Motor City finally runs out of gas: Detroit becomes the largest city in U.S. history to file for bankruptcy with debts of $20 BN
- Debt estimated to be as much as $20 million
- Union and pensions board refused to agree to last-chance survival plan
- City has been borrowing money to pay employees
By Jessica Jerreat PUBLISHED: 18 July 2013
Kevyn Orr, a bankruptcy expert, who was hired in March to lead Detroit out of a fiscal free-fall, made the filing in federal bankruptcy court today.
Detroit’s budget deficit is believed to be more than $380 million but Mr Orr said long-term debt was more than $14 billion and could be as much as $20 billion.
‘The citizens of Detroit need and deserve a clear road out of the cycle of ever-decreasing services,’ Governor Rick Snyder wrote in a letter included in the filing.
‘The city’s creditors, as well as its many dedicated public servants, deserve to know what promises the city can and will keep. The only way to do those things is to radically restructure the city and allow it to reinvent itself without the burden of impossible obligations.’
In recent months, the city has used state-backed bond money to pay its 10,000 employees.
Pensions are protected under Michigan’s state constitution, so they would be safe if the bankruptcy is approved. However, healthcare and other benefits for retired residents could be affected.
Mr Orr was unable to convince a host of creditors, the city’s union and its pension boards to take pennies on the dollar to help facilitate the city’s massive financial restructuring.
He laid out his plans in June meetings with debt holders, in which his team warned there was a 50-50 chance of a bankruptcy filing.
Some creditors were asked to take about 10 cents on the dollar of what the city owed them. Underfunded pension claims would have received less than the 10 cents on the dollar under that plan.
A team of financial experts put together by Mr Orr said that proposal was Detroit’s one shot to permanently fix its fiscal problems.
Several factors, most notably sharp declines in the population and tax base, have been blamed on Detroit’s tumble toward insolvency.
The city lost a quarter of a million residents between 2000 and 2010. A population that, in the 1950s, reached 1.8 million is struggling to stay above 700,000.
‘You get certain creditors to agree upfront to certain adjustments, and then essentially you then use that agreement to go to the judge,’ he said.
The economist added: ‘If the other creditors are not willing to agree, then the judge can do what is called a “cramdown” or forced adjustment on the other creditors.’
If the bankruptcy filing is approved, city assets could be liquidated to satisfy demands for payment.
Central Falls, Rhode Island, is the only other city that has had a similar managed municipal bankruptcy. It filed for the measure in August 2011.
It took that city a year for the debt plan to be worked through, under a scheme to pay off bondholders by cutting employees and pensions and raising taxes, according to the New York Times.
‘It would be very difficult for the image of [Detroit]. It would be the largest municipal bankruptcy in the history of the country. It would probably last three years and be very unforgiving to the employees and residents,’ Derek Howes, a Detroit journalist, said.
According to Forbes, unlike a corporate bankruptcy, federal bankruptcy gives the debtor the authority to abrogate labor union contracts, which will be controversial in a city that deals with dozens of city unions.
And, while the bankruptcy will not affect political institutions, the city may need to seek a federal bail out or help from the state.
Known as Motor City for its boom years from 1910 to 1950, Detroit used to be the destination for success, with thousands attracted by its wealth and industry.
Major car companies, including Chrysler, Dodge and Cadillac had plants in and around the city where one in ten people worked in manufacturing, according to PBS.
By 2011, that figure had dropped to one in 50 people, and the population had fallen from its height of 1.8 million in 1950 to 714,000.
The city’s troubles came to national attention in 2009 when General Motors sought a $49.5 billion government loan to help it bankruptcy because of its debt and high labor costs.
The U.S. government got a stake in the restructured company, part of which was sold in an initial public stock offering in November 2010, the Huffington Post said.
Many of the car factories and motor plants, which helped the city make its fortune in a boom likened to the gold rush years, have closed.
Buildings, such as the Le Plaza Hotel or 35-storey David Broderick skyscraper, that hint of the city’s once grand past, are crumbling and deserted, and many schools have been forced to close, according to Time magazine.