CHICAGO — As Michigan officials near their deadline for deciding the future of Detroit, a new report suggests that one of the more dramatic options on the table — a Chapter 9 bankruptcy — doesn’t offer a panacea to the city’s deep-seated financial problems.
If it opted for such a filing, Detroit would be the largest American city to file for municipal bankruptcy, and the first local government to do so in Michigan. Many steps remain before it could file for Chapter 9 protection, and there is no indication that state officials would be willing to let that occur.
But with the threat of a state takeover hanging over the city’s head, and with Mayor Dave Bing warning the city will run out of cash by early spring without major union concessions, the possibility of bankruptcy looms large.
A 10-member state review team that is examining the city’s books for evidence of a financial crisis is expected to recommend to Gov. Rick Snyder within the next seven to 10 days whether a fiscal emergency exists.
The team can recommend that the governor appoint an emergency manager, work with local officials to craft a so-called consent agreement, or do nothing.
The new report, “Evaluating a Chapter 9 Bankruptcy for City of Detroit: Reality Check or Turnaround Solution?” examines six municipal bankruptcy cases and asks what Detroit would gain or lose if it seeks bankruptcy protection from creditors.
“I wanted the review team to have the facts to the extent that we can predict what Chapter 9 can and can’t do,” said Eric Scorsone, a Michigan State University professor and the co-author of the report with Nicolette Bateson. “It will be the emergency manager’s decision ultimately, but I wanted to make sure the review team had access to that information.”
On the plus side, bankruptcy serves as a reality check forcing all stakeholders to the table, the report said. More importantly, it is one of the only ways to bring down so-called legacy costs, such as pension payments and other post-employment benefits, that are crippling cities like Detroit.
“The big news coming out of Vallejo and Central Falls is the major reduction in legacy costs that has been achieved,” Scorsone said, noting that Detroit’s OPEB liability is $5 billion, among the highest in the country. “These are not going to be easy to be reduced [outside of a bankruptcy court].”
“The real question in Michigan is whether the emergency manager is able to do the same thing, or is there some other mechanism to achieve those reductions in a way that makes Detroit financially sustainable without bankruptcy?” he said.
Michigan’s relatively new law for fiscally stressed local governments allows an EM to terminate and re-write labor contracts, but does not allow for the reduction of retirement costs. The law also specifies that an EM’s union contract modifications are temporary. “Does this mean that in three years this all gets unwound?” Scorsone said. “That’s very problematic.”
Even if the state’s laws fall short, there are a number of drawbacks to a Chapter 9, Scorsone said. The negative press surrounding a municipal bankruptcy remains a major problem, even in Michigan, where the recent corporate bankruptcy reorganizations of General Motors and Chrysler are widely seen as successful, he said.
“Given the good news coming out of the auto industry, which is often referred to as Detroit, this would be a negative impact when Michigan is trying to rebuild its image,” Scorsone said.
The threat of the so-called contagion effect, when a bankruptcy filing drives up borrowing costs of nearby localities and the state itself, is real, though often more short-lived than expected, Scorsone said.
Because of Detroit’s size and municipal workforce, Chapter 9 would be long, costly, and complicated. Like other aging industrial cities, Detroit faces a myriad of structural problems that have worsened over decades and largely fall outside the purview of a federal bankruptcy court, Scorsone said.
“A federal judge has so many limitations,” Scorsone said. “At a minimum, you’d have to combine [bankruptcy] with some state policy, like the emergency management law in Michigan’s case, and you have to look at the whole structure of the government. If you find a route to reduce costs without going to bankruptcy, you’re better off.”