Detroit Goes From Motor City to Junkyard

Detroit's unavoidable bankruptcy can shrink the obligations the city must pay. Yet what's really needed is to shrink the city itself.

A Michigan judge has just declared that Detroit must withdraw the petition for bankruptcy that it filed yesterday, criticizing Michigan's governor Rick Snyder for rushing the filing before she could rule on a bid by bond investors and pensions to stop the city from stiffing them.

But notwithstanding the judicial ruling and attempted procedural trickery, Detroit faces an ugly and unyielding truth: It can't pay its debts and obligations. The city'sfinancial condition has been weak for decades, and over the last 15 years, it has collapsed. Since peaking in 1950, the population of the city has fallen by more than half; what's left is poor, with a median household income of only $27,862. Unfortunately, Detroit still has the size and government benefits structureof a much larger, more prosperous city. Something has to shrink.

Source: Office of Emergency Manager Kevyn D. Orr, City of Detroit

Unfortunately, most of that "something" looks to be its promises to retirees. Much of the city's private debt is secured, and while investors in its general obligation bonds will probably take a hugeloss, that won't be enough to protect pension funds and other retiree benefits, which have billions and billions of dollars in outstanding unfunded obligations. The 2008 financial crisis whacked Detroit's pension assets, just as it did every other pension in the country. But the city was in a particularly bad position to recover, because it had no cash to make up the deficits, and no prospect of getting any in the future. The city has been borrowing to make up for its contribution deficits. Meanwhile, firefighters and police have been rushing toretire early so that they won't get their pay cut by Detroit's emergency management plan.

This hasn't done them much good; instead, they may yet get their pension benefits cut. The judge can order the bankruptcy stayed. She cannot, however, order into existence the resources needed to pay the pensions. Cutting pensions is monstrously unfair to city workers who have been planning on those benefits for decades -- and particularly hard on police and firefighters, who are not eligible for Social Security benefits. But the city has no choice. A median income of $27,000 a year is not enough to cover the generous benefits that more prosperous governments promised decades ago.

Source: Office of Emergency Manager Kevyn D. Orr, City of Detroit

The pale blue space represents pension obligation certificates -- borrowing to fund the gap between the pension funds' liabilities, and their assets. The rest of the debt can be written down, but pension obligations will keep racking up every year unless something drastic is done. (Source: Detroit Emergency Manager's Report)

Even a big haircut for both bondholders and pensioners may not be enough. If the city defaults on its general obligation bonds -- bonds voted in by taxpayers, and "secured" by future tax revenue -- it will have to balance its budget every year. Shedding bond payments will buy a temporary reprieve, but over time, the need to keep the budget balanced is going to force ever-deeper cutbacks in other areas, including pensions, unless something changes.

You never want to count a city entirely out. Still, it's hard to see where Detroit's recovery will come from. In earlier decades, the suburbs that absorbed much of the city's population could at least be counted on to provide a trickle of commerce; now, the whole region is ailing along with its biggest industry. The modern automobile industry is dispersed, no longer dependent on the cheapness of shipping iron and coal across the Great Lakes. Detroit's once prime location has become a snowy northern outpost, far from every thriving urban center except Chicago. Large swaths of the city are slowly reverting to the farmland they were built on.

Detroit's Chapter 9 filing is necessary; everyone except the bondholders and the union members seems to recognize that much. But will it be enough? Bankruptcy can shrink the obligations the city must pay. Yet what is really needed is to shrink the city itself, and its workforce, into a size more appropriate to today's economic realities. And unfortunately, no judge has the power to order such a transformation.

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