The City of Detroit Files for Bankruptcy

The former automotive capital has been hit by the decline of its traditional industry, bad management of its finances and a massive population exodus.

On Thursday, the city of Detroit officially filed for bankruptcy. A federal court has three months to decide if the largest city in Michigan, crushed by $18.5 billion of debt, is eligible. It would be the most significant municipal bankruptcy in the history of the United States.

Kevyn Orr, the emergency manager named by the governor last March to manage the American automotive capital, would, thanks to Chapter 9 of the U.S. Bankruptcy Code, have a large margin, in which to force reductions to the social security benefits of the city’s employees and wipe out most of its debts.

“It is clear that the financial emergency in Detroit cannot be successfully addressed outside of such a [bankruptcy] filing, and it is the only reasonable alternative that is available,” declared Republican Governor Rick Snyder, in a letter authorizing Orr to begin the bankruptcy proceedings. The African-American lawyer, a bankruptcy expert, has been asking the trade unions of the 30,000 employees and retirees in the city, as well as his other creditors, to agree to considerable sacrifices for more than a month now. Several weeks ago he declared Detroit “insolvent.”

This dramatic new chapter in the decline of a city with a population of 1.8 million in 1950 but with fewer than 700,000 residents today is the result of the refusal of these creditors to negotiate with Orr, the two principal ones being the holders of municipal employees’ pension funds, who will try to block Detroit’s recourse to Chapter 9.

Undermined by corruption for decades, a victim of a massive exodus caused by the closing down of the area’s factories formerly run by General Motors, Ford and Chrysler, Detroit has become a dysfunctional city. It lacks a sufficient tax base, is crushed by promises of benefits made when prosperity appeared to reign and unable to provide basic municipal utilities. The mere servicing of its debt already accounts for 42.5 percent of its revenue. This is a considerable proportion: No other large municipality in the U.S. pays more than 20 percent of its income to cover this type of expenditure.

Detroit’s current situation is reminiscent of New York’s in 1975. After having suspended certain payments, the “Big Apple” avoided bankruptcy by favorably renegotiating its debts and reducing its costs. However, Orr’s tactics have shaken the entire municipal bond market, which is worth $3.7 trillion in securities. In effect, he requires sacrifices from all the city’s bondholders, including those who hold general obligation bonds, securities usually protected from the risk of default by the municipality’s promise to increase taxes in order to honor its commitments.

“If you lent money to an insolvent city that has been going insolvent as openly and notoriously as possible since 2000, and you don’t have a security interest, then you are an unsecured creditor,” confirms Orr.

If this logic is validated by a future restructuring of Detroit’s debt, it will be applied to other cities in decline. This precedent would immediately increase the cost of financing all the American municipalities.