LAFF Society

NEWSLETTER

Detroit Bankruptcy: A Work in Progress

By James Kelly

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

It’s the largest municipal bankruptcy in American history: a once-thriving city now in court-supervised bankruptcy following decades of population loss, economic decline and city mismanagement. But it’s also a city with considerable reason for optimism about its future—well, let’s qualify that and call it “guarded optimism”.

 

It’s a fascinatingly complex story involving every major aspect of a city’s political economy: declining revenue, budget deficits, overhanging pension obligations, state-imposed “emergency” financial management, federal bankruptcy, state-local politics, public posturing in the media and, last but not least, an unprecedented philanthropic initiative to help Detroit move forward to a more promising post-bankruptcy future. 

 
And the Ford Foundation’s new president, Darren Walker, is front and center among foundation leaders who are involved in that initiative. 
 
Is Detroit broke? Yes, the city government is really bankrupt with between $16 billion and $18 billion of debt (depending on who does the accounting). The city simply does not have money to pay its bills or meet future obligations. 
 
Widespread corruption during the administration of a recent mayor (now in the federal penitentiary for the next 25 years) exacerbated the fiscal problems but was not the fundamental cause. In response, an overwhelmingly African-American population elected a new mayor last year: a white politician promising to fix problems and get the city moving forward. 
 
It’s important to keep the city government’s difficulty in perspective. Detroit’s population of about 750,000 is only one-sixth of the total population of the seven-county Detroit metro region. Southeast Michigan, in fact, enjoys a strong and growing economy based not only on a once-again healthy automotive sector but increasingly on significant high-tech and entrepreneurial activity. 
 
Contrary to images seen frequently in national media focusing solely on blighted neighborhoods, downtown and midtown areas (Wayne State University and dozens of museums and other nonprofits) are booming. For example, one employer, Quicken Loans, has moved almost 10,000 young professionals into downtown in just the past two years. Two major hospital complexes (Henry Ford Hospital and Detroit Medical Center) are doing well and stimulating new startups. New rental housing units in downtown and midtown Detroit are snapped up within days, and vacancy rates are near zero. 
 
Three professional sports teams draw millions into downtown; two of them (Tigers and Lions) are in relatively new stadiums and the third (Red Wings) is breaking ground on a new arena. Three large casinos draw millions annually into the downtown area. The Detroit Symphony Orchestra emerged three years ago from a long strike and supplements programs at Orchestra Hall in midtown with new neighborhood programming across the entire metropolitan area. 
 
The Detroit Institute of Arts (DIA), the nation’s sixth largest general art museum and located in midtown Detroit, is both an iconic symbol of the wealth that built Detroit and deeply enmeshed in the bankruptcy proceedings. Even though it is operated by an independent non-profit with virtually no support from the city, the city actually owns it. Decades ago, the city used tax revenue to purchase some of its most valuable works of art. But its vast holdings are viewed by some creditors not as sacrosanct and privileged but as just another city asset. They demand that major works of art (think Monet, van Gogh, etc.) be sold to raise money to pay off some of the city’s debts. 
 
Bankruptcy was officially declared in 2013. The federal bankruptcy judge who controls the eventual outcome has put the proceedings on a fast track intended to resolve all major aspects of the bankruptcy and get Detroit restored to independent operations by later this year. 
 
Detroit’s state-imposed emergency financial manager has proposed an overall “plan of adjustment” that, if adopted, would result in all creditors getting less than they are owed, the typical outcome of bankruptcy. For example, those holding unsecured bonds would get about 15 cents on the dollar. Banks that loaned the city money would also get far less than they are owed. 
 
It’s very important to note that the proposed plan would set aside almost $1.5 billion over the next ten years for a wide variety of program and infrastructure improvements in the city of Detroit. The bankruptcy judge has made clear that just selling major city assets to pay off debts was not going to be accepted, and that the settlement of the bankruptcy would set aside funds needed to assure a viable future for the city. 
 
