Detroit Failed Because It Didn’t Do What Cities Do; Detroit forgot the economic case for cities: When you put different industries and different people with different ideas in close contact with another, magical things happen

Detroit Failed Because It Didn’t Do What Cities Do

Detroit’s city government filed today for Chapter 9 bankruptcy after years of financial trouble and industrial contraction. It’s easy to think that the city’s fault was going all in on auto manufacturing. Detroit made a bet, and the bet went bad. No surprise, then, that Detroit went bad, too. Including, in this case, its municipal debts.

Detroit’s dependence on cars, though, wasn’t exactly the problem. It was dependence itself. Cities should never go all in on any industry, cars or otherwise. It didn’t realize that until it was too late.

Detroit forgot the economic case for cities: When you put different industries and different people with different ideas in close contact with another, magical things happen.

“Magical things” is, of course, the technical term economists use for a number of spillover benefits created by urban areas. Their work suggests that the magic happens mainly from the mix of ideas.And for economists and historians, the irony is rich: Detroit was the textbook example of these urban spillovers before World War II. The textbook was Jane Jacobs’s, an urban sociologist who rose to fame in the 1960s.

Jacobs observed that Detroit’s shipbuilding industry, prosperous in the 1800s, fertilized the development of its auto industry. It was a creative application of industrial know-how, and it saved the city as its original geographic advantage withered.

Diverse cities, as subsequent research confirmed, really do outperform ones like Detroit. They create more jobs and faster increases in wages.

Other evidence comes from inventors who file for U.S. patents. If inventors live in the same city, they are two to six times more likely to cite each other’s patents than if they didn’t rub elbows. This interaction in patents, too, tends to happen between fields. The key to urban success lies in putting brains in the same place but on different projects.

Detroit will have a hard time turning itself around. It faces a tough chicken-or-egg problem: How does it attract talent, when it doesn’t have any? The only way back is to rediscover the industrial diversity that built the city and, economists think, sustains all cities.

(Evan Soltas is a contributor to the Ticker. Follow him on Twitter.)

Detroit Becomes Biggest U.S. City to File for Bankruptcy

Detroit became the most populous U.S. city to file for bankruptcy, seeking court protection from creditors while it tries to eliminate a budget deficit and cut long-term debt.

“I authorize this necessary step as a last resort to return this great city to financial and civic health for its residents and taxpayers,” Michigan Governor Rick Snyder, a Republican, said in a letter today authorizing Kevyn Orr, the city’s emergency manager, to file the petition.

Michigan’s largest city has seen its population decline to 707,000, down 7 percent since 2010, according to U.S. Census data. Median household income was less than $28,000, compared with $49,000 statewide, and more than 36 percent of residents lived in poverty as of 2011, Census data show. The median home value of $71,000 was barely half the $137,000 value statewide.

The city listed assets and debt of more than $1 billion in a Chapter 9 petition filed today in court in Detroit. Chapter 9 of the U.S. Bankruptcy Code is reserved for municipalities and differs from the rules used by bankrupt companies in Chapter 11.

Orr warned in May that the city might run out of cash. His proposal to restructure more than $17 billion in debt and long-term obligations includes cutting pension payments for public employees, ending cost-of-living increases, removing some workers from the system and making the rest pay more.

‘Significant Restructuring’

“Without a significant restructuring of its debt, the city will be unable to break the cycle of damaging cutbacks in essential municipal services and investments,” Orr said in a report.

William Nowling, spokesman for Orr, didn’t immediately respond to requests for comment on today’s filing.

A state court judge today temporarily barred Snyder and Orr from taking any action that would allow cuts in pension benefits for city retirees, while allowing the bankruptcy to proceed. The pension funds sued yesterday seeking to stop the filing.

Detroit joins Jefferson County, Alabama, and the California cities of San Bernardino and Stockton in bankruptcy. Years of job losses at U.S. automakers intensified a decline that began in the 1950s, when white homeowners began moving to the suburbs, Scott Martelle, author of “Detroit: A Biography,” said in an e-mail before the filing.

