Will Detroit Once More Lead The Way?

At one time in American history Detroit was a leader in commerce, capitalism, and civic development.  As the home of the American auto industry, Detroit experienced the boom.  More recently, Detroit has experienced the bust.  Now the question is whether Detroit will become a leader in a different way — by showing how local governments can use the federal bankruptcy laws to try to free themselves from the product of decades of financial mismanagement and shortsightedness.

Yesterday, federal bankruptcy judge Steven Rhodes ruled that Detroit’s pension obligations are not immune from scrutiny in a federal bankruptcy proceeding, notwithstanding a Michigan constitutional provision that specifically protects public employee pensions.  In effect, the judge said, contractual obligations that require cities to pay public pensions are like any other contracts and thus may be modified and restructured by a bankruptcy judge after all sides present evidence and argument.  It is the first clear ruling on this issue — one that is of enormous interest to other local and state governments that are dealing with the fiscal consequences of overly generous public employee benefit and pension arrangements that were reached when times were flush but that now threaten to crush the governments’ ability to provide basic services to citizens.

The bankruptcy judge’s ruling will be appealed, and the judge also has promised to be careful and thoughtful before changing any monthly pension payments.  Neither of those circumstances may provide much comfort to former Detroit employees who have retired in reliance on their monthly pension payment from the city and who now must wonder how they personally will be affected.  At the same time, Detroit’s financial challenges are so staggering that city administrators have few options.  The bankruptcy process will work for Detroit only if the city emerges from the bankruptcy with a balanced budget and financial obligations that it can realistically carry given its current, shrunken state — and employee and retiree benefit programs have to be considered as part of that process.

When we visited Detroit earlier this year we stopped to look at a famous downtown statue called the Spirit of Detroit, of a seated man holding the sun in one hand and a family in the other, with a quote from the Bible about liberty behind him.  Viewed in the context of Detroit’s current, crippling financial problems, the figure looks like he is trying to decide which way to turn.  A bankruptcy judge will now help him make that decision.

The Detroit Dilemma

Detroit is a mess — financially, socially, and otherwise.  It has filed for bankruptcy in what is the biggest municipal bankruptcy in history.

Detroit owes billions of dollars.  Its listing of creditors in its bankruptcy case is more 3,500 pages long.  Among other debts, it has huge, unfunded pension obligations to active and retired public workers.  In its bankruptcy Detroit will attempt to obtain significant cuts in those obligations.  Today, in an effort to forestall such cuts, Detroit’s two public employee pension funds are expected to file objections to the bankruptcy, arguing that the bankruptcy proceedings and the attempts to cut pension obligations violate the Michigan Constitution.  The city’s condition is so dire that it has hired Christie’s, the auction house, to value the city-owned items in the Detroit Institute of Art and advise the city on how it could “realize value” from those items.

Much of the focus has been on how Detroit got to its current state.  There is value in that process, because understanding the bad decisions and mismanagement — as well as the failure to recognize the impact of broad economic trends such as the departure of manufacturing jobs — may help other cities to avoid Detroit’s fate.  But it is equally important to think carefully about what happens now, and how America should handle the Detroits of the future.

At present, there doesn’t seem to be any appetite in Congress or in the Obama Administration for using federal money to bail out Detroit.  That’s a relief.  The prevailing view about Detroit may mean that we have moved beyond the notion of bailing out mismanaged entities, be they private or public.  (Speaking of prevailing views, advocates of governmental thrift will grind their teeth when they read the article linked in this paragraph, in which a spokesman for Detroit laments the city’s prior failure to take advantage of federal funds, which he describes as “free money.”  It wasn’t “free” to taxpayers, but local and state governments have long looked at the federal government as an endless source of money.)

It’s important that we set the right precedent with Detroit — because there will be other municipal bankruptcies, and with the massive unfunded public pension and health care obligations in states like California and Illinois, there could well be state bankruptcies, too.  I think the President and Congress are right to resist calls to bail out Detroit, and should similarly resist the the temptation to assume the obligations of badly managed states.  In the meantime, we can hope that the failure to bail out Detroit will cause mayors and governors of other troubled governmental bodies to get serious about getting their fiscal houses in order.

The Meaning Of “Fine”

President Obama stepped into a controversy yesterday, when at a morning press conference he said about the economy:  “The private sector’s doing fine.”

