How bad are Detroit's fiscal problems?
Detroit's $18 billion bankruptcy will be the biggest municipal bankruptcy in US history. It's more than four times larger than the next-biggest: Jefferson County, Alabama's $4.2-billion case in 2011. Detroit's case is also agonizingly complex; the city has around 100,000 creditors — including retirees, banks, and bond insurers — to appease.
Creditors in municipal bankruptcies often try to prove that the city in question isn't really insolvent, that it just needs to reach deeper to pay them back. But Detroit's fiscal woes are severe enough that many of its creditors have simply conceded it's insolvent.
"It's notable that while, in a lot of cases, financial creditors fight very hard on the insolvency question, they did not in Detroit," says Melissa Jacoby, professor of law at the University of North Carolina. "They all sat that out. It was unions and retiree associations that fought it."
Where did all of Detroit's money go?
This chart from the Huffington Post breaks down Detroit's debts by category. About half of the city's liabilities are worker-related, including pension-related obligations and retiree health benefits. But there are other big chunks of debt, as well — $6.4 billion in debt, for example, is "obligations backed by enterprise revenue," which is mostly made up of bonds that pay for the city's Water and Sewerage department, HuffPo's Jan Diehm explains. General obligation debt, meanwhile, is debt raised by the city to pay for public works, like infrastructure.
Many of the holders of this debt will end up receiving much smaller payouts than they were anticipating. For retirees, cuts will likely come in the form of reduced benefits and pensions. But all of this depends on the type of debt — some forms of debt, like obligations backed by enterprise revenue, will be protected.
So were Detroit's retirees getting huge benefits?
On average, no. CNN's Melanie Hicken reported in 2013 that Detroit's average annual pension for retired police officers was $30,000. That's lower than Kansas City, Dallas, and Chicago, and just over half of the $58,000 the average cop gets in LA. Pensions for general city workers were even lower, at just over $18,000 per year on average. Worse, some of the city's public-sector retirees aren't eligible for Social Security benefits, or receive less from the program than private sector workers.
Of course, those numbers are averages, and the size of a pension depends in part on a person's salary when they were working. So some people ended up with much more generous pensions, and others with less generous ones. And these pensioners are receiving healthcare benefits in addition to their cash pensions.
Improper payments from the pension program also drove up costs . For decades, the Detroit pension fund made payments outside of normal disbursements to pensioners, as well as active workers and their families, amounting to $2 billion over 23 years ((as the New York Times reported in 2013). Those payments included "bonuses to retirees, supplements to workers not yet retired and cash to the families of workers who died before becoming eligible to collect a pension," the Times' Mary Williams Walsh wrote.
Why is Detroit so poor?
Detroit's fortunes have always been closely linked to the health of the auto industry. A booming auto industry and the Great Migration of Southern blacks to the North helped make the city a bustling and fast-growing metropolis in the early- and mid-20th century.
But with all its eggs in the manufacturing basket, Detroit was set up for problems when the auto industry started to decline. Starting in the 1950s, US auto companies started to lose ground to foreign manufacturers like Toyota. That trend got especially bad in the 1970s: high gas prices both put a dent in auto demand, and shifted that demand toward foreign companies' more fuel-efficient cars — an area in which US automakers had to catch up.
The auto industry also started moving out of Detroit proper. In a 2013 feature tracking Detroit's decline, the New York Times' Amy Padnani writes that the dispersion of the auto industry in the 1960s was in part a function of race (as blacks and whites refused to work side by side) and in part labor disputes, as factories spread out to ensure a strike in one place didn't kill productivity everywhere. The bottom line was that people began to leave Detroit — and lots of working-age people leaving means fewer people to pay taxes.
When a city built to support 1.8 million people is instead populated by only 700,000, certain infrastructure problems emerge — for example, all that sprawl and fewer people are one reason police response times have been so slow.
Governance has played a role as well. As the Detroit Free Press showed in its 2013 in-depth report, "How Detroit Went Broke," mayors and city councils mismanaged city funds for decades. For example, the city boosted retiree benefits and funded it by raising taxes, driving people into the suburbs and making the new benefits less sustainable. Falling property values haven't helped, either. In a vicious cycle, a flight of people can pull down property values, meaning fewer revenues in property taxes, making it harder for the city to catch up financially.
But no matter who's to blame, it is undeniable that Detroit is economically depressed relative to the rest of the country. As of July, the Detroit metro area had an unemployment rate of 9.8 percent, compared to the national average of 6.2 percent, according to the Labor Department. And according to the Census Bureau, the city's 2008-2012 poverty level was 38.1 percent, compared to the national rate of 16.3 percent.
How can a whole city go bankrupt?
A city files for bankruptcy when it has so many debts, and so few assets to handle those debts, that it doesn't think it can successfully meet its obligations. The city doesn't necessarily have to be entirely out of money; rather, it simply might know it can't meet its future obligations. So, like an individual or a corporation, it files for bankruptcy to seek protection from its creditors while it figures out a more workable plan for becoming financially stable.
Different states have different laws governing municipal bankruptcy. Some states don't allow it at all; in others, the state has to specifically permit a city to go through it. This map from Governing magazine shows states' different laws.
But even if a state allows a city to file for bankruptcy, getting a court to rule that it's eligible can be quite difficult.
