Not like this is a surprise though. Back in March Michigan Governor Rick Snyder appointed renowned bankruptcy expert Kevyn Orr as the emergency manager of Detroit when it appeared Detroit was in imminent danger of defaulting on several upcoming bond and pension payments.
Since that time Kevyn Orr has been in talks with Detroit’s numerous creditors in an attempt to find some common ground with the municipal bond holders and the unions representing the city’s huge municipal employee pension obligations.
In the past few decades Detroit has hemorrhaged jobs and population as the historical manufacturing jobs moved overseas or to the right-to-work states in the South. In recent years Detroit’s unemployment rate has hovered around 15-16%, over double the national average. Similarly the number of properties with delinquent property taxes is absolutely stunning if viewed visually. Housing vacancy rates are so high in some areas, and the budget so restricted, that the city has actually turned off street lights and restricted policing to save money.
Perhaps worst of all, for decades the city failed to spend the necessary money to evolve itself and its workforce, and hence has been passed over. Eventually stagnation descends into decay. Although to be fair these investments are difficult to make when rent-seeking unions maintain a stranglehold on public policy, actively opposing the necessary innovations while simultaneously consuming an ever growing portion of the budget.
Detroit is a profound example of the growth of public employee remunerations outstripping the growth and hence tax revenue of their municipality. This forces the city to deficit spend in order to fulfill the unions’ unobtanium-plated pension obligations.
The result is a self-perpetuating cycle of debt; the city sells municipal bonds but then funds the interest payments on those bonds with sales of new municipal bonds, pays interest on those newer bonds by selling more bonds, etc., but each time the interest rates are higher. It’s equivalent to getting a new (higher interest) credit card in order to payoff other credit cards; eventually no one will lend you anymore money and you’ll still be in debt.
However unions are not the only ones to blame. Wall Street was kind enough to make huge losses for Detroit’s pension plans, though this moribund failure has not stopped bankers from still happily taking their extensive cut:
The debt sales cost Detroit $474 million, including underwriting expenses, bond-insurance premiums and fees for wrong-way bets on swaps, according to data compiled by Bloomberg. That almost equals the city’s 2013 budget for police and fire protection. The largest part is $350 million owed for derivatives meant to lower borrowing costs on variable-rate debt.
As a quick example: back in March of 2010 when Detroit’s outlook was rosier – the city sold 14 year maturing municipal bonds at an outrageous yield of 7.56%, double that of top rated municipal debt. Recall the rule of 72 – a 7.56% interest rate doubles in 10 years, hence financing at this rate over 14 years is a massive bill. You’d have to expect nothing short of a miracle in Detroit to expect that money would be repaid.
Currently if we tally up the numbers, municipal worker pensions are expected to lose 90% of their value, with an 81% loss for unsecured creditors and a 75% loss for secured creditors.
What’s the lesson to be learned here? Well there is a saying “debts that cannot be paid will not be paid,” the finance equivalent of economics’ caveat emptor.
Lastly, here’s a good list of what to expect next in Detroit.