This week the city of Detroit officially declared title 9 bankruptcy. It is estimated that the city of 700,000 people has total debts of $18-$20 billion. For years city expenses have far outstripped revenues. The time of reckoning has come, leaving Detroit’s bondholders, city employees, and retirees holding the bag.
The governor of Michigan believes that bankruptcy will put Detroit on the right track. The city will be able to re-negotiate union contracts with its employees, significantly lowering its cost of labor. Pensioners will take a severe “haircut” on their retirement benefits, perhaps as much as 90%. Holders of Detroit municipal bonds will find their paper almost worthless, but the city will be relieved of its debt obligations.
No doubt this is bitter medicine for city employees, retirees and bondholders. However, bankruptcy will give Detroit a clean financial slate, ironically making it easier for the city to borrow in the future. As a place to do business the “new” post-bankruptcy Detroit will be much more attractive than the “old” Detroit, but it will take a long time for the motor city to recover.
If Detroit follows through with its bankruptcy the municipal bond markets will freak out. Virtually all other cities will have to pay more to borrow, especially if they factor in the probability of a “haircut”.
My fear is that the federal government will bail out Detroit with newly printed money. Once that precedent is established there a ton of debt-laden big cities that will line up at the federal trough. Chicago is one of them. While Chicago is more prosperous and has five times the population of Detroit, the windy city has 36 billion of pension debt and 7.7 billion of general obligation bonds. Like Detroit, despite grinding taxation, Chicago spends more money each year than it takes in.
Let’s see, the Federal Government has $5 trillion of unfunded Social Security liabilities, roughly $90 trillion worth of unfunded Medicare liabilities, and God knows how much of a deficit due to our latest entitlement, Obamacare. Why not add a few more trillion by bailing out America’s largest cities?
Line up at the trough, boys. Obama and the Democrats aren’t going to abandon their union friends and their comrades that run the municipal bond houses on Wall Street. The Bernanke printing press is ready to run!