Let Courts Handle Detroit's Inevitable Bankruptcy

A pre-packaged bankruptcy that requires state involvement would be politically explosive.

Michigan Governor Rick Snyder has postponed his decision to appoint an emergency manager to deal with Detroit's fiscal crisis. He was expected to act after a state audit last month found that the city's long-term debt was $12 billion, $2 billion more than previously reported. But the delay won't postpone Detroit's inevitable date with insolvency.

The main issue that Snyder, a Republican, will ultimately have to confront is whether to put Detroit through a managed bankruptcy, which would be legally less nettlesome but require his maximal involvement, or a conventional Chapter 9 court process that will be legally arduous but would minimize his role.

He should opt for the latter.

The audit pegged the city’s annual debt-service costs alone at $597 million, while its three biggest sources of revenue generate only $538 million. Worse, the value of the city’s net assets, which in 2010 were worth $265 million, has collapsed and they now have a negative value, the report said.

More urgently, Detroit will run out of operating cash before the fiscal year ends in June (although that didn’t stop it from handing out year-end bonuses to nonunion employees). Snyder had allowed Detroit to borrow $137 million through a municipal-bond sale on the state credit card last summer. Before the funds could be released from escrow, however, the city was supposed to meet prescribed restructuring goals under a consent agreement.

The city failed, no surprise, thanks to squabbling between a dysfunctional city council and Mayor Dave Bing. The council even blocked Bing's effort to hire a private law firm to help overhaul contracts with unions and vendors, even though the city has little in-house expertise to handle something this technical and complex.

The upshot was that the state has halted the release of $30 million of the bond money. Bing is planning to stretch out his meager resources by furloughing the city’s 11,000 workers for long periods, starting this month, but no one believes this will delay the inevitable. Short of a federal bailout or divine intervention, Detroit will be insolvent within a matter of months.

In a "prepackaged" bankruptcy, as opposed to a conventional process, deals are cut with as many creditors as possible in advance of a court filing and followed quickly with a plan for reorganization. This would put the burden on Snyder for negotiating "haircuts" with public-employee unions, investors, and vendors. Detroit would be the largest U.S. city to undergo anything like this, and Snyder would be in uncharted legal territory.

Every decision he makes would be politically fraught. President Barack Obama was criticized for offering a better deal to the United Auto Workers than to secured creditors during the auto-industry bankruptcy. Should Snyder do the opposite and favor secured creditors over public unions—either because it is legally the right thing to do or to keep Detroit’s future borrowing costs low—he will be accused of crony capitalism, especially given his background as a business executive.

Indeed, city leaders regarded even the original consent agreement, which came backed by the state credit card, as an affront just because it required them to clean up their books under state oversight. Protests broke out. Jesse Jackson flew in to join a coalition of pastors, civil-rights leaders, and local officials condemning the alleged assault on the city’s democratic rights. "We are prepared to go from education, mobilization, litigation, legislation, demonstration and civil disobedience," Jackson said.

That showdown would pale compared with what would happen when Snyder tries to get public unions to accept pennies on the dollar in order to reduce the city's crippling legacy costs. Many in Detroit still believe that the city is going broke not because it overpromised but because of meddling from Lansing, Michigan's capital. Consider what a union representative, Ed McNeil, said at a recent city council meeting.

"We're going to get the people out of Lansing out of Detroit," he said. "If we get them the heck out of here, we won't be broke."

A conventional Chapter 9 bankruptcy would be legally arduous because each side will mount pitched court battles to get a bigger portion of the spoils. But unions will have a harder time protesting the final outcome. And if they do and enhanced security becomes necessary—not a remote possibility given the fierce public-union demonstrations that erupted in Lansing when the Legislature passed a right-to-work law—it would be much better if a judge orders it rather than Snyder.

Politicians, even well-meaning ones, can't save Detroit. Any salvation will have to come directly from the courts.

This column originally appeared in Bloomberg View.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Geoff Nathan||

    While I completely agree with what Ms Dalmia is saying, the warnings about Detroit running out of money 'tomorrow' have been floating around since September, and yet each time the warning comes out, it turns out to be false, so I'm starting to wonder where the extra funds keep coming from.
    Bing seems to be a nice guy, but nobody can deal with our dysfunctional city council, who want to make it all about race, regardless. In fact, that's the additional 'elephant in the room' that Shikha doesn't mention.

  • Drake||

    How about Chapter 7? Just liquidate it.

  • Almanian.||

    liquidate it

    A sort of "final solution", eh, Drake? Excellent...

  • Pro Libertate||

    Why Detroit doesn't institute a cyborg police force is beyond me.

  • Tim||

    Omni Consumer Products(OCP) should take the whole City private. They specialize in traditionally unprofitable areas. Sell them the whole thing for a Dollar!

  • Pro Libertate||

    I'd buy that for a dollar!

  • JWatts||

    That would be a very bad deal for you.

  • Almanian.||

    Buying and selling a whole city? Of PEOPLE?

    RAAAAAAAAAAACIST!!!111!

  • Stephdumas||

    Speaking of private city, I spotted that article on the Detroit News about a private city on Belle-Isle Island http://www.detroitnews.com/art...../301120319

  • C. S. P. Schofield||

    They tried. The cyborgs promptly decamped for Japan, where they are now working in various animation studios as models.

