Many of may have heard about the filing for bankruptcy of the city of Detroit over the week. It is the largest public sector bankruptcy in history….to date! I say that because there are many other bits and pieces of the United States, counties, cities (Harrisburg being a good example) and even several US states, most notably California, which are living hand to mouth and may well follow Detroit down to the bankruptcy court. And of course certain parts of the Eurozone are far from healthy either. Consequently how the bankruptcy of Detroit plays out will be keenly watched by many.
I happened to wander over to Michael Moore’s website curious what he had to say about it all. He didn’t have much too say, Michigan born I suppose he’s always known Detroit was living on borrowed time…and borrowed money by the sounds of it! I mean how would any city cope if it lost 1 million citizens and most of its industry…likely in the UK wed call it Glasgow or Birmingham and replace the population with Chavs ;D
But he does have an interesting wee article on his site by Dean Baker of the Centre for Economic and Policy Research regarding the fate of Detroit’s pensioners. One of the key “creditors” in Detroit’s bankruptcy is it pensioners (i.e. former state employee’s such as firemen, policemen, librarians, etc.). Funding their pensions represents about half of Detroit’s massive $18 billion in debt.
Normally when a company goes bankrupt pensioners are some of the first in the queue for a pay out, with venture capital investors (who hold the rest of Detroit’s debts) towards the back of the queue and may well get very little back. But the city authorities, or more to the point the liquidator, is arguing that the pensioners get the same pay out as everyone else, which means some Detroit pensioners could be looking at their life savings being pretty much wiped out and be facing virtual destitution. The US media seem to be jumping on the bandwagon and assuming this as a given, just cos the nice man in a suit from the liquidators says so.
However, as Dean Baker points out, this not only violates the basic principles of bankruptcy but its actually illegal under a 1960’s era Michigan state law. This law clearly states that in the event of liquidation pensioners will get paid first, in full and if there’s any dimes left at the end, they will go to the banks and private lenders. After all, this law has been on the books since the 60’s. Any fool silly enough to lend money to Detroit must surely have known what he was getting himself in for. But then again, as Ive discussed before, many of the MotU dont seem to understand that they can lose money on a deal.
The courts seem to agree with the pensioners and have issued a ruling ordering the city to withdraw its bankruptcy filing (as reported in the BBC). However, the city seems to be hinting that they plan to just carry on regardless and ignore what the law says. After all perish the thought of investors having to lose money because they made stupid investment decisions!
Damned if they do or damned if they don’t
The situation in Motown creates a bit of a daunting dilemma, in part because many will interpret the outcome as a precedence for how other US public bankruptcies pan out.
If the authorities in Detroit for example comply with the law, then this will have serious knock on implications across the US and Western world. Many other US public authorities, notably many states and the federal government have huge pension liabilities on their books. If the markets take Detroit as a signal that, say in the event of California going bankrupt, that the pensioners will get bailed out come what may, then a few back of an envelope sums will tell you that private investors will be lucky to get back a few nickels on the dollar. In short those US Treasury bonds they hold with an AA+ rating ain’t worth the paper they are printed on.
Consequently only a complete fool would lend money to any public authority in the US. The US would thus find it increasingly difficult to raise capital, an effect that will spread to private investors too (if the state goes down, that makes private investment risky also, just look at Greece). Given how dependent the US government at all levels is on cheap credit (county, city, state and federal), such a market panic could easily bring down the entire US economy, although a more likely scenario is just a cut in credit ratings and a hike in interest rates, which will at the very least kill of America’s present recovery.
On the other hand if they authorities burns the pensioners that will send out an equally dangerous signal. To be blunt, if I was a public sector worker in California or Pennsylvania I would be looking to immediately stop paying into my pension plan, cash out, even if I had to shoulder some losses, and stash that cash somewhere safe (property, an offshore account, anywhere but where “the fed’s” can get their paw’s on it). Obviously if only a small fraction of America’s many millions of state employees took this views it would create a virtual “bank run” on US pension funds. These funds are, as noted, heavily in debt and rely on money coming in the door from people still working, to pay those who’ve already retired.
So like I said, there’s more at stake here than Detroit and its pensioners.
Indeed in some respects the mere idea that any part of the US, even Detroit, nevermind places like California (one of the wealthiest places on planet earth) could even consider going bankrupt is ludicrous in the extreme. There is more than enough money tied up in the US, both in public and private hands to bail cities like Detroit out many times over. But like the Eurozone crisis it is very much a consequence of an unwillingness of politicians to make important, but unpopular decision with electorates, even when those politicians are actually protecting those citizens life savings and jobs.
Ultimately the source of America’s problems financial problems can be traced down to the fact that America is every bit as much a “big government” state as countries like France, but that US taxpayers are reluctant to pay the sort of high taxes we do in Europe for such services. Instead they prefer to maintain the illusion of being a low tax economy, as I highlighted before with regard to issues such as the differences in tipping culture across the pond. And as Andrew Sullivan & Fareed Zakaria point out, poll after poll regardless of what any US tax payers say about the benefits of small government, voters will punish any politician who either puts up taxes or cuts back on core public services.
Inevitably this has left US politicians (be they Republican or Democrat) with only two options, hack away and make short term savings that will cost them heavily in the long term, which is why much of America’s public infrastructure is crumbling (I recall seeing these huge rust patches on the Brooklyn bridge and massive potholes in the middle of freeways in the mid-west). Or politicians simply borrow money on credit from the Chinese or Middle East oil sheik’s.
Sooner or later US politicians are going to have to just bite the bullet and either cut the bits of the US budget that will actually make a difference, which as I’ve pointed out before means ending “corporate welfare” and serious cuts to the military budget, and raising taxes up to the point where the US can balance its books. But like the Eurozone, the longer the US ignores this reality, the worse things will get.
And of course there are some in the Tea party who would have been doing cart wheels over Detriot’s bankruptcy. They have long fantasized about “shrinking government down and drowning it in the bath tub“. However, as I’ve pointed out before you’d be drowning you’re biggest collective customer (are any of those pauperized Detroit pensioners going to be spending much money any time soon?), send private investors fleeing across 6 continents away from the country and see the infrastructure many Americans rely on to run their businesses (such as those freeways that Americans love to drive on while paying a fraction of what we Europeans pay for the privilege) crumble. In short, the state goes down, you’re business, whether you’re Joe the Plumber or Warren Buffett is toast. Hopefully if there’s one positive that comes out of events in Motown it will be to lay bare the fallacy of this fantasy.