What Chapter 9 Bankruptcy means for Detroit

What Chapter 9 Bankruptcy means for Detroit

Even wonder what happens when a city goes bankrupt? Does a form of government even control the city anymore? Other questions such as who provides the public services or do the residents still pay tax also come to mind. Since the city of Detroit filed for Chapter 9 bankruptcy protection on the 18th of July 2013 at an estimated $18 billion worth of debt, I guess it is worth talking about it how it could pan out.

Although it is rare it is not unprecedented for local municipalities to run into some financial trouble, just like any other individual, business or sovereign government would. Most of us would know about chapter 7 bankruptcies in which case the assets get liquidated the proceeds go to creditors and you get thrown out onto the street or the business gets shut down. Then there are chapter 11 filings in which case the business operates under the protection and oversight of the court until it emerges. This way the court will oversee the negotiation of how the debt is repaid and the reorganization of the business. Of course businesses also have the option to sell or merge the business before filing for bankruptcy.

For Sovereign governments there are a variety of solutions available, such as austerity measures, debt relief, privatisation of public assets, printing money to inflate away the debt, or even devaluing the currency to spur export growth. Stuck in the middle are municipals who files chapter 9 which is similar to chapter 11, except that the powers of the bankruptcy courts are weakened by the tenth amendment and cities have greater power to rewrite collective bargaining agreements. The city has the right to tax like any sovereign government, but it cannot print money nor devalue the currency like individuals and businesses. There is also one other avenue of help in the form of state government and the federal government bailouts. However both the state government and federal government have so far refused, the state preferred reforms rather than throwing money at the problem while the federal government doesn’t have any money to spare from the budgetary deadlock in Washington.

In a way it is very similar to the debt crisis in the Euro zone. Bailouts are difficult to come by, debt troubled nations are stuck with difficult choices of austerity, throwing more money at the problem or implementing economic reforms. The notable differences are that people are less willing to move to another country as opposed to people moving to another city in America. This is exactly what has happened in Detroit, which once boasted 1.8 million residents in the 50’s. The city is now a scourge of abandoned neighbourhoods and empty buildings with less than 700,000 residents left, all dispersed widely making it difficult and inefficient to provide public services.

Detroit’s bankruptcy is in a sense unique in that it defaulted due to decades of mismanagement of the local economy. Historically, accounts of municipality chapter 9 filings involved sudden changes in tax revenue or sudden litigations filed against the city. These events usually had an economy strong enough to endure the pain of austerity until the city is back on its feet. Despite Detroit once being one of the powerhouses of the Automobile industry during the 50’s and 60’s, competition from overseas and automation within car manufacturing have lead to the decay of its economy and the subsequent outflow of residents. The city has been doing it tough ever since the global financial crisis during which General Motors and Chrysler had to get bailed out by the government. As people cut out luxury spending; which includes new cars, it leads to lower car sales and unemployment in the car manufacturing industry.

The fact is Detroit was stuck in a downward spiral, as the local economy struggled and unemployment grew, tax revenues would’ve diminished, and so too would public spending. This would lead to deterioration in the public services like teachers, police officers and nurses, which leads people to migrate to other cities. This then triggers the chain again, resulting in tax revenues to continue to dwindle and more people to leave until we end up in a situation that Detroit is currently facing.

So, what happens next? Well, currently the city is attempting to renegotiate the terms with creditors, these range from Unions to pensions, bankers to bond holders. In the event of successful negotiation, it would still require the city to balance its budget which means more austerity is likely. This is probably not the best solution going forward given that austerity simply drives this downward spiral forward. More cuts to public services, salaries, city maintenance, pensions and not to mention an even higher surge in crime rates due to a dwindling police force will mean Detroit won’t be a pretty site anytime soon. The worst case scenario would be that the municipal would have to hand over its jurisdiction to some other government entity e.g state or county. Although it would be difficult due to legal barriers and possible constitutional powers it would be the most logical solution, in this case the state will run the public services and the municipal finances. Therefore it is unlikely the no taxation scenario would pan out, as for other unlikely solutions like a private billionaire or Canada buying up Detroit, both would have its legal and political complications.