Rebuilding the city’s economy: Part 1, unclog the carburetor

May 9, 2012 | Cities, Detroit, Economics, Markets, Municipal bankruptcy, Receivership, US News

By: David A. Smith

 

For more than a hundred years, Detroit has been associated with the internal combustion engine, to the point the city’s name became as synonymous with an industry as today’s Hollywood or Silicon Valley are to theirs. 

 

We’ve taken some losses lately

 

But the Motor City’s job engine has stalled, and as I’ve profiled at length, that has meant the city is imploding into itself and must be rationally shrunk.  With shrinking responsibility comes shrinking power, something men in particular handle badly, and that has led further to backbiting and a clogged political carburetor, as reported in The Economist (and supplemented by a followup story in Reuters, April 4, 2012):

 

Apart from more money, what the city of Detroit needs most is certainty.

 

I agree with that if by “certainty” the Economist means reliable government, rules with clear boundaries, and stable municipal finances – none of which Detroit has had for decades.

 

Both are in short supply at the moment. On March 21st a state-appointed review team unanimously agreed that it is suffering a “severe financial emergency.”

 

Unlike those mild financial emergencies Europe’s been having.

 

Emergency! Emergency!  Everybody to get from street!

 

The day before, Moody’s had downgraded more than $2.5 billion of the city’s debt, citing its lack of cash.

 

That’s so small-minded of them.

 

“There you go again, fixating on cash”

 

Amid this deepening financial crisis the state of Michigan, local unions, the mayor, the city council and the courts are battling over the future of Motor City.

 

I find it always curious that in a list of political decision-makers, the presence of one that is neither elected nor in government is always presented, unremarked, as coequal.

 

Like many of America’s struggling municipalities, Detroit is paying pensions, entitlements and salaries far larger than it can afford.

 

Without turning this post into a political tract, one can observe that giving public employees union negotiating power invites public-choice moral hazard (as the economists describe it) where elected officials can buy current political capital by promising to spend someone else’s future taxes to pay today’s political costs.  Under such circumstances, elected officials can take fiscal risk they can’t possibly know they can cover – and as a result, liabilities rise even as funding assumptions become ever more hopeful and ever less plausible.

 

I’ll handle those funding worries!

 

The simplest solution, a state bail-out, is tricky.

 

Only in politics, not in policy – but oh, those politics.

 

If we get in to funding Detroit, how do we ever get out?

 

Both the governor of Michigan, Rick Snyder, and the head of the state’s House Appropriations Committee, Chuck Moss, argue that yet another infusion of cash will not solve Detroit’s underlying problems.

 

Okay, kids, can you say ‘liquidity injection’?  And stop sniggering, Tompkins.

 

Repeat after me: Structural operating deficits are not solved by liquidity injections. 

 

To prove his point, the governor recently reminded citizens that the city has borrowed $600m since 2005 just to get by. It is also planning, with some state support, to issue $137m in bonds in order to refinance its debt and create cash flow that will allow it to totter on until the end of the financial year.

 

One uses liquidity, an extension of finance, only when time is the sole missing ingredient to a solution that will otherwise eventuate, either because (a) the entity has positive operations and cash flow is merely interrupted, or (b) the entity has already taken actions that will restore positive operations from internally available resources.

 

Detroit’s financial problems have been building up for decades.

 

At least five decades – half a century, though they first became visible in the mid-Seventies.

 

Detroit, 1974: Renaissance Center going up

 

Renaissance Center after completion: gleaming and inaccessible

 

City revenues have been hit by the collapse of manufacturing, declining property values and the flight of better-off people to the suburbs.  [Not black or white flight but green flight. – Ed.]

 

In fifty years, two-thirds of the city’s population vanished.

 

At the same time, the cost of servicing a still-sprawling city has not shrunk in proportion.

 

Ergo, the city must reduce its service obligations, and thus must get smaller.

 

Detroit has suffered a staggering population decline in recent years, causing its revenue base to shrink. Companies that once paid hefty taxes (such as General Motors) have reduced their presence in a city long synonymous with the auto industry.

 

Orion assembly plant workers protesting in Detroit

(The plant stayed open only after substantial union concessions)

 

(Of course, Detroit could cut public-employee pensions, which as we’ve seen are a huge component of municipal budgets and the cause of more than one municipal bankruptcy.)

 

Meanwhile, the engine block is almost out of lubrication:

 

Without new loans, the city will run out of cash in mid-May.  

 

That would be catastrophic, as the city would spin into unplanned default (like Prichard, Alabama, which simply stopped paying all its bills).

 

The state is pushing it hard to sort out its structural deficit.

 

Just as in Europe, the guarantor is a higher unit of government (therefore, ECB, here state of Michigan) and in exchange for extending either liquidity or a higher-level sovereign guarantee, it expects to take control over its spendthrift sub-entity’s finances.  (This is clearer in Detroit, which clearly is a subordinate entity even if it has its own budget, than in Greece or Spain, which think of themselves as sovereign nation just borrowing the Euro credit card.)

 

That’s the kind of story we like

 

Late last year it began a financial review of Detroit which was the legal prelude to bringing in an unelected emergency manager, as Michigan has done in several other distressed cities.

 

In effect, the emergency manager would be like a bankruptcy or creditors’ receiver.

 

Aspects of the agreement are controversial, particularly with the city’s labor unions.

 

Are we surprised the unions don’t like it?

 

AFSCME members in nearby Illinois

 

It would set up a Financial Advisory Board to oversee the city’s restructuring, recommend cuts in services and appoint a chief financial officer (CFO). It imposes tough terms on future union contracts, a chief cause of Detroit’s financial malaise, and insists that all existing contracts, even those recently ratified, can be reopened.

 

Quite reasonably, the state is requiring that before it provides new liquidity into a mess, it has to know there will be the tools to restructure Detroit’s budget and operations.  Like any other creditor in a workout situation, the state of Michigan wants its money to be accompanied by control: a receiver whose powers will be akin to those of a bankruptcy judge.

 

[Continued tomorrow in Part 2.]

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Comments

Comment from Matthew D Healy
Date: May 9, 2012, 8:55 pm

Seems to me, on both sides of the Atlantic problems of solvency have been treated as though they were only problems of liquidity.