptcy filing). Stockton, California (2012). Mammoth Lakes, California (2012). San Bernardino, California (August 2012), and now Detroit, Michigan (July 2013) with over $18 billion in debt, thereby making Detroit the largest Chapter 9 bankruptcy to date.

2. Half of the debt is unfunded retirement benefits

Being the largest American city ever to file for bankruptcy, Detroit has a whopping long-term debt of an estimated $18.2 billion ($27,000 per capita), partly as a result of the fact that it has spent $100 million more annually since 2008 than what has come into the city coffers as revenue. Of this debt, about $9.2 billion consists of unfunded retirement benefits. The situation is exacerbated by a feeble economy, a shrinking population and rapidly increasing legacy costs. Property tax revenues have declined by 20 percent since 2008, while income tax has declined by 30 percent since 2002. The composition of debt is nicely summarized in the following Huffington Post infographic:

3. Heavy population decline since 1950

In the 1950s Detroit was home to 1.8 million people, which has fallen to a mere 700,000 today. A large number are poor and uneducated—82 percent have no more than a high-school diploma. The city extends across an unmanageably large area, equal to 140 square miles (363 square kilometers), i.e. more than Boston, San Francisco and Manhattan combined. The demise of Detroit is visualized by the Economist:

4. Debt is held by 100,000 creditors

Detroit has about 100,000 creditors, which include banks, bondholders and more than 20,000 retirees who could see their pensions severely reduced. Also, many major municipal bond funds have loaned money to the Motor City.

5. Basic services continue during negotiations

There will still be publicly provided police departments, fire departments and other services during bankruptcy proceedings. Under the restructuring plan, Detroit would spend an additional $1.2 billion on city services over the next decade if a bankruptcy judge were able to negotiate with the city’s creditors.

6. Art collections could serve as revenue source

Detroit could consider selling the collections held in the Detroit Institute of Arts (DIA) to raise revenue; they are worth at least an estimated $3 billion. It is feared, however, that this would entail a severe depletion of the city’s cultural capital, since DIA is recognized as home to one of the largest, most significant art collections in the United States.

7. Litigation likely to continue beyond 2014 plan

Detroit emergency manager Kevyn Orr’s restructuring plan aims at finishing the bankruptcy case by 2014. The case is, however, likely to be a drawn-out affair, as assessed by Harvey Miller, partner at Weil, Gotshal & Manges when speaking on the topic to Bloomberg Law’s Lee Pacchia. The fundamental tension between bondholders, pensioners and taxpayers, along with the city’s gigantic economic challenges, makes it quite reasonable to expect that Detroit will be tangled up in litigation for a long time.

8. Municipal bonds rating will decline

One of the likely repercussions of the Detroit bankruptcy is a lower rating on municipal bonds. Detroit’s unlimited-tax general obligation (ULTGO) bonds are being treated as unsecure, just like retiree health care benefits and similar low-secured debt, despite ULTGO’s usual standing as one of the strongest types of municipal debt. In other words, Detroit’s general obligation bonds are unlikely to be repaid, according to Fitch. Fitch analyst Amy Laskey commented on the topic: “Our feeling was that with unlimited-tax general obligation bonds you have the pledge to levy property tax without limitation to pay the debt, and that seemed somewhat more secure [than other tax-supported bonds]…Obviously municipal bankruptcies are very rare, and cases of municipal bankruptcy, where there are unlimited-tax bonds outstanding are even rarer,” she said. “This would be a pretty landmark case, and whatever decision, assuming that it’s accepted by a bankruptcy judge, would be somewhat precedent setting.”  The current Fitch rating for Detroit’s general obligation debt is C, formally signaling an imminent default.

9. Pensioners receive lower benefits than elsewhere in the U.S.

Exorbitant public pension schemes and union involvement have been widely cited as causes for the bankruptcy. However, the average annual pension for retired Detroit police officers and firefighters is about $34,000, roughly half that of such pensions in Los Angeles and Chicago, 25 percent less than in Kansas City, Missouri, and 36 percent below benefits for those in Dallas. Retirees from Detroit’s general city pension fund receive, on average, less than $20,000 a year, which is not at all a generous pension by Michigan standards.

10. Poor government does not equal poor economy

It’s not all doom and gloom. As highlighted by Bruce Katz of the Brookings Institution, Detroit’s broken public finances should not be confused with its actual economics: “City governments don’t equal city economies. It’s possible to have unsustainable city budgets and dysfunctional politics and very exciting regional growth prospects, and all of those trends happening at once.” Richard Florida, a University of Toronto management professor and urbanologist, was mildly optimistic when speaking to AtlanticCities.com: “Detroit’s downtown urban core is seeing more investment, economic activity and an influx of talent than it has in decades. This revitalization is concentrated and spotty, and it is far from inclusive, but it is certainly something positive—generating jobs, revenue and much-needed hope and optimism that provide a foundation to build upon.”

Categories: Finance, North America

About Author

Mikala Sorenson

Mikala Sorensen is an Economist with regional expertise in Europe. She holds a first class honours degree in Philosophy, Politics and Economics from the University of York and a Masters in Economics from the University of Copenhagen. Having interned at the Danish OECD-delegation in Paris and currently working at the Danish Ministry of Finance, she specialises in politics and macroeconomics. Analysis for GRI is an expression of her own views.