The Winners and Losers in Detroit Bankruptcy
Much sympathy has been extended to the Detroit pensioners who are facing cuts to their retirement income.
Indeed, some have argued that they are the biggest losers in the Detroit bankruptcy. A proper accounting, however, shows that they have been among the most protected. This does not mean that cuts will not be painful. It shows that Detroit is in a bad situation.
City pensioners are one of the larger creditor groups, but they should not be. Cities should be setting aside sufficient funding to cover the pensions earned in any one year. This is mandated by the state constitution. However, they have not done so. There are a number of reasons why this is, but there are gaps between what employees and retirees have earned and what has been set aside to pay this obligation.
In Detroit, this amounts to at least $3.5 billion. That represents the present value of pensions — how much cash is needed today to cover the pensions earned that has not yet been set aside. Because invested cash is supposed to grow in value, these are discounted based on estimated returns.
That figure is disputed. The city's pension fund boards argue that investments should be assumed to grow at a higher rate than the emergency manager assumes is prudent. An additional gap is due to asset "smoothing," which delays recognition of investment gains and losses.
Overall, the projections on retirement obligations are set to drain city finances. Payments for pension contributions are expected to increase to roughly one-third of the city's general revenue, according to the city's proposal to creditors. Note that these are projected outflows of cash necessary to pay retirement obligations. There also are projected payments on other types of debt. With these costs included, more than half of the city's general fund revenue is pledged to pay for legacy costs.
Clearly, this cannot stand as it is and the city is seeking to mitigate this burden through cuts to the pensions earned by retirees.
Pensioners, however, are being asked to take a smaller cut than other city debt obligations. City officials have tried to structure a deal that would raise funds from the state and Detroit Institute of Arts and its supporters. A term of the deal, however, is to transfer artistic holdings to a nonprofit instead of the city itself.
Thus, pensioners would not be the largest winners. The DIA would be. The city owns valuable artwork that may otherwise be liquidated to pay off other debt. The amounts being raised under the proposed deal dwarf the expected value of the DIA's city-owned holdings.
On the losing end would be state taxpayers. The state already delivers more money to Detroit than every other city. The state has also helped Detroit borrow money that was supposed to bridge the gap between fiscal problems and solvency.
Still, other creditors are not subject to the protections offered to pensioners. Indeed, some creditors are being asked to take 85 percent cuts in the latest proposal.
So pensioners are being offered levels of protection beyond other creditors. Given the magnitude of DIA holdings, however, they may want to think twice before accepting the carrot being held out to them. With ongoing reforms to city finances and the possibility of additional asset sales, it is possible that they could find themselves in a better position. This is especially the case if the city improves its management and pursues an aggressive privatization agenda.
Arguing about who should take the largest cuts is an essential part of bankruptcy. While relieving itself of debt burdens helps Detroit's fiscal situation, it is also insufficient at revitalizing the city.
What is needed is competent administration of government services and fewer burdens on the city's people and businesses.
Michigan Capitol Confidential is the news source produced by the Mackinac Center for Public Policy. Michigan Capitol Confidential reports with a free-market news perspective.