Put Your Hands Up for Detroit
In the first of a three part series we look at the USA’s largest ever municipal bankruptcy. In part 1 we will look at what caused the City of Detroit to get into such trouble in the first place. In part 2 we will look at what the actual bankruptcy entailed and in part 3 we examine why something similar would be highly unlikely to occur in the UK.
Famous for car manufacturing and Eminem (and portrayed in the gritty film about the said rapper ‘8 Mile’) Detroit is a city of 630,000 on the border with Canada in the USA’s North East. On 18th July 2013 it filed for Chapter 9 bankruptcy owing around $20 billion and far exceeding the second largest US municipal bankruptcy of Jefferson County at $4 billion.
There are many reasons why it got into so much trouble. Some may be familiar to issues faced by local authorities in the UK, but others will be less so. Some are not the municipality’s ‘fault’, but others are clearly things that could have been avoided. Here are some of the main factors:
Famous for its motor industry Detroit’s population peaked during the 1950’s at 1.8 million. It has since declined by 60% as the car industry has moved to other countries with cheaper labour costs. This left the local government with far less people to pay the pensions of the higher number of staff they needed in the past. The population left was increasingly older (younger people are more likely to leave somewhere with no jobs) and poorer (people with wealth and resources are also more likely to leave a declining city). Residents were therefore more in demand of local government services and less able to pay taxes. Population decline still leaves you with a lot of streets to clean and bin rounds to do even if half the houses are empty. Finally, as more and more people left, property prices fell meaning the property taxes the city could collect also fell.
Pension and Healthcare Benefits for Employees Remained High Despite the Fact the City Could Not Afford Them
Despite a very concerted effort by the city to reduce the workforce, pension and healthcare costs for existing and retired staff were seen as overly generous. This including a questionable practice of paying out excess earnings from pensions to retirees and active employees instead of reinvesting them in the fund. Even as the City was under increasing financial pressure action to change this did not happen in time.
High Taxes Made Population Decline Even Worse
To help deal with its financial problems the city made the somewhat understandable decision to raise taxes on residents. Local governments in the US have far more extensive powers than in the UK to control local taxation. Unfortunately this made the problem worse not better as residents increasingly moved out of the city to avoid the higher taxes, making total taxation income lower overall.
The City Borrowed too Much
Too much debt is generally the reason behind most bankruptcies and Detroit is no exception. The city borrowed extensively to fund capital expenditure but also (as would not be allowed in the UK) to fund revenue budget gaps. There is a widespread impression that the city increasingly borrowed to fund holes in its budgets rather than face up to and manage the difficult financial situation it was in.
The City Struck a Complex Financial Deal that went Bad
Mayor of Detroit from 2002 to 2008 Kwame Kilpatrick is a convicted felon who served a long prison sentence for fraud, racketeering and perjury. Whilst this clearly didn’t improve the fortunes of Detroit perhaps his least good move was to engineer a complex financial deal with Wall Street to restructure the city’s pension fund debt. Funded by borrowing $1.4 billion the deal was supposed to save the city but went bad with the onset of the 2008 financial crisis, eventually costing the city $2.8 billion.
A Local Taxation Tale of Two Cities
Local Authority Counterparty Risk