America's First Big-City Bankruptcy of 2013

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Detroit city bankrupt
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In the early days of the financial crisis, banking analyst Meredith Whitney famously predicted the near-death experience of Citigroup (C). But when Whitney came back on the national stage to warn of a similar financial apocalypse striking the municipal debt markets in 2011, that warning fell flat.

The wave of municipal bankruptcies never happened. The "hundreds of billions" of dollars lost to investors were not, in fact, lost. America dodged a bullet -- but none of that is going to help Detroit.

The Motor City Stalls

You see, according to Kevyn Orr, the state-appointed financial manager charged with saving the Motor City from itself, Detroit's in pretty dire straits right now. The population upon which it levies taxes to pay its bills has shrunk by two-thirds from its apex. And of those few Detroiters still living in the city, 18 percent are unemployed -- and consequently paying little or no taxes.

Meanwhile, the city is saddled with $15.7 billion in bond debt, pension liabilities and other long-term obligations on its balance sheet. Just keeping up with the interest payments on all this debt, and paying the health benefits of public employee retirees, cost Detroit $461 million of the $1.1 billion it's expected to collect in tax revenue this year.

That leaves less than $640 million with which to pay for all the daily services required by a city of more than 700,000 -- just $905.76 per citizen.

Lies, Damn lies and Damnably Difficult Statistics

That's not enough -- not without borrowing money to pay for the services these citizens need. As a result, if things keep on going as they have been, then by June 30, Detroit will have spent $380 million more than it collected in tax revenues.

Orr says that already, the city is "insolvent on a cash basis." And all this, of course, is before you even consider how to try to tackle Detroit's debt and start digging out of the hole the city's in.

According to Orr, if Detroit took every revenue dollar it collects for the next 20 years, and devoted all of it to paying down debt -- turned out the lights, let the potholes pot and the retirees eat cat food -- it still wouldn't collect enough money to pay off its debt.

Stating the obvious, Orr warned: "No one should underestimate the severity of the financial crisis."

Anybody got the number for AAA?

So what is the solution? Orr has a laundry list of ideas, none of which is going to be popular.
  • The city can cut the benefits it pays its retirees -- essentially breaching the contracts it's signed with its workers over the years.
  • It can lay off workers now on the job, breaking the social contract with its citizens (and probably eroding its tax base further as these citizens flee a deteriorating city).
  • Last but not least, Detroit can try to renegotiate payment terms with its lenders, and cut its "debt principal" -- which both sound like reasonable options ... until you realize that they're really just a polite way of saying: "Default on the debt."
On one hand, yes, default can dispose of a debt problem rather quickly. On the other hand ... good luck borrowing money in the future, once you've proven to lenders that you're quite willing to stiff them when the bill comes due.

The Endgame

The likely endgame for all of this, of course, is that Detroit will probably have to follow Harrisburg, Pa., Jefferson County, Ala., and Stockton, Calif., into Chapter 9 bankruptcy court. It won't be the first U.S. city to go this road. It probably won't be the last.

But (for the time being, at least) Detroit can claim the distinction of having been the biggest U.S. city to ever go completely bust.

Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup Inc.


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Walter Burien

If you noticed the liabilities are mostly "projected Liabilities" going far into the future.

Projected tax income is mentioned "for the year' of 1.1 billion. So what is the income projected out 20-years as is the debt they are projecting out 20-years?

Tax income is but one (1) source of income. What is their consolidated investment income? Enterprise operation income? Those two would probably be substantially greater than their tax income.

Has anyone done a careful review of the Detroit City CAFR (Comprehensive Annual Financial Report) for the last several years? http://www.detroitmi.gov/Departments/Finance/tabid/86/Default.aspx (2002-2012)

** Government was NOT supposed to operate at a profit. How did they get around this restriction?

ANSWER: If for example a city had a 100-million dollar profit for the year from any of its operations, at a stroke of a pen they create or deposit into a "liability fund" and poof, there goes the profit re-designated now as a liability.

June 11 2013 at 9:28 PM Report abuse rate up rate down Reply
michilady22

What idiotic comments. The reason Detroit is failing is because they rely too heavily on the auto industry and we just started to recover from the aftermath of 9/11 ONE year ago. BUSH is who got us all into trouble when he went after the wrong country- started a false war and bankrupted the economy. Your great grand kids will be paying for this idiot who runs naked painting pictures of himself. They say he has Alzheimers- no kidding. There was something lacking in him all eight years he "ran" the country. A D student should not be allowed behind a wheel let alone run a country. Now they want to run Jebb- the one who Daddy pardoned after the savings and loan scandals he helped create. Stop blaming our president - who came in to clean up after the circus elephants. Detroit also had one of the most corrupt Mayors in histroy- Kwame Kilpatrick. I suggest you read- yeah read. You know nothing about the economy or what is going on, only how to point fingers at the wrong president. (in respone to obamyfailedagain)

May 16 2013 at 10:35 AM Report abuse rate up rate down Reply
fishlover

No more food stamp .

May 16 2013 at 9:23 AM Report abuse -1 rate up rate down Reply
Jim

I remember way back when a black politician makking the grandiose statement that as soon as we can get the last whiteman out (talking about city government) and blacks can do what they want, you will see the glory of a city run by black people. YEP, sure is glorified!

May 16 2013 at 9:08 AM Report abuse +2 rate up rate down Reply
andromeda2mly

lets have a break dancing contest and raise some money for detroit.

May 16 2013 at 9:06 AM Report abuse +2 rate up rate down Reply
stevendy1

poor Detroit,,used to be such a nice city till that racist ,coleman young, became its mayor in the 70 "s and then went downhill after that.,,,Bring back the white people !!!!!! you all know I am right,,

May 16 2013 at 8:00 AM Report abuse +4 rate up rate down Reply
ALEX TURNBULL

Arsonal of Democracy? What a laugh. You don't need no arsonal for a democray that does not excest anymore. Blame the left?. It took both the left and right to steer this boat into the rocky shoals.

May 16 2013 at 7:16 AM Report abuse +1 rate up rate down Reply
ALEX TURNBULL

Does that mean Detriot won't chip in and help the American people pay off the 2.3 trillion dollar debt with interest it owes Japan and China?

May 16 2013 at 6:47 AM Report abuse rate up rate down Reply
mscellanus

Black, Brown and Broke!

May 16 2013 at 6:31 AM Report abuse +1 rate up rate down Reply
phrasiercrane

Haiti and Detroit. 2 examples that black people are just as bad as white people at running things.

May 16 2013 at 3:07 AM Report abuse +4 rate up rate down Reply