The Fiscal Crisis in Detroit: Problems and Solution

I will devote this post to some reflections on the event I had attended, sponsored by the Penn Social Science and Policy Forum and the Penn Institute for Urban Research. The topic was titled “Bankrupt: Lessons from the Detroit Fiscal Crisis” (Penn IUR 2013; Penn SSPF 2013; ). Four scholars from the University of Pennsylvania were invited to speak on a panel about what they found to be the problem in Detroit and what potential solutions there are. Detroit had recently declared bankruptcy, and now the debate is what shall be done. Three scholars in the panel were economists (Gilles Duranton, Robert Inman and Jeremy Nowak), and one scholar was a historian (Thomas Sugrue). I will summarize their arguments, and then add my own commentary to it. My own initial commentary will be in parentheses.

Sugrue argued that Detroit’s crisis had been long in coming. Detroit consists of many working class and poor people. Enormous racial flight has reduced Detroit’s white population, while leaving behind an impoverished mostly black population that could not sufficiently fund city services. A lack of investments made the infrastructure and education system very decrepit, which are important pillars for economic advancement. Due to international competition and globalization in the car industry, on which most of Detroit’s industry relied on, the industry declined rapidly. International competition implied that other countries could sell cars cheaper and at better quality (especially Germany and Japan), while globalization implied that the major car companies were free to hire workers in other parts of the world, where labor is significantly cheaper. The private car corporations, Ford, GM and Chrysler, were setting out abroad in order to maximize profits, while neglecting the city in which they were founded. Sugrue continued with the question of who should bear the burden for the bankruptcy of the city of Detroit. Should it be the African American leaders, who have run the city at least since the mid-1970s? Should it be the Democratic Party, which had run the city for over 50 years, and have given overly generous pensions to retirees that could never be paid? Should it be the public employees, who have asked for too much in pensions? (It is noteworthy that Sugrue never spent a second on blaming the creditors, the car companies, wealthy suburban residents, or the state government of Michigan, but I should come to that point later.) Sugrue left many questions unanswered, but he refuted the claim that the Democratic Party had made too many concessions to the public sector workforce. The argument is belied by the fact that the number of public employees in Detroit has actually been reduced in half since the 1990s. Finally, who shall bear the costs? The pensioners or the investors? (Now, here comes the twist. Both will take losses, but the banks, who have also invested in Detroit will not lose out. The pensioners are technically also creditors, and since they do not have a strong influence in the political process anymore, they will lose out. The private creditors are principally the pension funds of other private sector workers or other small investors with significant savings to invest (e.g. doctors and lawyers), but who were not big or influential enough to sell of at the last moment. A gain for the 1%, a loss for the 99%.)

Robert Inman laid the blame of the fiscal crisis on the political economy of defined benefit plans. He essentially argued that the city could simply not afford these generous pension plans, and that in order to solve the fiscal crisis, the city will have to commit to spending cuts and tax increases in order to maintain a balanced budget. Inman attacked the short-term thinking of most city politicians, and demands more accountability from city leaders. His practical solution would also be to divide the city of 700,000 residents into multiple different neighborhoods and business districts. The calculation is that smaller municipalities will have it easier to handle their finances, and more business districts will advance economic opportunities and compensate for any cutbacks in the public sector. (I find his proposals very doubtful, and his unilateral blame on city policy-makers is conspicuously biased. Cutting city spending is enormously foolish, because much of Detroit’s economy is built on things like schools or hospitals and government services. These all require significant public investments. Dividing the city into several districts won’t help them, because the poor people that live in those neighborhoods will not have improved their fate by that measure, and more business investments are not in sight, so poverty and debt will stay, but with an even weaker political structure in place.)

Gilles Duranton painted a very pessimistic picture about the future outlook of Detroit. His basic analysis rests on the fact that Detroit had to heavily relied on the car manufacturing sector, which could no longer sustain itself, while the few industries that still remain in Detroit (mainly small shops, hospitals, schools and city workers) are not enough to replace the loss of manufacturing. Detroit has suffered from significant foreign competition, the automation of factories, which cost jobs, and a lack of a consumer base, resulting from a rise of poverty as a result of a lack of investment. Houses and other properties have become very cheap. Then he used a historical comparison, arguing that British manufacturing had collapsed back in the 1920s, and has not returned, so what is going to make Detroit different, which had declined since the 1950s, i.e. 30 years later? The population that has left the city (middle class whites) are not coming back, and what conditions should invite them to come back?

