Detroit Files for Bankruptcy; Debt Could Total $20 Billion

Detroit Files for Bankruptcy; Debt Could Total $20 Billion
July 18, 2013

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)

Kevyn Orr helped turn around Detroit-based automaker Chrysler LLC but apparently needs help turning around Detroit itself.

The City of Detroit has filed for bankruptcy. If a federal bankruptcy court approves the filing, it would be the largest municipal bankruptcy in United States history. Orr estimates the city’s debts could be as high as $20 billion.

The July 18 bankruptcy announcement came one month after the city defaulted on a scheduled debt payment of $39.7 million.

Orr is an attorney who represented Chrysler during its restructuring with Italian automaker Fiat in 2009. In March, Gov. Rick Snyder (R) named him emergency financial manager for Detroit.

Pennies On the Dollar

Last month Orr issued a debt restructuring plan that would have given unsecured creditors $2 billion of limited recourse participation notes to replace $11 billion of unsecured debts. That’s less than one-fifth what creditors are owed but more than Orr said they might receive if the city goes into bankruptcy.

“It's no surprise that Detroit filed for bankruptcy,” said James Hohman, assistant director of fiscal policy at the Michigan-based Mackinac Center for Public Policy. “The city's creditors were clearly not willing to take the major concessions Orr asked of them. Without buy-in from bondholders, note-holders and retirees, the city cannot implement its plan to restructure debt. Only a bankruptcy judge can limit those debts now.”

Snyder announced his support for the bankruptcy filing in a letter to Orr and State Treasurer Andy Dillon.

"The citizens of Detroit need and deserve a clear road out of the cycle of ever-decreasing services," Snyder wrote. "The city's creditors, as well as its many dedicated public servants, deserve to know what promises the city can and will keep. The only way to do those things is to radically restructure the city and allow it to reinvent itself without the burden of impossible obligations."

His letter also noted a "vital point" made by Orr, that "Detroit tax rates are at their current legal limits, and that even if the city was legally able to raise taxes, its residents cannot afford to pay additional taxes."

Employee, Retiree Benefits Under Fire

Under bankruptcy, a judge could change or end city employment contracts and retiree pension and health insurance packages, and force the sale of city assets.

Already, though, Detroit’s pension funds have sued Orr and Snyder to block benefits cuts to current employees and retirees.

Two months ago Orr issued a report that called for a “complete restructuring” of Detroit’s government operations. The report called special attention to the city’s huge retirement costs and other obligations. The report notes twice as many people are taking money out of the city's pensions as there are paying in.

“The city’s operations have become dysfunctional and wasteful after years of budgetary restrictions, mismanagement, crippling operational practices and, in some cases, indifference or corruption,” he wrote. “Outdated policies, work practices, procedures and systems must be improved consistent with best practices of 21st-century government.”

Decades of Decline

Detroit has been in decline for 50 years. The city has approximately 714,000 residents, less than half the number who lived there in the 1950s. Detroit's population has dropped more than 25 percent since 2000.

For much of the 2000s Detroit city government was virtually a criminal enterprise. On March 11, former Detroit Mayor Kwame Kilpatrick and others, including Kilpatrick’s father Bernard Kilpatrick, were convicted on dozens of corruption charges. The mayor himself was found guilty of 24 charges including racketeering, extortion, bribery, mail fraud, wire fraud, and filing false tax returns. Among other things, prosecutors said Kilpatrick spent $840,000 more than he earned during his 2002 to 2008 tenure in office, much of it by diverting government grants and other taxpayer dollars to personal use.

Current Mayor Dave Bing has been cleaning up City Hall and working to improve the city, Hohman said, but faces a daunting task because of the many years of mismanagement, corruption and economic decline that preceded him.

In a statement, Bing said, ""Today's bankruptcy filing is an unfortunate event in our City's history. While it has never been my desire that the City file for bankruptcy, I understand why Kevyn found it necessary to do so. I said when I entered office four years ago that our City was in a financial crisis. I also said we cannot simply cut our way out of this situation."

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)