  • R C Dean||

    Why any sane person would want to get deeply involved with Detroit's governance and finance when there is an alternative is completely beyond me.

  • Whiterun Guard||

    They'd rather be lord of a hellhole than average in an average place?

  • ||

    I think you just summed up every single politicians' ideology.

  • Whiterun Guard||

    What do I win?!

  • Almanian.||

    Toledo!

  • ||

    No, Cleveland!

  • Whiterun Guard||

    Aww man :(

    If I won Toledo I would make the official slogan: See You In Toledo!

  • Lexy||

    East Palo Alto

  • Lexy||

    Oakland, California

  • Sevo||

    Please.

  • Tim||

    It's easier to steal, cheat, swindle and defraud in a broken corrupt system.

  • Fist of Etiquette||

    Worse, the value of the city’s net assets, which in 2010 were worth $265 million, has collapsed and they now have a negative value, the report said.

    Everything's covered in graffiti?

    It's odd to see a reason contributor advising a politician for political reasons to shy away from making tough decisions.

  • Tim||

    Dick Jones: Suit yourself Clarence... But Delta City begins construction in two months. That's two million workers living trailers, that means drugs, gambling, prostitution...
    [Clarence backtracks into Jones' office]
    Dick Jones: Virgin territory for the man who knows how to open up new markets... one man could control it all, Clarence.
    Clarence Boddicker: Well I guess we're gonna be friends after all, *Richard*.

  • SugarFree||

    Boddicker also had the classic line: "Bitches leave!"

  • Fluffy||

    You know, for close to 20 years now I've been hearing people quote/say "Bitches leave!" and I thought they were paying homage to the True Romance screenplay, because Gary Oldman (in his greatest performance ever) says the same thing.

    But then a few months ago I saw Robocop again (everybody bitching about the remake production made me sit down and watch it) and I saw Clarence's version of the line.

    And I was like, "Son of a bitch, you just KNOW Tarantino was referencing Robocop when he wrote that scene. And I fucking never knew!"

    Quentin gets me like that all the time.

  • Pro Libertate||

    And don't forget The Crow was also set in a quasi-post-apocalyptic Detroit.

  • Whiterun Guard||

    I thought that was a documentary filmed in real time.

  • ||

    No, that was The Highlander.

  • Whiterun Guard||

    A Spanish guy with a Scottish accent? Who made this thing, Michael Moore?

  • Fluffy||

    Wasn't he actually Egyptian?

  • Whiterun Guard||

    You're thinking of The Mummy.

  • Pro Libertate||

    I find it odd that people object to Connery's accent in that film, but not to Lambert's. At least the Connery character was originally Egyptian, so he could be expected to talk funny.

  • ||

    Let's see what your ass knows about flying!

  • Bardas Phocas||

    Who buys Detroit's debt? I've never done anything in the muni bond market but I'm always seeing these anemic (other than tax write off) returns on these shitty cities and states.

  • Whiterun Guard||

    Spain?

  • Almanian.||

    I heard it was some guy named "Geitner".

  • Kyfho Myoba||

    Geithner.

    FTFY

  • Sevo||

    "I've never done anything in the muni bond market but I'm always seeing these anemic (other than tax write off) returns on these shitty cities and states."

    Maybe you buy it a $shitty discounted an additional 10% and it works?
    Much as I despise hit politics, WB bought MBSs in 2009 at $0.40 and probably did well on it.

  • Hopfiend||

    Frankly what's wrong with letting mother earth reclaim Detroit.

    If people paid any attention at all it might be a great object lesson in unintended consequences. But I think all the teachable people have figured it out.

  • ||

    Foreseeable consequences are not unintended...

  • sonofloud||

    As someone who grew up in the Detroit metro area.....burn Detroit to the ground and start over.

  • Almanian.||

    Here we go again, with the white suburbanites trying to tell Detroiters what to do.

    Also, RACIST!

    Also, fried chicken.

  • EDG reppin' LBC||

    I gotta' hand it to you, Almanian. You are really keeping the "Also, fried chicken" meme going strong on HyR. Keep it up.

    And now for a meme of my own: Fuck Michigan!

  • Geoff Nathan||

    +1
    Also mentioned this above. We should get together some time.

  • ChrisO||

    Fort Apache Detroit.

  • Tim||

    Reason tried to save Cleveland but I notice even they wouldn't touch Detroit with Drew Carey's.... dextrous hands.

  • Doctor Whom||

    In my fantasy world, places like Detroit are left to their own devices, so that the voters and the politicians whom they keep reelecting can take ownership of their choices. But whom am I kidding? Even thinking such things is RACIST!!!

  • Sevo||

    ..."so that the voters and the politicians whom they keep reelecting can take ownership of their choices"...

    I simply don't think that happens.
    The politicos can claim they weren't given enough pelf; they're not about to take any of the blame.
    Ditto the voters; they didn't vote for the guy or gal who could swing the hammer for more bailout dough.
    They simply are NOT going to admit they played any part in it at all. See, for example, Obozo cultists and the national debt.

  • Lexy||

    Le "deluge" est arrive a Detroit

  • Kyfho Myoba||

    "Democracy is the theory that the common people know what they want and deserve to get it good and hard."

    Nowhere is this more apparent than in Detroit.

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