Debtroit: Coming To a City Near You

By Paul Jacob

Sunday, July 21, 2013

Detroit, Michigan, may be the nation’s only large city to have sported three distinct pronunciations: the original French, du-TWAH; the 19th century American, deh-TROIT; and the more recent and homegrown DEE-troit. A fourth may soon evolve: DEBT-troit.

The City of Detroit owes to creditors $18 billion that it cannot pay back. Most of the debt is owed to those who provided loans to the city by buying its bonds; next in line are the nearly 30,000 retired and still working city employees owed billions collectively in future pension benefits, which are woefully underfunded.

Detroit has been ailing for decades, losing more than a million residents as it slipped from the nation’s fourth largest city and a vibrant economic engine to the 18th largest and a financial basket-case. You will find, littered across the town, over 70,000 abandoned homes, one for every ten remaining residents.

Some suggest the city never really recovered from the 1967 riots. That would make 46 years of non-recovery.

A federal bailout saved General Motors and Chrysler, but no bailout appears in the offing for the Motor City itself: last week its state-appointed emergency manager went to court to declare that Detroit was belly up — the nation’s largest-ever municipal bankruptcy.

Sure, it might be easy for folks far away from Detroit to brush this story off their shoulders or to simply mutter, “Poor Detroit,” as if their own cities were immune to such outrageous fortune. Sadly, however, the truly frightening thing about the failure of America’s once great Motor City isn’t merely a decades-long slog of big government programs and promises gone awry. What is more scary, because it is more relevant to most of us, is that our own cities are currently embracing the same stupid policies and employing politicians making the same unfunded promises.

Last week, Moody’s Investor Services downgraded the bond ratings of two major cities, neither named Detroit.

“Chicago likely will have to pay more to borrow money after Moody’s downgraded the city’s credit rating and says the outlook for the future is negative,” reported WLS-TV, the city’s ABC affiliate. “Moody’s Investors Service lays the blame squarely on the city’s large and growing pension liabilities.”

Moody’s found the city had only 22 percent of the assets needed to meet its obligations. In 2012 alone, Chicago shortchanged its annual required pension contribution by more than a billion dollars.

Also last week, WLWT in Cincinnati told Southwest Ohio viewers that “Moody’s Investor Services has downgraded the bond rating for Cincinnati under a new formula that takes into account cities’ pension responsibilities.”

In an editorial earlier this year, the Cincinnati Enquirer warned readers, “The city of Cincinnati, as of the end of 2011, owed $728 million more in pension costs than it has paid for. That’s more than twice as much as the city takes in each year in income taxes.”

Having a bond rating reduced isn’t quite bankruptcy, admittedly, but Mike Shedlock with SitkaPacific Capital Management is certainly not alone in concluding: “There is absolutely no way Chicago, Oakland, Baltimore, Philadelphia, LA, Houston, and numerous other cities can meet pension obligations without a major restructuring of promises.”

The easiest way to restructure may be through bankruptcy. So expect more of them.

And in your town? Your state?

Research by Professors Robert Novy-Marx at the University of Rochester and Joshua Rauh at the Stanford Graduate School of Business looked at the pension commitments state and local governments had already made and then calculated how much your taxes would have to go up to pay for those unfunded promises. The professors found that, “on average, a tax increase of $1,385 per U.S. household per year would be required, starting immediately and growing with the size of the public sector.”

And, then, continuing to pay that annual sum for the next 30 years.

That’s only the average, though. “New York taxpayers would need to contribute more than $2,250 per household per year over the next 30 years,” according to the research. “In Oregon, the amount is $2,140; in Ohio, it is $2,051; in New Jersey, $2,000.”

The point is not simply to lament the size of the hole being dug through this ubiquitous system of promising benefits, while refusing to actually pay for them. The point is to (1) recognize there is a hole, a really big one, and (2) to stop digging.

For until we get a handle on this problem, the size of the financial pit will continue to grow and get more dangerous.

We can blame the politically powerful public employee unions for pushing for unsustainable benefits. But what worker doesn’t want higher pay and better benefits?

On the other hand, we can blame our elected officials for agreeing to benefit packages they weren’t honestly willing to pay for. But then, we elected those officials.

The solution is obvious: Don’t allow our governments to make promises they cannot keep. While the law requires that those workers who have earned pension benefits receive those benefits, no law says we have to continue an unsustainable system that could lead to bankruptcy.

Move new government workers to the same retirement system used by most American workers: a defined-contribution 401k-style program. Let cities and workers negotiate over how generous an employer match to such retirement savings should be made, just as they bargain over salary and other conditions of employment. But whatever contribution is promised by a city or state government must be legally required to be paid in full every pay period.

With the credit-worthiness of our politicians, let’s stick with pay-as-you-go.

After all, Detroit isn’t a model city to emulate — no matter how you pronounce it.