Could bankruptcy be the answer?
Published: August 8, 2012
Let's call it the "B" word.
The word that dare not be uttered.
Detroit's ongoing financial crisis has created a vocabulary of decline. There are the widespread layoffs of workers, with severe pay cuts and increased health care costs for those who remain. Meanwhile, residents are forced to endure the consequences of deteriorating city services. Malfunctioning streetlights leave some neighborhoods in the dark for months at a time. Ambulances break down on their way to emergencies. Police can take hours to respond to calls, if they come at all. Grass in parks goes uncut.
Austerity is the word of the day as the city operates under the terms of a consent agreement forced on it by Gov. Rick Snyder, with state-mandated appointees now exercising newly created power.
Amid all the suffering, though, there is one group that remains untouched by the demands of sacrifice: the banking industry that played such a large role in creating the crisis in the first place. A housing bubble fueled by widespread fraud and predatory lending practices that targeted the poor and minorities drove America into its most severe economic meltdown since the Great Depression.
When that occurred nearly five years ago, Detroit was already in deep trouble. Decades of flight from the city and the decline of the auto industry here combined to decimate the tax base.
To deal with its chronic budget shortfalls, the city began borrowing massive amounts of money for its general fund obligations. But surviving day-to-day on borrowed millions meant piling up long-term debt, a sea of red ink that by some estimates approaches $21 billion.
That works out to about $30,000 for every man, woman and child living in the city, according to a study done by the consulting firm Foster McCollum White & Associates.
Despite all this, the powers that be have declared that the lenders who provided all this money — knowing that they were doing so despite long-term trends showing the city's revenues were in steep decline — have declared that, no matter what suffering others may endure, the banks will be protected.
There is a mechanism that could, in theory anyway, force the bondholders to share in the sacrifice. But that option has been taken off the table.
And it's not just for the city of Detroit. Struggling municipalities and school districts across the state that sink into insolvency and find themselves under the control of state-appointed financial managers who have near-dictatorial powers can see labor contracts broken and public assets sold off, but none will be allowed to default on any debt.
The controversial emergency manager law, formally known as Public Act 4, guarantees that will be the case, mandating that financially stressed municipalities and schools taken over by the state must pay in full "all bonds, notes, and municipal securities of the local government and all other uncontested legal obligations."
Forget about any inherent risks on the part of lenders.
According to the analysis done by the state-appointed financial review team in May, the city's "mounting debt problem" resulted in it paying nearly $600 million in debt service in 2010. That same year, the ratio of long-term debt to total net assets was more than 32 to 1.
Even so, when Gov. Snyder appeared before rating agencies last summer, he assured them that they had no reason to fear the "b" word, telling them that bankruptcy "was not on the table" for Detroit or any other Michigan city.
As the Free Press reported at the time, the declaration filled the governor with glee:
"Detroit's not going into bankruptcy," Snyder told reporters, as he beamed with encouragement from his meetings Monday with three top bond rating agencies in New York. He said he hopes Michigan's rating returns to the highest levels possible.
It is a joy that critics on the left fail to share.
Not that they want bankruptcy. It's not something anyone wants to go through. But, they say, given the circumstances, fairness demands that everyone share in the sacrifices that are necessary. City workers, pensioners and residents are all feeling the pain. Why shouldn't the bondholders, to employ a widely used euphemism, get a "haircut" along with everyone else?
Especially considering the dubious nature of some of these loans.
In 2008, according to the financial review team's report, the city engaged in a swap agreement, hoping to obtain better interest rates. Instead it ended up losing what amounted to a bet with the banks that interest rates would rise. Consequently, when rates fell, it ended up having to pay "hedging derivatives" which, over the life of the debt, added an additional $1.1 billion to the amount owed by the city.
Detroit is far from alone is suffering such severe setbacks.
What's come to light recently is a scandal involving what's known as the London Interbank Offered Rate, or Libor, which is supposed to be a "reliable reflection of the rate at which banks are lending to each other." But, as a story on the AlterNet website noted: "It has been widely reported that Libor ... was rigged by a banking cartel ..." What's been widely missing from the coverage, according to the left-leaning nonprofit news organization, was that the Libor rate was used to manipulate, not just tens of millions of consumer loans, but hundreds of trillions of interest rate contracts (swaps) with municipalities across America and around the globe."
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