Detroit officials hope the bruising bankruptcy battle ahead of them will bring the reward of a leaner, more efficient and ultimately prosperous Motown.
However, history has few storybook endings to offer as a guide when it comes to US municipal bankruptcies.
Fact is, they are rare events — just 61 local governments have gone through Chapter 9 bankruptcy since 1954 — and while the process is devoted to restructuring debt and provides temporary cash flow relief, it does not help a city enhance its revenue or economic outlook. Furthermore, cities typically lose access to capital markets in the wake of a bankruptcy.
“Detroit has a very high level of debt and the bankruptcy can correct some of it, but is it going to turn around its economy quickly? That’s probably unlikely,” said Jeff Previdi, managing director of local government ratings at Standard and Poor’s.
Detroit’s financial disarray was decades in the making — a downward spiral of company departures and failures accompanied by a dramatic drop in its population, to just below 700,000 from a peak of 1.8 million, and a rise in crime.
Once the cradle of the US automotive industry and Motown music, Detroit appears to have run out of alternatives to bankruptcy barring a bailout from the state.
New York, Cleveland and Philadelphia previously teetered on the edge of bankruptcy, but Detroit is the first major US city to file for bankruptcy, pressured by US$18.5 billion of outstanding liabilities.
To this point, only much smaller local governments have gone the bankruptcy route without external help and facing similar issues.
Take for example Vallejo, California, with about 116,000 people. It spent more than three years in bankruptcy from 2008 to 2011, weighed down by generous labor contracts and retirement benefits.
The city, about 50km northeast of San Francisco, was allowed to terminate its collective bargaining agreements, but it never renegotiated US$128 million of unfunded pension liabilities and while Vallejo generated about US$34 million in savings on some of the liabilities it faced heading into bankruptcy, those have been nearly matched by expenses related to the bankruptcy itself, according to a study by Standard & Poor’s last year.
Now, two years after emerging from Chapter 9, it has yet to balance its budget and the police force is roughly half its previous size. Vallejo remains shut out of the municipal bond market and it cannot raise money to address much needed infrastructure repairs.
“We have not done enough and the budget we just adopted in June still has a US$5.2 million deficit on an US$82 million general fund budget,” Vallejo City Manager Daniel Keen said.
Both Vallejo and nearby Stockton, which before Detroit’s filing last week had been the most populous city to file for bankruptcy, have seen further increases in crime after seeking protection from creditors. Stockton, with nearly 300,000 people, was granted permission to enter Chapter 9 protection in April and will file a debt-adjustment plan later this year.
The brightest post-bankruptcy story is perhaps California’s Orange County, but its 1994 bankruptcy — the largest in history at the time — stemmed from US$1.7 billion in bad derivative bets, not the kind of grinding economic slump and population flight that feature so prominently in the Detroit case.