In the Detroit Bankruptcy, There's Sacrifice But It's Not Shared

In the wake of the Detroit bankruptcy, there has been no shortage of finger pointing, blame, and calls for “shared sacrifice.” On a personal note, I love hearing the phrase “shared sacrifice” because what usually follows is a lot of sacrifice that is rarely shared. And, the case in Detroit is no exception.  As the city starts to make decisions for its financial future, it is clear that fiscal promises will have to be broken (the sacrifice part) and the way it looks to pan out is a 25 percent discount on outstanding debt to banks and a whopping 90 percent cut to pensions (the not so much “shared” part).

The New York Times editorial board called out this dynamic and noted that while the banks are taking a bit of a hit, they have already made money on their original transactions (interest rate swaps). In contrast, pensioners are left in a precarious position because public pensions are not federally insured and many municipal retirees do not receive Social Security. The proposed pensions are the only income for many retirees and a 95 percent benefit cut would be devastating.

It’s also important to note that pensions are deferred income. Employees agree that the employer will withhold part of the employee’s compensation, invest it and then release it at some point in the future. Pensions are not some added bonus that municipal employees get just because they are public servants. They are part of the employment package and pensions are promised payments. Just like Detroit promised to pay the banks back, it promised to deliver a part of its employees compensation at some time in the future. So why is it that the banks get what is due to them but municipal employees don’t?

As the Times’ editorial board said:

The special treatment banks receive when debtors are in or near bankruptcy is unfair and economically destabilizing. Detroit’s agreement with the two banks requires court approval, but, in general, swap deals by banks are not subject to the constraints that normally apply in bankruptcy cases; in effect, the banks are paid first, even before other secured creditors and certainly before pensioners. That privilege, dating to the heyday of derivatives deregulation in the 1990s and 2000s, is destabilizing because the assurance of repayment fosters recklessness.

In other words, banks are reckless because they know that no matter what, they are first in line to be repaid. There is no incentive to be careful and cautious with municipal funds because regardless of what happens to the municipality, banks get their money. Like I said, there’s sacrifice for sure, but it’s definitely not shared.