Mike Boening / Creative Commons
Mike Boening / Creative Commons
State Budgets

Bankruptcy in Detroit: Harsh Reality and Ray of Hope

After decades of utter mismanagement combined with a collapsing population, the City of Detroit became the largest municipality in United States history to file for Chapter 9 bankruptcy protection. The word bankruptcy, alone, carries negative connotations, but in this case the filing represents real hope for the Motor City.  Struggling municipalities across the country should look to Detroit and learn a valuable lesson; there is not always a bailout on the other end of the overspending rainbow.

According to Kevyn Orr, Detroit’s state appointed Emergency Manager, outstanding obligations total $15 billion. This includes a completely unfunded $5.6 billion retiree healthcare liability. Detroit’s unfunded public pension liability, State Budget Solutions found, is at least $3 billion. These challenges have grown from failure of political leaders to adapt to the needs of a population that has fallen from a high of 1.8 million to just 700,000 today.

The Chapter 9 bankruptcy process is long, and complicated. Not many understand it, given its rarity. Between 1980 and 2010, there were just 239 filings. Since January 2010, there have now been 36.

Once a bankruptcy court approves Detroit’s filing, the city, will receive protection from creditors while it crafts a debt adjustment plan. Obviously, this plan will include modifications to the terms of outstanding debts – a harsh reality for creditors of all stripes, including retirees and employees. Where previously it had not been possible to adjust debts to bond holders that option now becomes certain.

Adjusting these debts and crafting a new plan for the future is the first step on the road to recovery. While many of Detroit’s powerful political leaders certainly thought they could fight off the inevitable just long enough to prompt federal bailouts, municipal bankruptcy is an alternative that, though painful, is more than just another way of temporarily patching a hole in a sinking ship.

Municipal bankruptcy, like any other form, is not without its pitfalls. The decision to file and ultimate outcome could have a tremendous impact on the ability and costs of other municipalities seeking to borrow money. Further, if political tensions prevent Detroit from properly addressing financial issues that lead to this filing, the City could end up back at square one.

The possible benefits of Detroit’s bankruptcy are significant. New, promising sprouts of development in the downtown area will have the opportunity to grow and mature shielded from the crushing weight of political failure, debt and corruption. Developers and families alike can plant roots in a city they are confident will be able to provide vital public services like safety, trash pick up and street lighting. Current, former, and future employees will be able to count on a secure retirement.

Bankruptcy is never an ideal outcome, but Detroit was out of options. The bold step taken in the Motor City could serve as a warning and a signal, that municipal bankruptcy is a real option for other municipalities failing to address their debts. This includes cities like Syracuse and Chicago, along with other municipalities in states like Pennsylvania and California. The Windy City is likely the next shoe to fall. Above all, elected officials around the country must take this lesson from Detroit: Do not spend money you do not have because one day, the bills will come due.

In Depth: State Budgets

Smart budgeting is vital to a state’s financial health. The ALEC State Budget Reform Toolkit offers more than 20 policy ideas for addressing today’s shortfalls in a forthright manner, without resorting to budget gimmicks or damaging tax increases. One way to stabilize budgets over time is to embrace…

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