Asymmetrical Information - Megan McArdle

05.13.13

Saving Detroit: When a Big City Stops Being Big

Detroit's Emergency Manager has released a new plan for the city. It's not looking good.

Detroit's population has fallen by 60% since its peak.  15% of its land parcels are vacant, and over 70,000 buildings stand empty.  As the city's finances plunged deep, deep into the red, the state appointed an emergency manager, who just released his preliminary plan for the city.  The plan suggests, though it does not quite say, that things are pretty hopeless.  

Consider what has happened to income taxes over the last decade:

The city's gambling tax now takes in more than its property tax.  I've been to Detroit's casinos, and they're fine, but they're not going to form the basis for a revitalized urban economy.  

Orr's emergency budget does manage to be balanced next year, thanks to some pretty aggressive cost cutting.  But what about next year, and the year after that?  There's no reason to believe that the decline will cease.  Indeed, as city services shrink, presumably even more people will be inspired to move away.  

The problem is that the old infrastructure is still there, and still needs to be maintained.  Detroit might have the makings of a nice 50 square mile city within its population.  But it has to maintain 139 square miles of water and sewer, electric, police and fire coverage, transportation, and so forth.  It also needs to maintain legacy pension costs that were incurred when the city was more prosperous.  For the last five or six years, Detroit has made up the mismatch between taxes and spending by borrowing money and deferring its pension contributions.  But this only means bigger bills in the future, when Detroit may be even less able to pay.  

Radical action is needed.  But what sort of radical action is feasible?  You can imagine a sensible plan that would essentially condemn all the houses in the outer rings of Detroit, arranging land swaps to bigger and nicer houses closer in, in order to compress the city into a manageable size.  But you can't actually imagine it being implemented. The politicians whose districts would go away would freak out.  So would many of the home and business owners.  The downsized public service departments would also be none too pleased.

When a business runs into this sort of problem, we know what to do: liquidate and sell off the non-performing assets.  But Detroit doesn't have any way to stop existing, even if it needs to.  

As a result, most of the adjustment burden will be mostly borne by the city's workers, past and present.  Looking at that dreadful math, it's hard to escape the conclusion that payrolls are going to be slashed and pension obligations are going to take a big haircut.  There simply is not enough city there to finance the payments they are obligated to pay.  

Why pensioners and not bondholders?  Well, the bondholders may take a hit too.  But the bondholders don't absorb nearly as much money as payrolls and retiree benefits.  And the tragic fact of urban bankruptcy is that the workers rarely have as much negotiating power as the creditors.  Cities in parlous financial condition often need creditors to keep going.  But often they'd prefer fewer workers.  Too, the cities in which workers have a lot of bargaining power are almost never the cities that go bankrupt.  Which is to say that if your city has a job market so strong that you need to really worry that workers angry about compensation cuts will quit en masse and go to work elsewhere . . . well, your city probably doesn't have a severe cash flow problem requiring radical restructuring of its financial obligations.