Report Shows Real Factors Behind Detroit Crisis: Revenue Decline, Wall Street Deals Play Largest Role

Release Date: 
November 20, 2013

Modest Pension Benefits Play Little Role in Financial Crisis

DETROIT — In their push for bankruptcy, Emergency Manager Kevyn Orr and other public figures are incorrectly looking at Detroit’s long-term debt—figures generated using aggressive and in some cases inaccurate assumptions—to the detriment of solving the City’s immediate cash-flow crisis and its long-term structural challenges, according to a report released Wednesday by Demos.

Detroit is not a corporation, it’s a city, and its bankruptcy proceedings have been focused on the wrong numbers.

The Detroit Bankruptcy shows how the current bankruptcy filing is the result of a severe decline in revenue, caused by the 2008 financial crisis, and cuts in annual state revenue sharing starting in 2011. Risky Wall Street deals further jeopardized the city’s public finances by threatening immediate payments that the city could not afford. The report also details how the pension benefits of teachers, firefighters, police officers, and the thousands of other public servants had little to do with the crisis.

“Detroit is not a corporation, it’s a city, and its bankruptcy proceedings have been focused on the wrong numbers,” said Wallace Turbeville, Senior Fellow at Demos, who authored the report.  A lawyer, former Goldman Sachs investment banker, and founder of the Kensington Group, Turbeville is a leading expert in infrastructure finance and public private partnerships. “Emergency Manager Kevyn Orr is blaming workers, but this mistaken focus on pensions obscures the real cause of Detroit’s crisis. It will prevent local leaders from fixing the underlying problems that got Detroit into this mess to begin with.”

Municipal bankruptcies differ from corporate bankruptcies because cities cannot be liquidated; therefore cash flow, as opposed to long-term debt, is the issue that leaders must resolve. The headline figure of “$18 billion in debt” is not only beside the point, it is downright misleading. To overcome its immediate cash flow shortfall, Detroit must bridge its cash flow gap of $198 million.

Detroit’s crisis was caused by multiple factors:

  • A depleted tax base: Detroit’s population has declined by 1.25 million residents since the 1950s. Critically important, the number of employed Detroit residents fell by 53 percent between 2000 and 2012, with half of that decline occurring in a single year—2008. Detroit was uniquely vulnerable to the effects of the financial crash, precipitated by reckless and greedy Wall Street bankers, and it cut deeply into Detroit’s key revenue sources, including property taxes, income taxes, and fee revenues from utilities.
  • Skyrocketing financial costs: Detroit’s financial expenses have increased dramatically, a direct result of large, complex and risky financings promoted by Wall Street banks for questionable public purposes. Those banks, having already been paid $300 million to terminate interest rate swaps, are now poised to collect another $300 million simply to terminate unconscionably risky swaps that were embedded in bond deals that exposed the city to market bets that it could not afford to lose.
  • Corporate subsidies and tax loopholes: Detroit gave away millions of public money in tax loopholes and subsidies to big corporations. A wealth of research finds that tax breaks like these are ineffective and it is apparent they have done little to create good jobs for Detroit residents. These tax breaks should be on the table, just like other obligations of the city in resolving the cash flow crisis.
  • Slashed state revenue sharing: In 2011, the state legislature exacerbated Detroit’s revenue crisis when it slashed $67 million in state revenue sharing. While the drop in Detroit’s population accounted for some revenue loss, 64 percent of the total cuts were at the discretion of the State Legislature. Coming on the heels of the decimation of the city’s tax base from the Great Recession, this tipped Detroit into the cash flow crisis that precipitated its insolvency.

City spending and pensions are not the culprit.  Following the crash, the city reduced its operating expenses by 38 percent—or $356.3 million—by laying off public workers and cutting their benefits and salaries. The city’s pension contribution expenses remained relatively flat, rising only $2 million during this time. 

While Orr has declared his intentions to pay banks hundreds of millions in projected but uncertain future profits outside of the bankruptcy process, the modest pensions of firefighters, police officers and thousands of other public workers could be all but drained.

“What allows us to charge into burning buildings is the promise that when something happens to us, the city will help take care of our families,” said David Allen, a 50-year old firefighter and father of two, who retired in 2012 due to a spinal injury sustained when the wall of a burning building collapsed on his head. “We’ve been steadily paying into our pension fund for decades—it’s our own money that we set aside. Now we’re told that the retirement security we were promised could be gone in the bankruptcy, yet somehow there’s still enough money to pay off Wall Street banks.”

Following the immediate cash-flow crisis, the report suggests that elected officials at the city and state level should implement structural programs to grow Detroit’s tax base, allowing the city to return to prosperity over time, a task accomplishable by: coordinating revenue sharing with the state; closing corporate tax loopholes; reclaiming corporate subsidies; and abandoning swap termination fees.

“Misguided and irresponsible decisions by politicians over the years, often at the urging of Wall Street, have funneled wealth out of Detroit’s neighborhoods, and enriched financial institutions and corporations in the process,” said Turbeville. “If Detroit wants to come back from this and rebuild a strong economy, it needs to reverse that trend and start prioritizing the people who live here over the interests of Wall Street bankers.” 

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Dēmos is a public policy organization working for an America where we all have an equal say in our democracy and an equal chance in our economy. Learn more at www.demos.org