Once the very symbol of American industrial might, Detroit became the biggest US city to file for bankruptcy on Thursday, its finances ravaged and its neighbourhoods hollowed out by a long, slow decline in population and auto manufacturing.
The filing, which had been feared for months, put the city on an uncertain course that could mean laying off municipal employees, selling off assets, raising fees and scaling back basic services such as trash collection and snow ploughing, which have already been slashed.
“Only one feasible path offers a way out,” Governor Rick Snyder said in a letter approving the move.
Kevin Orr, a bankruptcy expert hired by the state in March to stop Detroit’s fiscal free-fall, made the filing in federal bankruptcy court.
Michael Sweet, a bankruptcy attorney in Fox-Rothschild’s San Francisco office, said the city would pay current employees. But “beyond that, all bets are off.”
“They don’t have to pay anyone they don’t want to,” Sweet said. “And no one can sue them.”
Detroit lost a quarter-million residents between 2000 and 2010. A population that in the 1950s reached 1.8 million now struggles to stay above 700,000. Much of the middle-class and scores of businesses also have fled Detroit, taking their tax dollars with them.
In recent months, the city has relied on state-backed bond money to meet payroll for its 10,000 employees.
Orr was unable to persuade a host of creditors, unions and pension boards to take pennies on the dollar to help facilitate the city’s massive financial restructuring. If the bankruptcy filing is approved, city assets could be liquidated to satisfy demands for payment.
Snyder determined earlier this year that Detroit was in a financial emergency and without a plan for improvement. He made it the largest US city to fall under state oversight when a state loan board hired Orr. His letter was attached to Orr’s bankruptcy filing.
“The citizens of Detroit need and deserve a clear road out of the cycle of ever-decreasing services,” Snyder wrote. “The city’s creditors, as well as its many dedicated public servants, deserve to know what promises the city can and will keep. The only way to do those things is to radically restructure the city and allow it to reinvent itself without the burden of impossible obligations.”
A turnaround specialist, Orr represented automaker Chrysler during its successful restructuring. He issued a warning early on in his 18-month tenure in Detroit that bankruptcy was a road he preferred to avoid.
He laid out his plans in June meetings with debt holders, in which his team warned there was a 50-50 chance of a bankruptcy filing. Some creditors were asked to take about 10 cents on the dollar of what the city owed them. Underfunded pension claims would have received less than the 10 cents on the dollar under that plan.
Orr’s team of financial experts said that proposal was Detroit’s one shot to permanently fix its fiscal problems. The team said Detroit was defaulting on about US$2.5 billion (HK$19.4 billion) in unsecured debt to “conserve cash” for police, fire and other services.
“Despite Mr. Orr’s best efforts, he has been unable to reach a restructuring plan with the city’s creditors,” the governor wrote. “I therefore agree that the only feasible path to a stable and solid Detroit is to file for bankruptcy protection.”
Detroit’s budget deficit is believed to be more than US$380 million. Orr has said long-term debt was more than US$14 billion and could be between US$17 billion and US$20 billion.
Orr’s decision to file now may have been influenced by lawsuits filed by some city workers and retirement systems to prevent Snyder from approving a bankruptcy request from the emergency manager, said Detroit-area turnaround specialist James McTevia.
They have argued that bankruptcy could change pension and retiree benefits, which are guaranteed under state law.
Orr has said federal bankruptcy laws trump state law in this matter.
A bankruptcy judge will stay all the litigation, McTevia said.
“One court will adjudicate all these,” McTevia said.
Some are concerned that a bankrupt Detroit will cause businesses large and small to reconsider their operations in the city. But General Motors, which filed and emerged from a Chapter 11 bankruptcy, does not anticipate any impact to its daily operations, the automaker said Thursday in a statement.
“GM is proud to call Detroit home and today’s bankruptcy declaration is a day that we and others hoped would not come,” the statement said. “We believe, however, that today also can mark a clean start for the city.
Detroit has more than double the population of the Northern California community of Stockton, California, which until Detroit had been the largest US city ever to file for bankruptcy when it did so in June last year.
Before Detroit, the largest municipal bankruptcy filing had involved Jefferson County, Alabama, which was more than US$4 billion in debt when it filed in 2011. Another recent city to have filed for bankruptcy was San Bernardino, California, which took that route in August last year after learning it had a US$46 million deficit.