"It is very, very difficult for a municipality to be eligible for bankruptcy. The standard is extremely high," says Melissa Jacoby, professor of law at the University of North Carolina. A city has to prove insolvency, she says, and one way to do that is establish "service delivery insolvency." That's when a city can't provide basic services to residents, like water, lights, and safety.
The legal steps toward bankruptcy in Detroit have been going on for more than a year. In early 2013, Michigan appointed bankruptcy attorney Kevyn Orr as Detroit's city's emergency manager. In July 2013, the city first filed for bankruptcy, with Gov. Rick Snyder's approval. The city argued that it needed bankruptcy because of its sky-high debt and more than 100,000 creditors. In December 2013, Judge Steven Rhodes agreed that Detroit is eligible for Chapter 9 bankruptcy, the part of the federal bankruptcy code that deals specifically with municipal cases.
How common is city bankruptcy?
In part because of state laws restricting it, municipal bankruptcy is relatively rare. According to an early 2013 analysis by Governing magazine, only 0.6 percent of eligible municipalities filed for bankruptcy from 2008-2012. That figure is even smaller if you're looking at cases that weren't dismissed.
While municipal bankruptcies aren't necessarily becoming more common, the last six years have made them much more visible. The Great Recession has worsened the fiscal situation in lots of municipalities. Five out of the six biggest municipal bankruptcies in history (including Detroit's) have taken place since the financial crisis, according to data gathered by the New York Times.
What is Detroit's bankruptcy plan?
Detroit's bankruptcy plan lays out how the city expects to deal with its debts — what the different classes of creditors are and who will be paid what. It's by no means a static document — currently, it's in its seventh amended version.
Many creditors have reached agreements with Detroit reducing the city's future obligations. The city's retired public workers agreed last year to take pension cuts of up to 4.5 percent, plus smaller cost of living adjustments, as the Times reported. Bond insurer Syncora, which says it's owed $333 million, will receive only 13.7 percent of that as a result of this deal, according to Bloomberg. Some of the deals involve more than money — as part of the deal with FGIC, another bond insurer, the city will demolish the Joe Louis Arena, a hockey arena, and FGIC will build a hotel.
There are other elements which cover how Detroit will handle its finances going forward — for example, the city may assume a lower expected return on pension investments than it had used in the past. If the city assumes too big of a return, that could cause pension shortfalls.
Martha Kopacz, the expert that bankruptcy judge Stephen Rhodes chose to testify on the plan's feasibility, has said that the plan is workable, but barely. Speaking October 22, she said the borrowing the city will have to do under the plan is "at the edge of what the city can be able to service in the future." According to Crain's, the city could take on nearly $1 billion in additional debt.
How far along is the Detroit bankruptcy?
On November 7, Judge Stephen Rhodes declared the city's bankruptcy plan feasible and fair to all creditors, and allowed the city to cut $7 billion in unsecured debt. After that, the city just had to finalize deals with all of its creditors, as USA Today explains. On December 10, the city exited bankruptcy, and Emergency Manager Kevyn Orr's resignation went into effect.
But the city's work is nowhere near done. Now it has to implement that bankruptcy plan. That involves a few changes. For example, the city will now have a nine-member Financial Review Commission overseeing all of its fiscal affairs. Relatedly, the city will have to balance its budget and set aside enough money for debts and pensions each year, as The Detroit News reports.
At the Nov. 7 hearing, Rhodes emphasized to the city's leaders that the way the city is run will have to change:
"You are about to get your city back from us in the bankruptcy world. We give it back to you with the fresh start that this city needs and deserves under our federal bankruptcy laws. We hope we helped. It is now on you to implement this plan. I have found that you will do that. Please make me right. It is in the city's best interest. The city's true and full fresh start depends on it."
One of the central (and more fascinating) parts of that deal was a so-called "grand bargain" involving the Detroit Institute of Arts, home to many well-known (and high-value) works of art. Rather than selling off those works to benefit Detroit, the city sold its stake in the DIA to the non-profit that runs it for $816 million. The Wall Street Journal reports that much of that money was raised from foundations and donors, along with $200 million from the state.
What more should I be reading?
There is lots of great information out there on the history behind, and the road ahead for, Detroit's bankruptcy. Here's a rundown of a few good resources:
- For a more complete rundown of the Detroit bankruptcy timeline, see Detroit's Metro Times and Free Press.
- To see the primary documents in the Detroit bankruptcy case, including updated plans of adjustment, see the city's bankruptcy page.
- To read a more nuanced discussion of what a city owes its residents in a bankruptcy, see Michelle Wilde Anderson's "The New Minimal Cities," a Yale Law Journal article from March 2014.
- For a more detailed look at how the city's politics and history led to today's bankruptcy, read the Detroit Free Press' "How Detroit Went Broke."
You didn't answer my question!
This is very much a work in progress. It will continue to be updated as events unfold and as fresh questions emerge.
So if you have additional questions or comments or quibbles or complaints, send a note to Danielle Kurtzleben: email@example.com.
How have these cards changed?
Here's a list of updates, changes, and major corrections made to these cards:
Nov. 11, 2014: Card 8 was updated to reflect that Judge Rhodes accepted Detroit's bankruptcy plan.
December 15, 2014: Card 8 was updated to reflect that Detroit had exited bankruptcy.