Detroit’s bankruptcy is so catastrophic, and its causes so local, that it is tempting to say that the Motor City’s downfall has few lessons for state and other local governments. It’s hard to imagine a combination of deindustrialization and population loss more powerful than what afflicted Detroit.
Still, mismanagement made matters worse. Anyone who doubts that should peruse the bankruptcy plan filed by the city’s emergency manager, Kevyn D. Orr, on Feb. 21. It prescribes pension cuts for city retirees and an 80 percent haircut on bondholders, and it documents the terrible governance that helped make these unavoidable.
Orr proposes cutting police and fire pension benefits by up to 10 percent per year; civilian retirees face a potential cut of 34 percent. The latter is especially painful, given that Detroit civilian pensions average only $19,000 per year. (The figure is $30,500 for police officers and firefighters.) Not surprisingly, the city’s unions want to fight the cuts, and a citizens’ group is vowing to “shut the city down” in protest.
As Orr’s report explains, however, Detroit’s pension funds might be less vulnerable today if their trustees, many of them city union officials, had not repeatedly dipped into them to make bonus payments, sometimes known as “the 13th month,” to retired and active city workers. That ploy cost the city’s two largest pension funds $1.92 billion between 1985 and 2008, according to Orr’s filings.
Bondholders, too, are bemoaning their fate under Orr’s plan. Pensioners are getting too much, and they are getting it at bondholders’ expense, they cry. Labeling the plan “hostile” to holders of $2 billion in general revenue obligations, the Fitch bond rating firm has issued a statement suggesting that Orr’s plan could damage the bond market’s “perception of the state and its local governments.”
Lenders have come to treat tax-backed municipal debt as nearly risk-free, and no doubt Detroit’s bankruptcy experience may cause some to reprice the risk of financing municipal governments, not only in Michigan but also around the country. But that might not be an entirely bad thing, within limits, if it prompts loosely run municipalities to keep their finances in better order. Surely banks that took fees to help Detroit fund its pensions with $1.4 billion in dodgy “certificates of participation” deserve to be taught a lesson. As Orr alleges in a separate lawsuit related to the bankruptcy, the certificates were essentially loans to shell corporations that enabled Detroit to take on debt in violation of its legal borrowing limits.
District Judge Steven W. Rhodes will decide whether Orr’s plan is “fair and equitable” under applicable law. Already, though, it has served one important public service: to remind every city and state in the United States that eventually fiscal irresponsibility catches up with you.