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Analysis: History offers few happy endings for Detroit to follow

Downtown Detroit is seen looking south along Woodward Avenue in Detroit, Michigan July 21, 2013. REUTERS/ Rebecca Cook
Downtown Detroit is seen looking south along Woodward Avenue in Detroit, Michigan July 21, 2013. REUTERS/ Rebecca Cook

By Michael Connor and Tiziana Barghini

MIAMI/NEW YORK (Reuters) - Detroit officials hope the bruising bankruptcy battle ahead of them will be rewarded with the birth of a leaner, more efficient and ultimately prosperous Motown.

History, however, has few story book endings to offer as a guide when it comes to U.S. municipal bankruptcies.

Fact is, they are rare events - just 61 local governments have gone through Chapter 9 bankruptcy since 1954 - and while the process is devoted to restructuring debt and provides temporary cash flow relief, it does not help a city enhance its revenue or economic outlook. Furthermore, cities typically lose access to capital markets in the wake of a bankruptcy.

"Detroit has a very high level of debt and the bankruptcy can correct some of it, but is it going to turn around its economy quickly? That's probably unlikely," said Jeff Previdi, Managing Director and Co-Head of Local Government Ratings at Standard and Poor's.

To be sure, Detroit's financial disarray was decades in the making: a downward spiral of company departures and failures accompanied by a dramatic drop in its population, to just below 700,000 from a peak of 1.8 million, and a rise in crime.

Once the cradle of U.S. automotive industry and Motown music, Detroit appears to have run out of alternatives to bankruptcy barring a bailout from the state.

New York, Cleveland and Philadelphia previously teetered on the edge of bankruptcy but Detroit is the first major U.S. city to file for bankruptcy, pressured by $18.5 billion of outstanding liabilities.

To this point, only much smaller local governments have gone the bankruptcy route without external help and facing similar issues.

Take for example Vallejo, California, with about 116,000 people. It spent more than three years in bankruptcy from 2008 to 2011, weighed down by generous labor contracts and retirement benefits.

The city, about 30 miles northeast of San Francisco, was allowed to terminate its collective bargaining agreements, but it never renegotiated some $128 million of unfunded pension liabilities.

And while Vallejo generated about $34 million in savings on some of the liabilities it faced heading into bankruptcy, those have been nearly matched by expenses related to the bankruptcy itself, according to a 2012 study by Standard & Poor's.

Now two years after emerging from Chapter 9, it has yet to balance its budget, and the police force is roughly half its previous size. Vallejo remains shut out of the municipal bond market and cannot raise money to address much needed infrastructure repairs.

"We have not done enough, and the budget we just adopted in June still has a $5.2 million dollar deficit on an $82 million general fund budget," Vallejo City Manager Daniel Keen said.

Both Vallejo and nearby Stockton, which before Detroit's filing last week had been the most populous city to file for bankruptcy, have seen further increases in crime after seeking protection from creditors. Stockton, with nearly 300,000 people, was granted permission to enter Chapter 9 protection in April and will file a debt-adjustment plan later this year.

ORANGE COUNTY: A RARE SUCCESS

The brightest post-bankruptcy story is perhaps California's Orange County. But its 1994 bankruptcy - the largest in history at the time - stemmed from $1.7 billion in bad derivative bets, not the kind of grinding economic slump and population flight that feature so prominently in the Detroit case.

Orange County, home to Disneyland and with median household income of more than $75,000, nearly three times Detroit's, has suffered few lingering effects from its 18 months in Chapter 9.

"Most county residents were not impacted," said Mark Baldassare, president of the Public Policy Institute of California. "Police services, streets and road, schools, things that people depend on local government for, went on."

Orange County also stands out as the only bankruptcy alumnus to successfully re-enter the municipal bond market. But its recovery bonds were fully backed by bond insurer MBIA Insurance Corp, an option that may not be available in the future since the 2007-2009 financial crisis crushed the bond insurance business.

JEFFERSON COUNTY: FUTURE IS CLOUDED

And the jury is still out on Jefferson County, Alabama, which before Detroit had held the mantle as the largest municipal bankruptcy ever at $4.2 billion that stemmed from debts to overhaul and expand its sewer system.

The county, home to Birmingham, the state's largest city, is on track to leave bankruptcy by year's end. By many measures, it is thriving: its jobless rate is just 5.5 percent compared with the U.S. rate of 7.6 percent; it has a diverse employer base; and private business investment is robust, totaling $579 million in 2012, more than double a 10-year average, according to the Birmingham Business Alliance.

Nonetheless, local officials are bracing for years of stunted government services such as few emergency crews to deal with deadly tornadoes, rising utility costs, and limited public resources for boosting local commerce.

"We have no money for economic growth," said David Carrington, president of the Jefferson County Commission and a negotiator of the county's debt-adjustment plan filed on June 30. "There will be on-going deterioration of infrastructure."

Road repairs in Jefferson County, home to 660,00 people, already lag other sizeable Alabama counties, according to Carrington, who also worries federal officials will sue over the county's below-par jails.

"Like any company, you have to grow, or you are going to die," said Robert Brooks, finance professor at the University of Alabama. "This is going to be a strain and make it unattractive for businesses to move into the Birmingham area."

Jefferson County also hopes to follow in Orange County's footsteps in returning to the bond market, with a $1.9 billion debt deal planned for later this year that is central to its negotiated reorganization plan. With slim prospects for the kind of bond insurance enhancement obtained by Orange County, however, the deal is likely to saddle the county with outsized interest rates for decades.

"Clearly, with such a huge liability for such an extended length of time, it is like having a ball and chain around our ankle," said Brooks.

In the end, though, the enduring costs of a municipal bankruptcy are tallied in more than dollars.

"The impacts of a bankruptcy on a community are pretty hard to predict but they are not very good. There is a loss of confidence ... there is a lot of anxiety in the city's workforce," Vallejo's Keen said. "We are still the city that all know for having being in bankruptcy."

(Additional reporting by Jim Christie and Verna Gates; Editing by Dan Burns and Tim Dobbyn)

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