Detroit bankruptcy filing comes after long financial decline

The main question raised by Detroit’s bankruptcy filing late on Thursday was how the 18th-largest city in one of the world’s wealthiest countries could decline to the point of financial ruin.

Once the US's economic powerhouse and a national cultural centre as the birthplace of muscle cars and Motown music, "Motor City" is the largest US city to file for chapter nine bankruptcy, the type of court bankruptcy that protects a heavily indebted city or town from its creditors. Eight US cities or towns have filed for chapter nine bankruptcy since 2010, including three in California.

Detroit, the fourth-most populous US city when it was the booming hub of the US car industry, has been dying a slow financial death over the past 20 years. Public corruption, heavy borrowing, mismanagement and violent crime have contributed to Detroit’s demise. The population has fallen from almost two million in 1950 to about 700,000 today. It fell by 26 per cent in the past 12 years alone, leading to a 40 per cent drop in tax revenue. The unemployment rate is more than double the US average, after almost tripling since 2000.

The city has spent $100 million (€76 million) more than it has raised in taxes every year since 2008, borrowing the shortfall. This was despite increasing taxes on the declining population. The debt has been raised at a heavy cost; the city has borrowed on a “junk” credit rating for the past four years.

It ranks first among the 50 highest-taxing cities in the US. Property taxes are more than twice the national average, while the average house price is almost 10 times lower than the next lowest city, Mesa, Arizona.

Self-perpetuating
Detroit's problems have become self-perpetuating, accelerating the city's decline in recent years. Reductions in the size of its workforce have deepened deficits in the city's pensions fund. Its shrinking workforce meant employee pension contributions could not keep pace with retired workers' entitlements.

In 2004, 51 out of every 100 workers were paying into one of the city’s two pension funds while 49 retirees were drawing on it; by 2011 39 workers were paying into the fund while 61 were being paid out of it. The city had to borrow $1.4 billion to plug a hole in the pension funds in 2008. Since then the hole has deepened to $3.5 billion.

"Detroit simply cannot raise enough revenue to meet its current obligations and that is a situation that is only projected to get worse absent a bankruptcy filing," said Rick Snyder, Michigan's Republican governor.

The city's state-appointed emergency manager, Kevyn Orr, has said there must be "significant cuts" in retirement pay to 21,000 retired city workers and their widows, and to accruing pension benefits for 10,000 current workers.

Orr was forced to seek bankruptcy protection after he was unable to reach agreement with bondholders and other creditors on an out-of-court writedown on their debts.

The city’s pension deficit amounts to about a sixth of Detroit’s total liabilities of up to $20 billion. Orr said this week that when he was appointed in March, he was told that the city’s liabilities were $14 billion but he has since discovered further debts. He must restructure these debts in a process that could take months, if not years. The timing is unclear as no American city has undergone a reorganisation of this scale.

About $9 billion of the debt is secured and considered off-limits to writedowns. The battle between bondholders and other creditors will be fought over $11 billion of unsecured debt, which includes $2 billion in general obligation bonds and other financing, $3.5 billion due to the pensions fund and almost $6 billion due in health insurance and other worker benefits.

Smaller pensions
Orr's out-of-court plan involved a haircut of 83 per cent on $11 billion of unsecured debt. As details of the bankruptcy restructuring are yet to emerge, it is not known how these or higher losses will shared among 100,000 unsecured bondholders and current and former city workers, but it is clear workers and retirees, paid an average of $1,600 a month, are in line for smaller pension cheques.

Bondholder interest groups have warned that repaying them just a few cent on the dollar could lead to higher borrowings costs for other cities in Michigan and across the US.

Detroit can forget about a bailout from the federal government as Democrats and Republicans struggle to agree on their own debt problems. The city will have to carry out the financial repairs on its own – it could be years before Detroit is motoring again, if at all.

There was an unexpected development late on Friday when a Michigan judge ruled that Detroit’s bankruptcy filing violated the state’s constitution and asked the state’s governor to withdraw it. The ruling will be appealed.