Detroit’s troubles spreading to other Michigan cities, finance expert says

With Detroit’s recent appointment of an emergency manager, the state and the region will witness a long-deliberated and – for many city residents – hotly contested financial restructuring in one of the nation’s major municipalities by a gubernatorial appointee. Eric Scorsone, who studies local government finance at Michigan State University, discussed last week the potential benefits and drawbacks that filing federal Chapter 9 bankruptcy could present, should the option be used in efforts to facilitate one of the most monumental financial turnarounds in modern memory.

Bridge: Please explain how the Chapter 9 option could be more advantageous for the city of Detroit than emergency financial management? 

A: I think we know what needs to be done. If the emergency manager is able to do these things, that's probably the preferred approach -- and Chapter 9 could be very time-consuming and expensive. But, that being said, if there are legal restrictions and other things that the EM just can't do, then you might have the chance to do both. They don't have to be mutually exclusive.

What has to be considered is the greatest ability to reduce government costs, the benefits side, payments for pensions, payments from premiums on retirement health care and other health-care costs. It could also be debt. All of these things are weighing the city down in significant ways. Chapter 9 provides a little more certainty.

Detroit is not unique among Michigan cities for struggling to match declining revenues with growing costs, such as retirement benefits, says MSU expert Eric Scorsone. (courtesy photo)

Bridge: What would be the biggest disadvantage of going the Chapter 9 route? 

A: Like I said, it's a time-consuming and potentially expensive process, and then there's the question of whether it would damage the state’s overall status.

Bridge: Can you discuss how this played out in Central Falls, Rhode Island, and any potential variables, like the size of that city compared with Detroit? 

A: They did what's called a managed bankruptcy, as opposed to a “free-fall,” or unmanaged, bankruptcy. Managed means that some of your creditors agree to a reduction in what they're owed. So you go to a judge and tell him or her about this agreement and the judge can do what's called a “cram down" and he can get agreements from other creditors who didn’t want to make the debt reduction. General Motors kind of had managed bankruptcy to some extent, and Chrysler. The managed bankruptcy helped Central Falls dramatically improve its credit rating.

Not all of their problems are fixed, but they’re doing better. The retirees did agree to major reductions in their pension payments. Some did not agree. The idea is that you set it up ahead of time and you have a better process, whereas Stockton, Calif., did not do that. They're having a much messier time. A lot of their problems stem from the Great Recession and the housing bubble that burst. Cities in California don’t need the state’s approval to declare bankruptcy.

Bridge: What can emergency managers do on the pension and retiree benefits front for Detroit, compared with how this would be addressed under Chapter 9? 

A: Well, an EM can certainly reject and modify contracts, especially with retiree health care. They can modify the costs and make the retirees go onto different plans, but there are some lawsuits pending. That's the question – whether the EM can legally do that. The U.S. Constitution says that bankruptcy (in government) is reserved for Congress, so there is some argument that what's being done in Michigan is unconstitutional. The city of Flint is being sued for this very thing, changing retiree health care. The problem is that you wait years for court cases to proceed and then you find out that you lose, whereas with bankruptcy, the court already has power to do some things. Now on the pension side, the Michigan Constitution protects pensions. An EM can't take that away. In theory, a federal court can say, “This pension is not protected.”

Bridge: So if I'm worried about my pension, I'm probably more in favor of an EM. 

A: Right. That’s why you might use Chapter 9 as more of a bargaining tool (in reaching municipal crisis solutions).

Bridge: Why do you believe the bankruptcy option isn’t discussed more often by municipalities facing financial crisis? 

A: I don't know. I think the EM law was written to try and avoid having to go to bankruptcy, to give the EM ability to do things that would avoid it. I think that’s not a bad idea. It's a good approach in a lot of places, but it's not going to fix all the financial problems in Michigan.

Lansing, Flint, Saginaw, even cities like Kalamazoo and Grand Rapids, to some extent, are facing challenges. If your health-care costs are growing at 8 percent to 10 percent and your revenue is only growing at 1 percent to 2 percent, you have a structural deficit. Basically, with that mismatch between revenues and spending, you probably have to look at statewide solutions. It's not unique to Detroit.

Eddie B. Allen Jr. is a Detroit-based freelance writer and editor.