Pew: Lessons from Detroit’s bankruptcy for other struggling cities

Local governments need a long-term plan for financial recovery when exiting bankruptcy, according to Pew (courtesy photo)

Detroit’s financial problems have not been of the one-size-fits-all variety, so state and local governments across the U.S. should take care not to assume the city’s historic Chapter 9 filing is the only solution for distressed municipalities.

That said, Detroit is a good case study for the importance of early state intervention when community fiscal troubles become evident. That’s the conclusion of researchers with Philadelphia-based Pew Charitable Trusts in a new report, released Wednesday, that outlines the lessons states and cities can draw from the nation’s largest municipal bankruptcy.

The report, “After Municipal Bankruptcy: Lessons from Detroit and Other Local Governments,” offers key takeaways that could help states and cities avoid bankruptcy:

• Early involvement by the state can help avoid a financial crisis. All city stakeholders — unions, creditors, retirees and state legislatures among them — should be involved in a municipal bankruptcy process to resolve conflicts. The recommendation is a nod to the famed “grand bargain” in the Detroit case that netted more than $800 million in financial aid from corporations, foundations, the state of Michigan and the Detroit Institute of Arts to save the city-owned art collection from being auctioned to satisfy creditors and mitigate pension cuts.
• Local governments need a long-term plan for financial recovery when exiting bankruptcy, especially for how they’ll fund underlying budget stressors such as pension and retiree health care obligations. Particularly, they should prioritize education, infrastructure, public safety and employee legacy costs and avoid the temptation to overinvest in good years. Multiyear budgeting can help cities and counties prepare for future revenue and spending needs, identify financial trends and account for retiree obligations.
• States should set up a process to monitor local finances in order to catch distress early. Besides bankruptcy, states should consider other ways to intervene in fiscally troubled cities, including appointing temporary emergency managers. Michigan is one of 19 states that does this. “Of the 19, there are only a few that … are real aggressive,” said Stephen Fehr, a senior officer with Pew who worked on the report. “These states allow intervention if they want to, but really only half a dozen do it in a systematic way. Michigan is one of them.” Municipal bankruptcy is still rare, despite high-profile cases in Detroit and in cities such as Stockton and San Bernardino, Calif.
• States have to give cities permission to file Chapter 9; only 24 do, according to Pew research.
• Besides the stigma attached, bankruptcy is considered a last resort also because it’s expensive: Cities are required to pay attorneys’ fees and retirees face cuts to pension benefits or cost-of-living increases.
• Finally, the cost of restructuring debt borne by residents can be high, through property tax or rate hikes. Detroit entered bankruptcy in July 2013 under the tenure of emergency manager Kevyn Orr, the bankruptcy attorney appointed by Gov. Rick Snyder to help the city out of insolvency.

The city officially exited Chapter 9 in December 2014 after restructuring $7 billion in debt and agreeing to be monitored by a state financial review board in exchange for the return of local control. Orr’s contract as emergency manager ended along with the bankruptcy.

Pew said one of the key reasons Detroit shed bankruptcy protection so quickly was because of the aforementioned “grand bargain,” which pooled money from multiple public and private entities to protect the city’s art collection and reduce the scope of cuts to pensioners.

“The thing about Detroit is not every city has an art collection they can leverage,” Fehr said. The art may be unique to Detroit, he said, the core decision in the city’s bankruptcy to include all stakeholders in the process is a practice that could be replicated elsewhere. “You have to bring everyone together to share in the sacrifice,” he said.

Credit to governor

The report’s authors credit Snyder for helping to bring the Detroit bankruptcy to a quick resolution and say Michigan is one of the best in the nation for early intervention. Michigan’s emergency manager law dates back to 1990.

Under its current form, Public Act 436 of 2012, the state reviews a municipality’s finances and, in the event of a financial emergency, authorizes local governments to choose among several oversight options ranging from mediation to a Chapter 9 filing.
Wayne County is the most recent local government to enter fiscal distress. County commissioners this week received a copy of a consent agreement with the state to deal with a $52 million budget deficit and pension system containing less than half of the money needed to fulfill its obligations. If they approve it, Wayne County Executive Warren Evans would be allowed to invoke pay or benefit cuts for the county’s employee unions.

“The governor is a huge believer and proponent of kind of taking steps on the front end to hopefully prevent a fiscal crisis,” Snyder spokeswoman Sara Wurfel said. “Bankruptcy is probably the last possible option and something he wanted to avoid at all costs.”

To that end, Wurfel said, one of Snyder’s first-term priorities was strengthening the state’s emergency manager law — which dates back to former Democratic Gov. Jim Blanchard’s administration — by adding more early-warning triggers. Wayne County is one example, she said: The consent agreement recently negotiated includes a provision that the county won’t file Chapter 9 bankruptcy. The state could improve the frequency of its monitoring program, Fehr said, although its emergency manager law has allowed it to catch problems.

The best municipal monitoring systems study revenue and expenses, a city’s tax structure, budget pressures, trend lines, available liquidity and debt load, he added. Credit rating agency Moody’s Investors Service last month upgraded Detroit’s bond rating — although it’s still in junk status — and considers the city’s outlook positive, up from stable. Moody’s cited bankruptcy restructuring as a main reason for the improvement.

“We’ve seen a lot of strong fiscal management support from the state as the city has been emerging from bankruptcy, but there’s still a lot of work to do,” said Mary Murphy, a manager with Pew Charitable Trusts and an author on the bankruptcy report. That work includes attracting new residents, rebuilding the city’s economic base and growing its tax base.

“We don’t have a crystal ball,” Murphy said, “so I think (success) remains to be seen.”