Detroit: Cautionary Tale

I doubt anybody missed the news this week about Detroit.  Or the subsequent protests from city employees and pensioners. Or how a Michigan state judge has since blocked the city's attempt to file for bankruptcy.  And, just for good measure, everybody and their mom's dog's opinion on why Detroit got into this mess in the first place.

In short, it was a bad week for Detroit and just about everybody there.

As Jared Bernstein said, "It’s obviously been a long way down for Detroit."  There's an understatement.  Detroit, in recent years, has been more of the proverbial snowball, rolling down a hill and rapidly collecting and compounding problems, than falling straight done to a hard landing.  The warning signs were there, and Detroit responded, but it was too little too late.

Detroit was a perfect storm of bad things.  With a largely homogenous industrial base, a rough reputation and housing stock that is particularly susceptible to price swings, it comes as no surprise that Detroit's tax base shrunk with gusto when the economy first started to shake.  Without that foundation, Detroit faced massive revenue shortfalls and with already substantial debt and pension costs. The whole house of cards came down pretty quickly as Detroit had few safeguards in place.  And here we are. 

Of course, that's only the local view.  Others can point to globalization, which hurt Detroit's major economic players.  As that occurred, the housing bubble compounded the problem.  Perhaps it's all a matter of perception about exactly whose fault it is.

However, I think this is a clearly cautionary tale to the rest of us and our communities.  Some clear lessons which we should take to heart:

1. Diversify: Detroit flew high when American autos corporations were kings.  When they fell, Detroit fell even harder.  Further damage came from the fact that Detroit wasn't just housing the auto corps but all their supply chains.  Once upon a time, keeping all the supply chains close was a smart philosophy for everybody, but those days are gone.
2. Manage Your Reputation: Detroit has long had a rough image.  Even native Detroit metro inhabitants admit this.  Of course, this has a subtle but still powerful impact on where businesses and individuals want to locate.  Detroit or Chicago? Detroit or Houston? These are generally not hard decisions.  Businesses can be incentivized, but individuals not as easily.  Keeping ahead of our reputations is an important part of keeping a vibrant community.
3. Plan Ahead: I'm not sure to what extent Detroit officials knew how bad this situation could become.  Nate Silver argues in his new book The Signal and the Noise that economists themselves had significant difficulty predicting the 2008 recession.  However, it's obvious to us now that we have to at least consider the worse case scenario and plan accordingly and install safeguards.
4. Obligations and Liabilities Need Proper Consideration by All Parties: Many are quick to blame pensions for Detroit's problems.  Pensions are one of many institutional factors that contributed to the situation.  To some extent, Detroit may have been able to control its pension liabilities - I'm not exactly an expert on pension law in Michigan.  However, in many states, it's up to the State Legislature to define pension benefits, which accordingly drive pension costs and contributions.  Communities must be vigilant in educating their elected representatives about pensions, how they function and their costs.
5. Federal Policy Matters: It's commonly said that local government has the most impact on the lives of residents.  That's true, but what's not as commonly understood is how federal law ultimately impacts local government.  In the case of Detroit, globalization is obviously a key factor in the problems which lead to the bankruptcy as major economic players struggled.  We often watch our State legislatures - we should be constantly watching Capital Hill as well and predicting its impact on us.

 So what say you, readers? What else can we learn from Detroit?

On Detroit, Emergency Managers and Dillon's Law

This past week, the State of Michigan formally announced that it would be seeking to appoint an emergency financial manager to takeover the City of Detroit, the 18th largest city in the US.  According to the New York Times, Detroit has roughly $14 billion in existing long-term liabilities.  The City has terrible, self-admitted liquidity problems, and all the symptoms of insolvency are present including revenue shortfalls ($326.6 million in FY 11/12 according to the City's CAFR), rapidly downgraded credit ratings and ballooning short-term debt (as a result of the shortfalls). A full history of the City's agreements and activities related to managing its solvency over the last few years is available in the Management Discussion & Analysis portion of its previous CAFR.

So, in short, Detroit is in dire straights.  With all major credit agencies now rating Detroit below investment grade, the City's ability to issue any more debt is significantly compromised.  Their efforts to control costs including 10% wage cuts, freezing of benefits and pay increases and various actions to outsource certain functions and reorganize debt seem to have aided slightly, but they have not been dramatic enough to demonstrate solvency to either the State or the credit agencies.  Therefore, Michigan has proposed invoking its controversial ability to assign an emergency manager to take over the city's operations and unilaterally make decisions to improve the city's finances.  Detroit seems to be somewhat ambivalent toward the whole thing. Much of Detroit's community isn't but is begrudgingly accepting it.

Michigan's authority to assign an emergency manager falls under the broad category of "Dillon's Law," which establishes municipalities as "creatures" of the State.  In simpler terms, it means the State is the boss and municipalities only have the powers given to them.  In some respects, it's a logical arrangement and makes complete sense.  After all, the State is the superior government and has a responsibility to ensure accountability.  In some instances, however, the arrangement leads to unnecessary burdens or extremely unfavorable terms on both parties.  This is, always has been and always will be a delicate balancing act.

In Detroit's case, the emergency manager situation seems somewhat necessary.  The city no longer has the ability to independently get itself out of the situation, and without some sort of guarantee of solvency, default is the only option.  An emergency manager can help prevent that.

However, the Detroit Free Press, amongst others, does make some valid points including the fact that it ignores regional issues and drastically reduces the ability of residents to use their democratic rights.  However, I think Michael Stampfler, the former emergency manager of Pontiac, MI, says it best, ""For a community to actually succeed, the Legislature needs to do more than send someone to work to balance the books and leave as fast as possible."  Balancing the books is a core necessity, and I don't think anybody can dispute that.  The problem though is that in doing so, an emergency manager, whether or not intentionally, sidesteps civil engagement and, perhaps just as gravely, can entirely dismantle an organization without leaving any easy method of putting it back together.  Then, as soon as the books are balanced, they leave without necessarily giving the organization the tools to succeed.  That's simply not sustainable.

So, I don't disagree with the Free Press's points in their editorial today.  I think their calls for transparency and cooperation are excellent, but they have to realize that the manager won't be able to make services better and fix Detroit's problems overnight.  Long-term problems require long-term solutions, and the manager is really phase one of a restructuring that Detroit needs to do together, as a community. Anything else will likely fail.

Simultaneously, the State of Michigan needs to stop such heavy-handed interpretation of Dillon's Law.  While the state is technically correct and certainly has an overriding interest in the success of its urban communities (better communities mean a better Michigan in more ways than one), they need to take the old economist adage, "Who feeds Paris?" to heart.  Just as Paris is fed through an extremely complex series of transaction, Detroit and Michigan become successful through micro and macro transactions and exchanges beyond simple fiscal solvency.  An emergency manager must preserve as well as salvage.  I urge Lansing to reconsider their approach and help cities pull themselves up with the aid of and not the commands of an emergency manager.