Why Detroit Went Broke

According to conservative myth and lore, liberals got control of Detroit, and through profligate spending and waste, that glorious city was brought down low. The reality is quite different. Detroit ran budget surpluses during the Clinton Boom; and when 90s prosperity gave way to the Bush Duh doldrums, successive mayors aggressively downsized the government. Their efforts might have kept the city afloat, but in the end Detroit was bankrupted primarily by the state of Michigan, the Great Recession’s ravaging of the US auto industry, and a shady refinancing deal that benefited Wall Street more than the city it was intended to serve.

Bankruptcy is about lacking the revenue to cover obligations. And so every bankruptcy has two stories: one about revenue, and one about expenses. After Detroit entered bankruptcy, its emergency manager pegged the annualized difference between revenue and expenses at about $200 million.

For most of the past 40 years, Detroit’s government did a reasonable job of keeping abreast of the city’s shrinking population by cutting services and reducing the size of the municipal workforce. In constant dollars, Detroit’s budget fell from $2 billion in 1960 to $1 billion today. The Detroit Free Press, in a remarkably comprehensive report (cited below) approves of the downsizing efforts of every mayor since and including Coleman Young (who served 1974-94).

Only mayor Dennis Archer (1994-02) is faulted for increasing the size of city government – but his administration ran budget surpluses during 7 of his 8 years in office. Archer also introduced a tax on the city’s new gambling industry, which continues to be an important revenue source. And the 90s were relatively kind to Detroit, which only lost 5% of its population between the 1990 and 2000 censuses – it would lose 25% between 2000 and 2010.

Even the disgraced mayor Kwame Kilpatrick (2002-08) slashed the city workforce, refinanced the pension system, and went to the extreme of shuttering the city aquarium and zoo, cutting more than $400 million from spending – a reduction of 25%. But when he left office (in handcuffs), the city was in the grip of the Great Recession, running a deficit of more than $200 million, and borrowing to pay its bills while it could still find lenders. Mayor Dave Bing (2009-13) dismissed more than 30% of the city’s remaining employees – firing 40% of all teachers – but the budget deficit hardly budged.

On the revenue side, property taxes were 50% of city revenue in 1960, but only 13% in 2012, despite higher rates – attributable to the collapse of home values. To make up the difference, new taxes were implemented along the way, on income, utilities and gambling. But as the city shrank in size, revenue from all sources shrank too.

Of the $200 million shortfall, fully one-third can be attributed to the State of Michigan, which, in its own fiscal straits, slashed support for the city by $67 million. The big banks who underwrote Detroit’s last-gasp borrowing binge expected Michigan to bail the city out if insolvency ever threatened. Ironically, it was the state that pushed Detroit over the brink.

While Detroit’s economy is probably more varied now than it’s been for the past 100 years, the auto industry remains the single largest employer. Ever sensitive to the business cycle, the Big Three were devastated by the Great Recession. Unemployment in Detroit was 13% on the eve of the Great Recession – it would climb as high as 27% – and the official rate persists at about 18% today, though informal estimates run much higher. Property and income tax revenues have never recovered.

All things being equal, over the long haul one should NOT expect a city of 700 thousand to be able to maintain an infrastructure for 2 million. Detroit might have made it, were it not for the explosion of healthcare costs across the US. While a city can fire its workers, it cant fire its retirees, who live longer than ever, and have higher-than-ever medical bills. Detroit actually kept retiree healthcare cost-increases below the national average. But as a consequence of shrinking so much so fast, Detroit in 2012 had twice as many pensioners as workers – and was spending more on retired cops and firefighters than active-duty personnel!

It would have been tough enough to pay for the retirees of a much larger city, but the 2005-06 refinancing deals, which restructured the city’s pension obligations, made the task impossible. “Legacy” payments since the Great Recession have gone up by $60 million – but most of the increase is attributed to the souring of the refinancing deal, which had contingencies to inflate debt-service costs if the city’s credit-rating were ever downgraded. When the Great Recession struck, the city was squeezed between tanking revenue and skyrocketing costs. City managers must take a share of the blame for their naivete – as well as local newspapers who advocated for the deal. But more culpable are the Wall Street firms who structured it, and stood to profit greatly from it. The Demos article (linked below) suggests that the deals were so poorly suited to a city like Detroit, that the banks who designed them may have breached their fiduciary duty to the city.

Why Detroit shrank so much is the last issue to be explored – when Detroit Week at the Field Guide concludes….

 

Refs:

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

http://www.demos.org/publication/detroit-bankruptcy

http://en.wikipedia.org/wiki/Motor_vehicle#Production_by_country

 

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