Dem-Controlled Detroit Defaults
Posted By Arnold Ahlert On June 17, 2013
In Detroit, more than a half-century of Democratic rule has taken the ultimate toll. On Friday, Kevyn Orr, the emergency fiscal manager appointed March 1 by Republican Gov. Rick Snyder, announced that the city intends to default on approximately $2.5 billion in unsecured debt. That default is detailed in a 128-page restructuring report aimed at preventing the largest municipal bankruptcy in the nation’s history. “We have to strike a balance between the legacy obligations to our creditors and our employees and retirees and the duty as a city to 700,000 residents for lights, police, fire, emergency management, cleaning the streets,” Orr told reporters.
Reality hit home on Friday when the city missed a $39.7 million payment on a debt obligation used to fund pensions. Orr met in a closed-door session with about 180 of the city’s creditors, including bond holders, union representatives, pensions trustees and others, seeking critical concessions that include taking ten cents on the dollar for what those creditors are owed, while underfunded pensions plans may get even less. Even if the deal is acceptable, Detroit’s chances of going bankrupt remain 50-50. “This is not a jaded effort just to get to a bankruptcy filing,” said Orr. “I sincerely want people to behave rationally and take this opportunity to work together.”
Rational behavior has been scarce in Detroit for quite some time. Beginning in 1962, Detroit has endured a steady diet of Democratic mayors and their social welfare agenda. Beginning in 1962, Mayor Jerome Cavanagh ushered in a “Model City” program to a nine-square-mile section of the city. It was based on a Soviet Union-style approach, aimed at rebuilding entire urban areas all at once. The effort was funded by a commuter tax and a new income tax that Cavanagh told residents would be paid by “the rich.” Yet the same central planning that that formed the heart of the Model City program was extended to the people themselves, who eventually resented being told by government how to run their businesses and their lives in exchange for government goodies. Unsurprisingly, the program was a monumental failure.
Then there were the riots. In 1967, police broke up a celebration at a “blind pig.” Blind pigs were after-hours clubs that featured gambling and prostitution and had been part of the traditional black culture in Detroit since Prohibition. The political leadership considered them antithetical to the Model City program. An enraged neighborhood did not. People took to the streets, igniting the worst race riot of the decade. Black-owned business were looted and burned to the ground. Forty people were killed and 5,000 were left homeless. Thus began the “white flight” out of the city center, totaling 140,000 people over an eighteen month period, ensued. The city never recovered.
None of this stopped the progressive agenda from continuing to be implemented. Public employees were given precisely the exorbitant wage and benefits packages that are coming back to haunt the city now. This Democrat-fostered attitude extended to private sector unions, whose equally exorbitant packages, along with efficiency-strangling work rules, made the cost of doing business in the Motor City prohibitive. As a result, much of the car industry that formed the city’s employment backbone left for right-to-work states that provided a far less hostile — and far more affordable — business climate.
As chronicled here, the same progressive-inspired insanity destroyed the Detroit public school system (DPS), which itself stands on the brink of bankruptcy. This tragedy is highlighted by several sad realities. In 2009, DPS students turned in the lowest scores ever recorded in the national math proficiency test over its then-21-year history. The state of Michigan, led by Detroit, has one of the highest black-white achievement gaps in the nation. As of June 12, only 1.8 percent of the system’s students were capable of doing college level work.
Yet by far the most telling indictment of the system is this mind-bending reality: a full 47 percent of city residents are functionally illiterate.
Thus, Detroit’s date with fiscal destiny was pre-ordained. Orr is applying the pressure, telling creditors that they might not fare as well in bankruptcy court as they can right now. “It doesn’t get better with time, OK?” he told the Detroit Free Press editorial board following the meeting. “It actually gets worse. So the sooner you come in, the better treatment you might get.”
