Despite the uncertainties surrounding what’s expected to be a hard-fought legal battle, the outcome promises to inflict more pain on Detroit’s already-beleaguered residents, businesses, creditors, investors and city workers, whose pension plans may now be invalidated.
The case will also set a legal precedent that will be watched closely by other major cities across the country, which are struggling under the weight of years of accumulated debt and underfunded pensions covering millions of public-sector retirees.
Pain in the Motor City
Detroit is the largest U.S. city to file for bankruptcy and that puts the city on an uncertain course that could lead to laying off employees and selling assets, reports CNBC’s Brian Sullivan.
“Everyone will say, ‘Oh well, it’s Detroit. I thought it was already in bankruptcy,’ ” said Michigan State University economist Eric Scorsone. “But Detroit is not unique. It’s the same in Chicago and New York and San Diego and San Jose. It’s a lot of major cities in this country. They may not be as extreme as Detroit, but a lot of them face the same problems.”
The bankruptcy filing follows a decades-long decline of a city that prospered through much of the last century as the capital of U.S. manufacturing. But as that industrial base has declined, so to have the city’s fortunes.
Detroit has endured booms and busts in the past. Even as the auto industry has roared back to life since the Great Recession, the economic recovery has left the Motor City in its rear-view mirror.
Though unemployment has fallen from a peak of nearly 28 percent in 2009, some 16.3 percent of Detroit workers are still without a paycheck. As a result, income tax revenues have fallen 30 percent in the last decade. Meanwhile, the national recovery in home prices has yet to spread to Detroit. Property taxes are 20 percent lower than 2008 levels.
“There’s no way Detroit can afford to service 140 square miles anymore,” said Scorsone. “So for parts of the city, if your streetlight’s out they’re not going to fix it. If your road has massive potholes, it’s going to turn it to gravel. It’s that stark.”
Many residents have responded by simply moving away. Once American’s fourth-largest city, Detroit’s population has fallen by a quarter since 2000. A shrinking population further erodes the tax base, intensifying the budget squeeze.
Union officials, who have vowed to fight any effort to reduce benefits to retirees and vested workers, claim the city has undermined the pension fund by outsourcing city services to workers who don’t pay into the system.
“As older people leave the workforce, the city has been privatizing those jobs instead of bringing people back in to pay into the fund,” said Ed McNeil, special assistant to the president of Michigan AFSCME Council 25, which represents city workers.
Fighting Blight in Detroit
Chairman of the Detroit Blight Authority, Bill Pulte is looking to get rid of the dangerous homes in the depressed city of Detroit. He is working to stabilize the city and help fix the suffering public safety issues by decreasing the number of abandon buildings.
Union officials also argue that the city is owed hundreds of millions of dollars in unpaid taxes that should be collected before retirees are asked to take a cut in benefits.
“If they went after that money, they could pay their debts,” said McNeil.
Detroit files for bankruptcy
Detroit is asking a federal judge for permission to go into Chapter 9 bankruptcy protection, reports CNBC’s Scott Cohn.
“You don’t want to have to do that because you want to keep your ability to borrow again to rebuild your city,” she said.
Orr must now persuade a bankruptcy judge to invalidate the city’s pension contracts, freeing him to reduce payments to retirees. The unions’ lawyers will argue that pension and health benefits are protected by Michigan’s constitution, one of seven states that specifically ban cuts in retiree pension and benefit payments.
That’s why the case will be closely watched by states such as Illinois and California, which also have badly underfunded their pensions. If Detroit is allowed to cut payments to its retirees, city and state workers in those states and others could see their future benefits pared back.
Future public sector workers can all but count on lower retirement benefits, as many state and local governments scale back the kind of financial promises that sank Detroit. With retirees living longer, those promises have become too costly to make.
China Cities to Become Like Detroit?
Medium-sized industrial cities across China could suffer the same fate as Detroit, which suffered a sharp economic decline as industry left the city, Sanjeev Sanyal, Global Strategist, Deutsche Bank told CNBC.
“I think there is going to need to be an understanding with public employees that working for 30 years and being able to have a pension for that much time or longer is not sustainable,” said Rueben.
Automakers said they plan to standby the city.
“We believe a strong Detroit is critical for a strong Michigan and our industry. The city has a difficult job ahead, and we are optimistic that governmental leaders will be successful in strengthening the community,” said Jay Cooney, a Ford spokesman.
Chrysler said it “believes in the City of Detroit and its people. We not only continue to invest in the city and its residents by adding to our presence in Detroit, we also are committed to playing a positive role in its revitalization.”
The crisis is also being watched closely in the White House.