The Banking and Strategy Initiative

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Misery in Motor City: What Happened in Detroit? – our new series from Guest Author Maxime Reiman

Detroit skyline

Detroit skyline (Photo credit: Bernt Rostad)

Detroit is not the first city to file for bankruptcy, but it is the largest to do so in American history. People unfamiliar with the situation may be wondering what drove this once-mighty, all-American city to financial ruin. This article discusses some of the factors that caused Detroit to go bankrupt, what filing bankruptcy means for the city, and what other cities can learn from Detroit’s experience.

Why Did Detroit Go Bankrupt?

According to various experts, Detroit’s decline has been slowly lurching onward since the mid-twentieth century. Although most people blame the auto industry, once one of America’s most formidably industries, there are a number of other factors.

Detroit’s decline began with “White Flight” in the 1950’s, when people began leaving the city in favor of the suburbs. The flight continued in the 1970’s and later when middle-class black’s left the city for surrounding suburbs or other regions entirely. This had a severe impact on Detroit’s population, which fell from a high of 1.8 million people in the 1950’s to just 700,000 residents today. The population decline resulted in a much smaller population attempting to shoulder the tax burden of a much larger city. Detroit still required almost as many resources to run a city with only half the population, resulting in huge deficits that they could not close with just taxes.

Over the years, Detroit has accrued somewhere between 18 and 20 billion dollars in debt to over 10,000 creditors. It is likely that the 2008 financial crisis both exacerbated and accelerated the city’s decline. The bank failures and foreclosure rates shot up, de-incentivizing remaining in Detroit for many citizens.

The combined stress of a decreased population, maintaining services for a dwindling city, and losing the auto industry’s support drove Detroit to where it is now: filing for bankruptcy.

What Does This Mean for the City?

Detroit has filed Chapter 9 bankruptcy, which is the form of bankruptcy available exclusively to municipalities to aid them in restructuring their debts. Chapter 9 gives the city greater flexibility in renegotiating collective bargaining agreements, trumping even local regulations on the subject.

As part of its financial restructuring, Detroit will attempt to reduce the pensions for its 30,000 retirees. Although this is not yet confirmed, this would be very beneficial for the city as pension costs have a major impact on the city’s budget.

Public services will be cut; however, it has not been decided which services or for how long. The mayor has assured people that the lights will stay on, but beyond that it is hard to know at this point. It is also possible that taxes will be increased, but the city council is hesitant to increase Detroit’s already-high taxes for fear of driving away any new businesses.

City assets may be sold off to pay creditors. Unfortunately, this means that the Detroit Institute of Arts’ $2.5 billion, publically-owned collection may be up for grabs. This would be distressing for the city and its residents, but selling it may be necessary, depending on how the bankruptcy proceeds.

Finally, the mayor is attempting to use the bankruptcy to catalyze change in the city. He hopes to transform the downtown and midtown areas and revitalize business. Some business leaders are seeing Detroit’s bankruptcy filing as the potential for a fresh start and a comeback for the city.

photo of a part of the Rivera Frescos at the DIA

photo of a part of the Rivera Frescos at the DIA (Photo credit: Wikipedia)

How Can Other Cities Avoid Bankruptcy?

It is in cities’ and counties’ best interests to avoid bankruptcy, but the laws on bankruptcy exist to protect municipalities. This means that it isn’t the worst thing ever if a city does go into bankruptcy. That said, Detroit as well as other municipalities that have gone through bankruptcy like Stockton, CA; San Bernardino, CA; Harrisburg County, PA; and Jefferson County, GA , can offer some lessons about how to avoid bankruptcy.

First, cities need to react to changing issues and demographics faster. Detroit’s slow decline could have been mitigated by early action, but city leaders did not act until it was too late. City services should match the needs of the population. Second, cities can’t wait for major businesses to come bail them out. Cities need to take revitalization and change upon themselves by encouraging small, local business or starting initiatives that will make people want to create, sell, or fill business needs in the city. Finally, cities need to invest in themselves. Detroit is at a point where it will take huge investments to rectify some of its issues, but perhaps offering small business grants or similar could have staunched the flow of business leaders from the city sooner.

Maxime Rieman is a writer for NerdWallet, a financial literacy website that provides information ranging from the best car insurance to the effects of current events on consumers.

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