Jeremy Nowak took a completely opposite view and tried to paint a very optimistic picture of Detroit, while blocking out the current negative situation. He pointed out the few industries in Detroit that are still very strong, especially the hospitals, universities and the non-profit sector. The city is also investing in businesses, technology, art and sciences. In the center city there is money and investment coming in. There are recent immigrants from the Middle East, who have populated Detroit at least since the 1920s, when Henry Ford went out to Lebanon, Syria and Armenia to recruit workers for his car factories (especially with regard to nearby Dearborn), and these Middle Easterners are supposedly very entrepreneurial, and open up their own businesses and provide positive economic value for the city. Nowak does note that Detroit is suffering from an enormous human capital shortage, because so many workers do not have a higher education credential, and the current knowledge-driven economy requires college degrees in order to advance economically. He was hopeful that the magnet and charter schools that are growing up in Detroit will offer the necessary (at least basic) education to the city residents. Detroit also has an infrastructure deficit besides the retirement deficit, and more investments are likewise required. (How that money is going to be accrued, he did not say. Besides, the privately-run charter schools are another profit opportunity for businesses. ) He ended on the note that with the very expensive interest-rate swaps it is difficult to get out of the fiscal crisis. These swaps are deals that the city managers entered into, where they borrowed money from Wall Street banks in order to finance short-term projects, while paying high-variable interest-rates on those loans.

The discussion continued with some Q&A, and I had raised my hand to ask why the panelists did not take into consideration the rich suburbs, who do not have to contribute a single penny to relieve Detroit’s debt burden, or why they did not factor in Michigan state government policies to continuously defund cities and municipalities such as Detroit. It was, ironically, the moderator of the panel, Susan Wachter, who responded to me directly that the suburbs of Detroit were doing poorly as well. I looked it up on Wikipedia, and found that the Detroit metropolitan income was the 17th highest in the country (household median income is about $49,160), and takes into account the nearby counties of Macomb, Oakland and Wayne (Wikipedia, Highest Income). There are in total 280 metropolitan areas in the US. That does not sound poor to me. Among the most affluent neighborhoods in the country are Grosse Pointe, on the northeast border of Detroit (Wikipedia, Grosse Pointe). Bloomfield Hills, which is about 25 miles away from Detroit and is counted in the Detroit metropolitan area, belongs to the top five richest counties in the US. The median income of this village is over $200,000 (Wikipedia, Bloomfield Hills). Palmer Woods is a historic districts within Detroit. It has 289 homes with the size of 188 acres each. It is close to a golf club, and can also be considered very wealthy (Wikipedia, Palmer Woods). What all these examples quite frankly imply is that these suburbs of Detroit are not as poor as they are portrayed, and it is questionable why they should not share in some of the burden of the city of Detroit. Sugrue eventually conceded and repeated my points, but makes no clear attack on anybody responsible. One other audience question was whether the unequal distribution of wealth and income had something to do with the fiscal crisis in Detroit. While I think that comment was very much on task, none of the panelists bothered to reflect on this observation.

Much of the discussion of the scholars lacked a crucial component. They lacked a discussion of other political actors that are responsible for the fiscal crisis in Detroit. I pointed out the banks, the suburban residents and the state government. Each should be analyzed in turn. The fault of the banks, which the professors were conspicuously silent about, is very clearly laid out in an editorial in the New York Times. Detroit had entered interest rate swaps (briefly pointed out by Nowak, but further implications were not fleshed out), where the city had taken out loans, in which banks were paid by the city if the interest rate would be low. With the economic crisis, the interest rate was reduced, and the city was forced to pay the banks $50 million from their general revenue, and $11 million from the casino-tax revenue as collateral. $61 million in rent payments from the poor residents of Detroit to wealthy bankers on Wall Street! Now, with the bankruptcy proceedings, the clear class bias of current policies become even more evident: banks are hit by a 25% loss, but the unfunded pension liability of retired city workers will receive 90% in losses. Detroit city workers, who had done the proper thing by having their paychecks be vested in the city’s retirement fund, are squeezed out, while bank creditors, who are considered too-big-to-fail are allowed to survive relatively unscathed. The banks are also paid first on the debt, and only afterwards so-called secured creditors and pensioners. The speculators are virtually guaranteed the highest repayment rate, while the savers and pensioners are punished (NY Times 2013). While Detroit is suffering from an $18 billion debt load, the nation’s six largest banks (JP Morgan, Wells Fargo, Goldman Sachs etc.) raked in $23 billion in profits for the second quarter of 2013 (Lanson 2013).

The second completely neglected culprit are wealthy, suburban residents, who do not feel responsible for the city that is being abandoned. It is virtually impossible to provide city services if wealthy residents are not asked to chip in. Some people might counter that by taxing wealthy residents it would merely be a transfer payment from those wealthy residents to pensioners, and an economic loss is incurred. I personally do not think that promising workers, who have spent all their working lives protecting homes from fire, and protecting communities from crime, or filing law cases in public courts, or collecting trash, a decent retirement is an undue transfer payment. After all, they have already paid into the system. It is also questionable why wealthy residents should be able to make their wealth on the backs of others, and then decide not to give anything back. The Ford or GM executives and managers, who have made their fortunes from the legacy of these major car companies, are essentially retreating their funds from the same communities that have originally provided them with the wealth. Their strategy to raise profitability (read: their own bottom line) by outsourcing and automation may have benefited themselves, but certainly not the residents, who have lost their jobs and income as a result of these economic changes. (This account does not suggest that all of the wealthy residents in the Detroit metropolitan area are Ford or GM executives, but illustrate very clearly from whence wealth is derived from.) The combined net worth of the eleven richest Michiganders are $21.4 billion, compared to Detroit’s $18 billion debt (Huffington Post 2012).