Orr may not be exaggerating. Left unchecked, the city’s debt obligations, including pensions and healthcare outlays that currently total a staggering 42.5 percent of all city revenue, will rise to 65 percent by 2017. No other major city has more than 20 percent of their revenues going to similar payouts. Thus, in addition to the aforementioned 90 percent losses Orr needs for the city’s creditors to absorb, other measures are also being considered. These include the possibility of selling city assets, including parking garages, and artwork from the Detroit Institute of Arts. The city park of Belle Isle will be leased to the state–under virtually the same conditions the Democrat-controlled City Council rejected. The Water and Sewerage Department will remain under ownership of the city, but spun off into a regional authority. And finally, the city wants to replace its retiree health-care plan with one relying on ObamaCare’s federal insurance exchanges or Medicare, coupled with some city supplements.
All of the ostensible savings generated by this plan will be plowed back into the city over the next ten years, including $500 million for blight removal and $1.25 billion earmarked for shoring up the police and fire departments, and restoring many of the streetlights in the city ranked by the FBI as the second-most dangerous in the nation.
Two of the nation’s rating services were unimpressed with the plan. Following the meeting, Standard & Poor’s lowered the rating on the city’s general-obligation debt from CCC-minus to CC with a negative outlook, while Fitch Ratings cut the city’s unlimited-tax and limited-tax general obligations, along with its pension obligation certificates, to C. The former rating indicates a debt obligation 10 steps below investment grade. The latter rating constitutes “imminent default.”
More than imminent, default looks inevitable. This is due to the reality that even if creditors sit still for ten cents on the dollar, the follow-up to this plan requires that the city borrow additional funds. Where will that money come from, given that current creditors have been asked to forgo 90 percent of their investment? National Reviews’s Kevin Williams reveals the infuriating answer, noting that “the unwilling taxpayers of Michigan and those of the United States” will be forced to foot the bill, even as “the collection of misfits, miscreants, and criminals who govern that poor city” remain in control of the municipal government.
Again, that would be a collection of Democrat misfits, miscreants, and criminals.
Yet as Williams correctly explains, it is not entirely clear whether pensions and retiree benefits can be legally reduced. The city furthest along the timeline in determining whether such an arrangement is viable is Stockton, CA. In April, U.S. Bankruptcy Judge Christopher Klein allowed that city to enter bankruptcy, pitting the city’s creditors against its public employee retirement funds, regarding who gets paid off first. Since that was the first Chapter 9 bankruptcy case challenging state pension obligations, it really becomes a matter of whether the Tenth Amendment of of the Constitution preserving states’ rights trumps federal bankruptcy law. The case is likely to end up in the U.S. Supreme Court.
Yet regardless of any court ruling, there are no winners. Either thousands of municipal employees take a hit on their contractually obligated health and benefit packages, or the $3.7 trillion municipal bond market where cities go to get much of their financing — long considered a safe, mom-and-pop investment vehicle — may be far more reticent to lend money to the nation’s municipal basket cases. Orr spokesman Bill Nowling expresses that no-win reality with regard to Detroit. “It’s going to have an impact” on the municipal-bond market, he said before the meeting. “But we’re at a crossroads.”
The city has 10,000 current city workers, roughly 20,000 city retirees, and 700,000 residents, and its current budget deficit could top $380 million by July 1. Nowling didn’t say whether Detroit would honor its next general-obligation bond payment, contending the city is “going to go month to month.” Kevyn Orr believes Detroit’s long-term debt tops $17 billion. Negotiations begin with union leaders next week, and continue through August. If they stall at any point along the line, Orr can file for Chapter 9 bankruptcy.
Orr wants to avoid bankruptcy. “What the average Detroiter needs to understand is that where we are right now is a culmination of years and years and years of kicking the can down the road,” he said, insisting his proposal should not be seen as a “hostile act,” but a step in the right direction. Maybe so, but it seems like an impossible task, given the reality that the city has spent $100 million more than it takes in every year since 2008. In three words, Orr expressed the reality that Detroit and several other cities mismanaged by years of Democratic control currently face.
“We’re tapped out,” he said.
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