August 26, 2013
Motor City madness as manifestation of a modern municipal malady
How does a bankrupt city like Detroit find itself in such a financial mess?
Revenue falling short of expenditures is the obvious answer, but there are many additional aspects to the question.
Some analysts are laying the blame at one-party rule (i.e., the Democrats) and corruption (former mayors have been arrested) and powerful and greedy public sector unions. It’s not as if we haven’t had corruption at the municipal level in Canada (e.g., Montreal) and firemen and police officers, as providers of essential public services, are able to bargain from strength everywhere.
Those are surface reasons obscuring some simpler truths.
Two of the most critical causes have been the length of time that the problem has been allowed to fester and the fact that both revenues and expenditures have been impacted, not just by economic circumstances — i.e., the relocation of Big Three auto production to the southern U.S. and other countries — but also by unexpected changes on both sides of the equation.
The word “unexpected” isn’t quite accurate. It’s well-known that “chickens will eventually come home to roost”. The day of the reckoning, however, was supposed be far in the future. No ambitious politician was prepared to acknowledge how quickly it might arrive.
It’s important to understand Detroit’s dilemma, because there are implications for other cities in North America and for the public sector in general.
There are both “length of time” and “timing” factors to consider. Revenues have been less than expenditures for far too long. It’s one thing to have a temporary shortfall, created by a cycle, but it’s another degree of difficulty when such a disparity is permitted to extend out indefinitely.
That alone can create an inescapable abyss. To finance ongoing annual shortfalls, the city kept descending further into debt, while assuring everyone things would work out in the long run.
That was deliberately misleading. Maybe there was the expectation that the state and/or federal government would step in to fix the problem. Such a solution is not unprecedented.
But the city has been unfortunate in its timing. These days, federal and state legislators have widely embraced austerity. There has been no “white knight” riding to Detroit’s rescue.
The accumulation of debt to finance long-standing annual deficits has meant too much of the budget being wasted on servicing costs — which is to say, interest payments.
This sets off a “vicious” (i.e., decidedly not a “virtuous”) circle. As more money goes towards carrying the debt load, there’s less money available for expense items usually taken for granted such as street lighting, road repairs and police car and fire truck maintenance.
As the level of services deteriorates, the incentive for people and business enterprises to stay in the city diminishes. An air of defeatism creeps in. Firms and individuals begin to look elsewhere for better prospects.
The population of urban Detroit (i.e., not the suburbs) has fallen by half, from nearly two million at its peak to well under one million currently.
The extent of this decline has been largely unprecedented. New Orleans suffered a large drop in population after Hurricane Katrina, but that was a natural disaster, and partial repatriation has occurred since.
As abandonment has accelerated, the revenue base has fallen further. Upping taxes has not been an option. That would be one more shotgun blast to speed the stampede to the exits.
Chicago has financing problems that are also making headlines. Moody’s recently downgraded the Windy City’s credit rating by three notches. But the population level remains firm and the economy is more vibrant. At this relatively earlier stage of its crisis, Chicago still has the wherewithal to raise taxes and bring its public sector costs under control.
Turning to spending, there have been efforts to save money by reducing Detroit’s civic payroll. But this has created a glaring disparity. The relationship between the present work force and the number of individuals collecting retirement pay has been stretched alarmingly.
Firemen and policemen are undoubtedly drawing inordinately high pensions in some parts of America. California seems to be hot spot for such imbalances.
But in Detroit, the pension problem has a different dimension. There are 3,000-plus workers presently employed by the city, but there are more than 9,000 former staff members who are still costing the city money.
The size of the pension-drawing contingent was easy to predict, but for political reasons, no one was prepared to tell the electorate how big a problem this was likely to become, nor how quickly.
It was convenient to assume the issue of unfunded liabilities would occur at some distant date, long in the future. That nebulous schedule has been firmed up and the toll has come due.
It’s true that the Big Three automakers are now seeing a revival in their fortunes. As for whether or not they can bail out the city’s public sector, there have been some significant shifts in operations. Only GM has its corporate headquarters downtown.
Many auto-related plants in the region were closed and production moved elsewhere in the lead-up to and during the “dog days” of the recession. Remaining assembly and parts plants are largely in counties outside the city’s boundaries.
Urban centers across the U.S. will be paying close attention to the ongoing bankruptcy proceedings. They’ll be particularly interested in: (1) the question of whether or not Detroit can legally shed or reduce its pension and health care obligations; and (2) how swiftly this process can take place and with what degree of acrimony.
If the city is tied up in a legal fight for years to come, other cash-strapped municipalities will be less likely to pursue the same path. Bankruptcy has traditionally been a course of last resort.
Once a debtor has reneged on its obligations, the willingness to lend to that individual, company or government entity evaporates. In tangible terms, it will take higher rates of interest for Detroit to entice lenders to accept a greater risk, adding to the cost of the city’s day-to-day operations.
There is also a more general observation to make. The social safety net is not unlimited. Unlike the federal authorities in Washington D.C., Detroit can’t print money to extricate itself from this quagmire.
The degree of competition between jurisdictions to create jobs and maintain economic momentum, with willing cheap labour seemingly available everywhere in emerging nations, has never been greater. City officials can’t afford to let business opportunities simply slip away. (Toronto might want to rethink its opposition to a centrally-located casino.)
Based on prospects for a second bridge crossing to Windsor, a new arena for the NHL Red Wings and commercial property investments (thanks to rock-bottom real estate prices) by Dan Gilbert, co-founder of Quicken Loans, there are indications that portions of Detroit are rising from the scrap heap.
But here’s a final thought to carry away. Detroit has fallen into bankruptcy while interest rates have never been lower. Imagine the extent of the city’s problems if it had been caught in a yield updraft. That day has been delayed so far, but it’s approaching nonetheless.
A “New York minute” is a saying which emphasizes the speed at which events can occur.
With respect to the payoff on a dollar from the financial madness in Motor City, let’s hope the phrase a “Detroit dime” doesn’t become part of our everyday language as well.