And last, the state policies of the Michigan government have been completely glossed over in the discussion. Since governor Rick Snyder (a venture capitalist) entered into office in 2011, he had been carrying out a consistent campaign of defunding cities, municipalities and school districts, and busting public-sector unions with right-to-work laws. This strategy of defunding communities creates inevitably a fiscal crisis in many poorer municipalities such as Detroit, who had already been struggling from financial problems (Daily Press 2011). The kicker is that even before the fiscal crisis emerged, the governor has also passed a bill, which allowed him to appoint an emergency manager of his choice- in Detroit’s case, Kevyn Orr (other examples are in Benton Harbor, Allen Park, Ecorse, Flint and Pontiac- Abbey-Lambertz 2013 ). This emergency manager can do whatever he wants to reduce city spending, raise city taxes, sell of public property at firesale prices, and declare bankruptcy. The undemocratic dictatorship becomes visible from this angle. In the mean time, the state used its savings to balance the state budget. But that is not it. It also used the savings to give 29 corporate tax breaks, reducing state revenues by $7.1 billion, mostly to Fortune 500 companies who do not have to provide investments or jobs in Michigan in return (Democracy Tree 2013).

The fiscal crisis in Detroit is very much a political choice, as the scholars rightly pointed out, but they are wrong to consider the wrong culprits. The city pensioners have not caused the crisis. The city’s leaders certainly do carry a part of the blame, because they had handed out pensions with insufficient funds. But the even bigger problem is that the capital had moved out of Detroit, and left city finances in shambles. Wall Street came as a temporary savior by providing short-term liquidity, but at a high cost. The wealthy residents want to have nothing to do with their fellow residents. And the state government has defunded Detroit and other cities.There is a real political and fiscal crisis in Detroit, but the question who caused it and who should pay for it requires very different answers than the ones that are provided now.

References

Abbey-Lambertz, Kate. 2013. “Michigan Emergency Manager Law in Effect in 6 Cities After Detroit Appointment.” Huffington Post, March 15. http://www.huffingtonpost.com/2013/03/15/michigan-emergency-manager-law-cities_n_2876777.html
Daily Press. 2011. “Governor Snyder is Pulling a Fast One.” March 21. http://www.dailypress.net/page/content.detail/id/529210.html
Democracy Tree. 2013. “Michigan is Leader in Corporate Tax Give-Aways.” June 30. http://www.democracy-tree.com/michigan-leader-corporate-tax-give-aways/
Huffington Post. 2012. “Michigan Billionaires 2012: The Richest Men, and a Few Women, in the State.” March 7. http://www.huffingtonpost.com/2012/03/07/michigan-billionaires-richest-men-women-forbes_n_1327623.html
Lanson, Jerry. 2013. “While Detroit Tries to Declare Itself Bankrupt, Banks Rake in Big Profits.” Huffington Post, July 19. http://www.huffingtonpost.com/jerry-lanson/detroit-bankrupt_b_3623322.html
NY Times. 2013. “No Banker Left Behind.” August 15. http://www.nytimes.com/2013/08/16/opinion/no-banker-left-behind.html?_r=0
Penn IUR. 2013. “Bankrupt: Detroit’s Fiscal Crisis.” September 10. http://penniur.upenn.edu/events/2013/09/10/bankrupt-lessons-from-detroit-s-fiscal-crisis
Penn SSPF. 2013. “Bankrupt: Detroit’s Fiscal Crisis.” http://www.sas.upenn.edu/sspf/event/2013/bankrupt-lessons-detroit-fiscal-crisis-gilles-duranton-robert-inman-jeremy-nowak-thomas-s
Wikipedia. “Bloomfield Hills, Michigan.” http://en.wikipedia.org/wiki/Bloomfield_Hills,_Michigan
Wikipedia. “Grosse Pointe.” http://en.wikipedia.org/wiki/Grosse_Pointe
Wikipedia. “Highest-Income Metropolitan Statistical Areas in the United States.” http://en.wikipedia.org/wiki/Highest-income_metropolitan_statistical_areas_in_the_United_States
Wikipedia. “Palmer Woods.” http://en.wikipedia.org/wiki/Palmer_Woods

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One Response to The Fiscal Crisis in Detroit: Problems and Solution

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