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‘The fact is that all of the older, post-industrial cities in this country are in financial difficulty to some degree,’ says one analyst. (REBECCA COOK/REUTERS)
‘The fact is that all of the older, post-industrial cities in this country are in financial difficulty to some degree,’ says one analyst. (REBECCA COOK/REUTERS)

public finances

Lessons from the Motor City Add to ...

The city of Boulder, Colo., has almost nothing in common with Detroit. A prosperous university town nestled near the Rocky Mountains, it makes sure to match recurring revenues and expenses. Five years ago, it began a budgeting overhaul to improve its long-term fiscal health. But Robert Eichem, the city’s chief financial officer, is nevertheless paying close attention to the Motor City.

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“These are the things that can happen in the long-term,” Mr. Eichem said. “We as finance people have to learn from this.”

Across the U.S., cities are taking a hard look at their vulnerabilities in the wake of Detroit’s historic bankruptcy, the largest-ever by a municipality. The good news is that Detroit is not the U.S. – the city’s woes were uniquely severe, accumulated over decades and compounded by a confluence of factors. The bad news is that some of the strains and stresses that helped humble Detroit, including rising pension costs for city employees and faltering revenues, are ones that other cities can expect to face – and in some cases, already do.

That means Detroit is less a harbinger of things to come than a warning shot. The Great Recession dealt a severe blow to municipal budgets, as property prices tumbled and cities were forced to shed workers and pare services. States, meanwhile, were under similar pressures, and cut their financial assistance to cities.

While the U.S. economy has steadied and the housing market has started to recover, city budgets remain stretched. And the coming years will bring a new fiscal ordeal, as pension and benefit payments due to public employees born during the baby boom swell.

“The fact is that all of the older, post-industrial cities in this country are in financial difficulty to some degree,” said Alan Mallach, a fellow at the Brookings Institution and an expert on urban policy. “They’re all seeing revenues that are at best not growing as fast as their costs.”

One major source of future obligations: pension and health care costs for retired city employees. A recent study of 30 American cities by the Pew Charitable Trusts found that half of them had set aside less than 80 per cent of the money needed to fund their pensions, a level that experts describe as inadequate. The city with the lowest funding ratio – 35 per cent – was Pittsburgh. On the opposite end of the spectrum, Washington actually had a surplus in its pension funding. (The figures reflect statistics for 2009, the latest year available).

The day before Detroit’s bankruptcy filing, ratings firm Moody’s Investors Service lowered its credit rating on the city of Chicago by three notches to reflect its concern about the city’s looming pension predicament. The city’s unfunded pension liability was an estimated $30-billion (U.S.), Moody’s said, a figure equal to seven times the city’s annual revenue.

At the same time, Chicago is very far from being Detroit. It remains a vibrant and dynamic city with the capacity to raise more revenue from taxes if it deems necessary, “an economic capacity that is completely absent” in the Motor City, noted Moody’s.

The larger problem posed by pension obligations is the way they can end up pitting the needs of a city’s current residents against the promises made to its former employees. “Eventually, as they grow over time, they can crowd out money and resources for other priorities,” said Kil Huh, who directs a project on state and local fiscal health at the Pew Charitable Trusts.

In Detroit’s case, this became a vicious bind: the city cut money for essential services and infrastructure – the very items that attract new tax-paying residents and businesses – and resorted to borrowing to fund its pension costs. The endgame there will pit angry bondholders against pensioners who are, if anything, even angrier. These are “both deserving parties who are looking at, to put it harshly, the remains of a corpse,” said Paul Maco, a lawyer and former regulator who oversaw the municipal bond market at the U.S. Securities and Exchange Commission.

Detroit will serve as a critical test case. The decisions made during its bankruptcy process will ripple through the municipal-bond market, impacting all cities. And for the handful of municipalities in dire straits, Detroit’s difficult choices will new set precedents.

“The vast majority of municipalities are not in stress and will remain bystanders as the Detroit events unfold,” noted a Moody’s report released Friday. But if Detroit succeeds in reducing pension benefits and discharging its debt, it may “enhance the appeal of a similar tactic for other stressed entities.”

Municipal bankruptcy remains rare and unpalatable, said James Spiotto, a bankruptcy expert and partner at Chicago law firm Chapman and Cutler. Since 1954, there have been just 62 cities, towns and counties that have filed for bankruptcy, he said, for a rate of roughly one a year. In many cases, there is a particular circumstance – a disastrous infrastructure project, a risky investment, an unforeseen legal settlement – that is the source of a city’s trouble.

No metropolis wants to follow in Detroit’s footsteps. “You get yourself on a list you don’t want to be on,” said Mr. Spiotto. “People remember it and there are consequences. What we don’t know, for the large municipalities, is how serious the consequences can be.”

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