March 20 (Bloomberg) -- Most people who are drowning would gratefully grab a lifeline tossed their way. But the elected leaders of the (formerly) great city of Detroit might actually prefer to drown.
How else to interpret their response to a proposal -- or a “consent agreement” -- crafted by Michigan Governor Rick Snyder to help the city avoid bankruptcy when it runs out of operating cash in less than 60 days?
Detroit Mayor Dave Bing, a former guard for the Pistons and a businessman who can barely raise his voice to a whisper when dealing with the city’s public unions, has found his inner lion against the Republican governor’s plan.
Unless Bing, a Democrat, and the city council sign the agreement, it can’t go into effect. But, Bing roared in a recent radio interview, “Why the hell would I sign it?” Likewise, some city council members have described the agreement as a hostile takeover that eviscerates the rights of Detroit’s voters.
What exactly in the agreement has gotten them so mad?
Essentially, in exchange for letting the city borrow an additional $137 million in state-backed debt so it can pay its bills until the end of the year, the agreement would put the city’s finances in the hands of a nine-member financial advisory board.
The board, which would be appointed jointly by the governor, mayor and city council, would pick a new chief operating officer and chief financial officer who would run the city’s day-to-day finances.
The panel would have sweeping powers to sell assets, outsource city services, and rewrite or void union contracts to put the city’s long-term fiscal health on a sound footing.
A consent agreement is actually the least intrusive deal on the table because, if Detroit stays on track and meets the benchmarks laid out in the restructuring plan crafted by the board, it would avoid the nuclear option: a takeover of its books by a state-appointed emergency manager. That is the worst option for everyone involved because it entails an even greater loss of control for the city. And it makes the governor solely responsible for its fiscal destiny, something that is politically risky.
But Bing and others reckon that they can play hardball with Snyder on the consent agreement and get more out of him for even less loss of control.
That’s because the bankruptcy of Michigan’s largest and most visible city would be damaging for the whole state. Coming at the heels of the federal bailout of General Motors and Chrysler, it would cement Michigan’s reputation as an economic basket case, potentially raising statewide borrowing costs while making it harder to attract businesses.
Bing is leveraging this fear to demand that the state hand over $220 million in cash -- not debt, mind you -- that Detroit is allegedly owed as part of a previous revenue-sharing formula. And he wants more control over the city’s finances.
There is certainly some room to negotiate on the second count given that, as the consent agreement currently stands, the advisory board would remain in charge of Detroit’s budget until the city posts three consecutive years of financial solvency and transforms its junk-bond credit rating to AA. But it might take Detroit 20 years to improve its rating that much, if it ever can, effectively giving the board control into perpetuity.
Timidity on Unions
It would be foolish of Snyder to run Detroit for that long, so he should back down on that provision. But it is hard to see how he can let Bing retain any control over the collective-bargaining aspects of the agreement, especially given Bing’s track record of timidity with public unions.
Detroit’s accumulated debt stands at more than $10 billion, something that puts its debt-to-asset ratio at 33-to-1. By contrast, GM’s debt-to-equity ratio when it went into bankruptcy was 22-to-1. Detroit’s annual debt payments -- $600 million a year -- exceed its primary tax revenue by $60 million.
This, despite the fact that Detroit has the highest income tax rates for residents (2.5 percent) and nonresidents (1.25 percent) in Michigan and its corporate tax rate is 1 percent. In other words, Detroit has maxed out its credit cards and is taxing its residents to the hilt, and it will still run out of money to pay its employees and creditors by the end of this year. Some vendors have been complaining that they have not been paid for months.
The main cause of Detroit’s fiscal crisis is simple: Its unions have fought tooth and nail to protect jobs and pay even as Detroiters, reeling from their demands, have rushed to the exit doors. Detroit has lost two-thirds of its population since its peak of 2 million in the 1960s, but the rolls of city employees had until recently shrunk by only about one-third. The city government is the second largest employer -- after Detroit’s schools. Employee benefits alone make up half of the city’s general fund costs.
What’s more, Detroit’s public-sector legacy costs are astronomical. They include $5 billion to cover health care and other promises for retirees in decades to come and a billion for the unfunded liabilities to pension funds. This is not surprising given that the city has twice as many retirees as employees. And retirees get deals virtually unheard of in the private sector. For example, firefighters can retire at the ripe age of 55 with 70 percent of their salaries and automatic cost-of-living adjustments along with nearly full health-care benefits.
It would be futile to give Detroit any money without razing this opulent entitlement edifice. Otherwise, a year from now, Detroit will be back rattling its tin cup in Lansing, and Michigan voters will have far less patience for extending any more largesse.
Governor Snyder understands this, which is why Detroit will either have to accept his lifeline -- or sink in its own red ink.
(Shikha Dalmia is a senior analyst at Reason Foundation and a columnist at The Daily. The opinions expressed are her own.)
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