Here’s a look at how the city spiraled into financial ruin and why it’s in so much trouble:
For decades, Detroit paid its bills by borrowing money while struggling to provide the most basic of services for its residents. The city, which was about to default on a good chunk of its US$14 billion-plus debt, now will get a second chance in a federal bankruptcy court-led restructuring. Detroit’s budget deficit this year alone is estimated at US$380 million, and Kevin Orr, its state-appointed emergency manager, chose bankruptcy over diverting money from police, fire and other services to make debt payments. The move conserves cash so the city can operate, but it will hurt Detroit’s image for years. It also leaves creditors with pennies on the dollar and places in jeopardy the pension benefits of thousands of city retirees.
WHY DID IT HAPPEN?
It took decades of decay to bring down the once-mighty industrial giant that put the world on wheels. The city grew to 1.8 million people in the 1950s, luring them with plentiful jobs that paid good wages to stamp out cars for sale across the globe. But like many American cities, Detroit’s fall began late that decade as developers starting building suburbs. Then came the 1967 riots that accelerated the number of white residents who moved to the cities north of Eight Mile Road, considered the region’s racial dividing line. At the same time, auto companies began opening plants in other cities, and the rise of autos imported from Japan started to cut the size of the US auto industry. Detroit’s property values fell, tax revenue dropped, police couldn’t control a growing murder rate, and many middle-class blacks fled the city for safer suburbs with better schools. By 2009, the auto industry collapsed along with the economy as a whole, eventually pulling the city down with it. Government corruption under former Mayor Kwame Kilpatrick only made things worse. In the 2000 census, Detroit’s population fell under 1 million in as the exodus continued. Today it’s barely above 700,000.
DID THE AUTO INDUSTRY’S FALL DRAG DOWN DETROIT?
It’s a big factor. The city is littered with abandoned factories built in the postwar boom years, most of which have multiple stories. As the Japanese auto invasion began cutting into Detroit’s sales, General Motors, Chrysler, Ford and hundreds of auto parts companies looked outside the city to build one-story plants that could handle modern assembly lines. With every downturn, more companies abandoned the city, leaving the hulking buildings to squatters. Detroit’s tax base continued to erode. By the time the auto industry melted down in 2009, only a few factories from GM and Chrysler were left. GM is the only one with headquarters in Detroit, though it has huge research and testing centres with thousands of jobs outside the city.
WHERE ELSE HAS THIS HAPPENED?
Before Detroit, the largest local government bankruptcy filing was in Jefferson County, Alabama, in November 2011. The county cited more than US$4 billion in debt, mostly from corrupt deals involving sewer financing that fell apart when the home mortgage crisis hit in 2008. The county is still trying to clean up the mess. Last month, commissioners sought a compromise that calls for paying creditors a little over half the money they’re due and raising sewer rates. They hope to exit bankruptcy by December. Jefferson County has nearly 700,000 people, which is similar in size to Detroit, and includes Alabama’s capital, Birmingham. The economic crisis also caused bankruptcies of smaller cities. The California cities of Stockton, San Bernardino, and Mammoth Lakes all filed for bankruptcy last year. Stockton and San Bernardino were hit by plummeting home values during the recession, which cut property and sales taxes, while Mammoth Lakes was overwhelmed by a US$43 million breach-of-contract judgment brought against it by a developer.
GENERAL MOTORS REBOUNDED AFTER BANKRUPTCY. CAN DETROIT FOLLOW?
Maybe. In GM’s 2009 government-funded bankruptcy, the company was split in two, with money-making assets staying at GM and decrepit plants and billions in debt going to a separate company. GM reduced its debt from US$46 billion to US$8 billion and used the bankruptcy to close factories, shed brands and get more concessions from union workers. The new, leaner company has since racked up US$17.2 billion in profits and added jobs in Detroit. For the city, the comeback will be much harder. Its decaying neighbourhoods can’t be sent elsewhere. But creditors whom Detroit owes more than US$14 billion will have to take pennies on the dollar. Thousands of retired city workers could lose at least part of their pension benefits. Concessions could be forced upon dozens of city unions, including pay and benefit cuts. Free of these financial burdens, Detroit will be able to concentrate its limited dollars on services such as basic police and fire protection. Better services could bring more people and lure more business investment. Already the downtown and an area to the north called Midtown are seeing business and residential growth - signs that Detroit has a future.