Politically, retired city employees are the most sensitive class of creditors. It’s important to note that retired city employees themselves are hardly to blame for the city’s bankruptcy. The average pension for retired public safety officers (police and fire) is about $39,000 a year, and for other retirees only $20,000 a year. Cutting these pensions drastically would not only be unfair to the retirees themselves but also so controversial politically that pension fund trustees could be expected to fight any proposed settlement and tie it up in litigation for many years to come. So finding a way to mitigate or even eliminate reductions in pensions was seen as a crucial element in getting a settlement accepted by all. 
 
Enter into this drama a team of court-sanctioned mediators, led by the Chief Judge of the Federal District of Eastern Michigan, Gerald Rosen, and a team of mediators working under him on several major parts of the bankruptcy. Under Judge Rosen’s leadership an idea emerged to ask private foundations to contribute substantial amounts to a fund that would be used to help achieve a negotiated settlement of the bankruptcy. Judge Rosen also proposed to remove the DIA from city ownership and re-establish it as an independent non-profit, thus free from the threat that it would ever have to sell art to settle municipal debts. 
 
In early November 2013, Judge Rosen enlisted Mariam Noland, president of the Community Foundation for Southeast Michigan (disclosure: Mariam is my wife) to help him convene a group of foundation presidents to consider this idea. The New York Times reports that Mariam’s initial response to the judge was, “Are you nuts?” But just ten days later presidents of a dozen local, regional and national foundations met in Judge Rosen’s chambers. Three of them met again that same evening at our house for further discussions with the judge. 
 
A key leader involved in those early discussions was Darren Walker, then only in his first few months as President of the Ford Foundation. Over the following weeks, with Darren actively involved in the process, a group of foundations pledged a total of $365 million to help Detroit move out of bankruptcy. Ford has been in the lead throughout this process and has committed $125 million to the initiative.  
 
These unprecedented philanthropic commitments to help a major city right itself and prepare to move forward have led Michigan’s governor to promise an additional $350 million and to publicly call on the DIA itself to raise another $100 million. Thus, in what is now called The Grand Bargain, more than $800 million has been committed to this extraordinary effort, contingent on the pension funds accepting the proposed settlement and the DIA becoming independent. 
 
In the originally proposed settlement, public safety retirees would see their pensions cut by 14 percent, but if they were to accept the  proposed settlement, their pensions would be cut by only 6 percent, with similar impact on other retiree pensions.
 
Following months of intensive negotiations, tentative agreements were reached in mid-April between both pension groups and the city that would result in almost no reduction for public safety pensioners, and 4.6 percent for other city retirees. It’s difficult to believe these agreements could have been achieved without the additional $800 million being available to help fund the pensions.
 
The bankruptcy judge has indicated he will hold the major bankruptcy trial in June. If he holds to that schedule, he could order an overall settlement of the entire case by early Fall of this year, including terms of the tentative agreements with the pension systems.  
 
It’s just not possible at this point to predict the outcome. Will enough local stakeholders in Detroit accept the proposed settlement?  Stakeholders across the country are watching this with keen interest. Detroit is hardly the only American city facing massive financial obligations that exceed likely available revenue. 
 
Will foundations elsewhere step up to help? Will any solution be found for unfunded public retiree pensions other than to reduce them dramatically? It’s a work in progress. Stay tuned!
 
James Kelly is president of Kelly Advisors, LLC in Grosse Pointe Farms, Mich. Jim worked at the Ford Foundation from 1970 to 1981 in the Education and Research program and has had a long career in education policy, education finance, philanthropy and teaching standards, assessment and certification. He was Founding President of the National Board for Professional Teaching Standards, is co-chair of Learning to Give, and is Chair of the Board of Advisors of TeachingWorks, a nationally influential teaching program at the University of Michigan. He can be reached at jakmcn@mindspring.com

 

 

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