Mitt Romney and other Republicans, ecstatic to be handed such a plum, jumped all over the statement, citing statistics like the unemployment rate and the number of home foreclosures to demonstrate that the economy is not doing fine and to portray the President as out of touch.  By the end of the day, the President was in wholesale retreat, saying:  “it is absolutely clear that the economy is not doing fine.”  We’ll have to see whether this incident is just one of those silly Washington, D.C. tempests in a teapot, or whether the President’s remark strikes a deeper chord with the American people.  (In that regard, the President’s constant fund-raising activities with high-money donors and Hollywood stars probably isn’t helping him dodge the “out of touch” label.  But who’d have thought that Mitt Romney, of all people, would take a crack at depicting President Obama as “out of touch” with ordinary folks?)

For now, though, I’d like to just pause for a moment to think about word choice.  “Fine” is a pretty elastic word.  At our firm, some partners use it to describe associate performance that is minimally adequate — a kind of air quotes “fine” — whereas others use it as synonymous for “good.”  Coin collectors will tell you that “fine” is in the top half of the scale — better than poor, fair, good, and even very good, but not at the extremely fine or mint level.  What meaning did the President intend to convey?  “Fine” as in people are not walking around wearing barrels and selling apples on the streets, or something else?  Given his later retraction of sorts, we’ll probably never know.

I’ll give the President the benefit of the doubt that he was using “fine” in a way that is consistent with our current economic reality; I don’t think it’s fair to seize on one word out of the thousands he speaks every day.  I also think what he said immediately after saying that the private sector is doing “fine” is more significant, anyway.  He went on to add:  “Where we’re seeing weaknesses in our economy have to do with state and local government, oftentimes cuts initiated by, you know, governors or mayors who are not getting the kind of help that they have in the past from the federal government and who don’t have the same flexibility as the federal government in dealing with fewer revenues coming in.”

There’s no mistaking the meaning of that statement; he thinks we need to spend more on public employee jobs in order to help our economy.  I could not disagree with him more on that point — and I think that, given recent election results in Wisconsin and California and elsewhere, that is where the President’s views might truly be “out of touch” with those of the majority of Americans.

Day Of Reckoning

Tomorrow is Election Day in Ohio, and the hoo-hah about Issue 2 finally will end. Unless there has been catastrophic polling failure — or Ohioans have been misleading pollsters for chuckles and giggles — Issue 2 will be defeated and the old collective bargaining rules applicable to public employees will be reinstituted.

Both sides have poured huge sums into the Issue 2 campaign, and anyone who regularly watches the news has seen more Issue 2-related ads than they care to remember.  The ads haven’t exactly been objective treatments of the relevant issues, either.  We had some friends in from out of town over the weekend, and after seeing countless Issue 2 commercials they were totally mystified about what Issue 2 was.  The only thing they knew for sure was that a yes vote or a no vote would effectively mean the end of civilization as we know it.

Whichever way tomorrow’s election goes, I suspect we haven’t seen the last of public employee-related initiatives on the Ohio ballot.  Those who want to cut government spending naturally are going to want to focus on public employee salaries, benefits, and jobs — and this election has shown that public-sector unions won’t be shy about mounting petition drives and spending significant sums to protect those salaries, benefits, and jobs.

The Rhode Island Lesson

Supreme Court Justice Louis Brandeis once described the states as “laboratories of democacy” — that is, in our federalist system, individual states were free to experiment with different policies and diverse approaches to common problems.  The idea was that, from the results of those experiments and the testing in state “laboratories,” sound policies could be distinguished from unsound.

Brandeis’ concept is playing out in Rhode Island, and in this case, the experiment has produced results that should give every other state pause.  As this New York Times article explains, Rhode Island and its cities are in desperate financial straits because the pension obligations owed to public employees have become crippling and are consuming ever-larger shares of governmental budgets.  A combination of rank politicking, ridiculously over-optimistic investment return projections, shrinking tax revenues, and longer-lived retirees have forced Rhode Island and its municipalities to choose between meeting its pension obligations and providing essential government services.  One city, Central Falls, has already declared bankruptcy, and the state itself has had to take special measures to try to protect its bond rating.

I mention this unfortunate story because it seems pertinent to Ohio’s impending vote on Issue 2, which relates to how compensation, health care benefits, and pension benefits should be decided for public employees.  As we consider Issue 2, it is important to keep in mind that government does not exist simply to provide benefits for public employees.  I don’t want to see Ohio become another Rhode Island, where pension and health care benefit costs are bringing down local governments or are imposing such all-consuming obligations that roads and bridges may go unrepaired.