Broken City: Detroit

How Detroit's epic bankruptcy could help the rest of the country

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Photograph by Dave Jordano. Background extended.

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Now comes the bankruptcy. Generally speaking, bankruptcy is a way for an individual, company or even government entity to solve the problem of having fallen so far into debt that it looks impossible to get out or even to continue paying everyone who is owed money. In bankruptcy proceedings, some of those creditors may get most or all of what they're owed, others may get some and still others may get nothing.

Municipal bankruptcies are an especially tricky business because they involve federal, state and local laws, some of which conflict. For starters, federal law states that in such defaults, secured creditors (typically big-name investors who hold general-obligation bonds) get paid first. Pensioners typically get whatever is left, and possibly zero. But Detroit is hoping to use bankruptcy to treat its general-obligation creditors as unsecured--meaning investors who thought they were guaranteed money might not get to collect as much as they expected. While that may or may not be legal, a lot of people feel it's fair to spread the pain around. "Public employees didn't cause these problems. Politicians making unfunded promises did," says David Crane, a onetime economic adviser to former California governor Arnold Schwarzenegger and now a lecturer at Stanford. "Yet employees are often the ones who suffer."

That's just what Susan Hyter is afraid of. Hyter, 65, drives street sweepers and salt trucks for Detroit's department of public works. "It's devastating to work and think you're going to have a pension and be told you're not going to have one, or maybe three-quarters of one," she says. She worries that damage to her pension is inevitable--as is the disruption of her retirement plans. "I'd rather use my retired life to volunteer and help people, but right now I'm thinking about getting a job at McDonald's."

But while it's painful--and sometimes tragic--for workers to contemplate benefit cuts, it is far from clear that labor unions serve their members best by taking a hard line. Pension funds in Detroit have launched lawsuits to try to prevent the city from declaring bankruptcy and restructuring $3.5 billion worth of unfunded pension contracts, written in far flusher times and assuming returns that were never all that realistic to begin with (8%!). It's true that Michigan's constitution has provisions protecting public-worker pensions, but all the magical thinking in the world won't change the fact that barring a federal bailout, making Detroit's budget work without restructuring entitlements is a losing battle--and a dying city is in no position to pay anyone. Detroit, said Governor Snyder in a July 18 statement, must lay the foundation for future growth and make a "fresh start" without "burdens of debt it cannot hope to repay."

Better Economies, Bad Finances

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