“As the tax base eroded, basic city services eroded, too,” he said. Detroit today “is too big geographically — 140 square miles — for its dwindling and impoverished tax base to support.”

Financial Crisis

In February, a state report concluded the city was in the midst of a fiscal crisis, a finding required under Michigan law before the city could be eligible to seek court protection from creditors.

Chapter 9 will give Detroit an advantage over companies using Chapter 11 to reorganize. Unlike companies, municipalities don’t need to ask the bankruptcy court for permission to pay any bills they ran up before filing for court protection, including wages, utility bills and rents.

That means creditors can’t put as much pressure on a city over its spending habits, as sometimes happens in Chapter 11 cases. Chapter 9 creditors also can’t offer their own reorganization plan and aren’t entitled to form an official committee with legal fees paid by the municipality. Unsecured creditors typically have those rights under Chapter 11, which is used by companies to try to stay in business and reorganize.

Biggest Drains

Among the biggest drains on the city’s general fund, which pays for police, fire and other basic services, are health benefits paid to 18,500 retired city workers, mostly former police and firefighters, according to Orr’s May report. Without changes, the city will pay $163 million for retiree health-care costs in the next fiscal year, which starts July 1, the report found.

The city has been operating under a financial stability agreement with the state. With the state’s help, the city issued $130 million in new bonds, part of which was used to pay off short-term debt. To get access to the remaining proceeds, the city was forced to hire a restructuring firm and, in December, the law firm of Miller Canfield Paddock & Stone Plc to help formulate a recovery plan.

Detroit ran short of cash last year and was forced to borrow $92.2 million from other funds, including its solid waste, street and risk management funds. At the end of June, the city also owed its retirement funds $60.5 million, according to the audit.

Detroit’s bond ratings were cut deeper into non-investment grade last year by Moody’s Investors Service, which cited the possibility of bankruptcy or default within two years.

The case is City of Detroit, 13-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).

To contact the reporters on this story: Dawn McCarty in Wilmington at dmccarty@bloomberg.net; Steven Church in Wilmington, Delaware at schurch3@bloomberg.net

Bankrupt Detroit Shouldn’t Scalp Bondholders

Detroit, which just became the largest U.S. city to seek Chapter 9 bankruptcy protection, is in many ways unique. It has managed to lose a quarter of its population since 2000, for one thing. For another, its liabilities are a staggering $17 billion, according to an estimate by Emergency Manager Kevyn Orr — in a city of roughly 700,000.

That’s why plenty of analysts are asserting that Detroit’s bankruptcy is also a unique case. Its finances are so calamitous, they argue, and its demographic and fiscal spirals so severe, that investors will treat its bankruptcy as a one-off event. So the haircut its bondholders will inevitably take is unlikely to result in significantly increased borrowing costs elsewhere.

Don’t be so sure. Orr — who will be in the driver’s seat in bankruptcy, and can force cramdowns on creditors as long as one party getting a haircut consents to his reorganization plan — has indicated he will treat roughly $369 million in unlimited-tax general obligation bonds on par with pension and benefit liabilities.

Those UTGO bonds were approved by voters and backed by tax revenue. They’re generally about as safe as it gets. So treating them on par with unsecured pension debt is a good way to panic investors. Five other cities and three school districts in Michigan are also under emergency managers. About 10 percent of the state’s population lives in a locality under budgetary oversight. School districts in Pontiac and Buena Vista have recently defaulted. If Orr follows through and treats those UTGO bonds the same as other unsecured debt, investors could be forgiven for wondering if the state is still committed to honoring its obligations.

That’s why we argued here that Michigan taxpayers should step up and help bail out some of Detroit’s pensioners. Doing so would ease their suffering and ensure that money still circulates in Detroit’s economy as it reorganizes. But — more selfishly for taxpayers — it would also help ensure that borrowing costs don’t rise across the state.

As for the UTGO bonds, Orr would be risking an awful lot of credibility — in Detroit and elsewhere in the state — for a paltry sum of money, given the scale of what the city owes. Ultimately, that’s the best argument against giving those bondholders an ugly haircut.

(Timothy Lavin is an editorial writer for Bloomberg View. Follow him on Twitter.)