Detroit Bankrupt:What Led To The Downfall Of The Motor City?

Understanding the Detroit Bankruptcy

The once prosperous Detroit, known as the home of the American auto industry, has gone belly-up. July 18, 2013 will forever be etched in the minds of Detroit residents – it’s the day the city filed for bankruptcy, becoming the largest city in U.S. history to do so.

There’s no denying economic times are tough today, no matter the continent. Greece continues to teeter on the edge of bankruptcy, and hardships are still being felt in Spain and Cyprus. Now that Detroit has fallen over the fiscal cliff, it seems governments are no longer the safe havens they once were. Could your city default next? Let’s take at what led the once prosperous Motor City into bankruptcy and the implications of an entire city going bankrupt.

What Led to Detroit’s Bankruptcy?

Detroit is the prime example of a city that relied too heavily on one industry. When the automotive sector was booming in the 1950’s, Detroit was at its peak. The city had nearly two million residents and was one of America’s fastest growing cities. Fast forward a half century later and things aren’t as rosy.

With rising prices at the pumps, times have been especially tough over the last decade for Detroit. From 2000 to 2010, Detroit lost approximately 250,000 people, shrinking from a city of 1.8 million residents in the 1950’s to only 700,000 residents today.

As the automotive industry left Detroit, so have businesses and middle-income earning residents.  Detroit is now a shell of its former self with city streets lined by abandoned houses. As property values and tax revenue plummeted, so did public services. With police services slashed to balance the books, crime rates skyrocketed. Detroit may be known as the Motor City, but it’s also known as the Murder City. In 2012 there were 386 homicides in Detroit, making it the second deadliest city in America.

Municipal Versus Federal Government

To understand why Detroit went bankrupt, it’s important to know the difference between how cities and the federal government treat debt and deficits. One key difference is that unlike the federal government, municipalities cannot run deficits by law. Whether it means increasing property taxes above the rate of inflation or cutting public services, municipalities are required to have a balanced budget. In Detroit’s case, the city was forced to balance its budget by taking on billions of dollars in long-term debt. When the federal government experiences slow economic growth, it can spend to stimulate the economy. While cities can resort to increasing property taxes, these efforts may lead to further economic slowdown.

What’s Next for Detroit?

Unlike a company, Detroit can’t simply close its doors and cease operating. The city still has thousands of residents that live and work there and depend on essential public services like the police and firefighters on a daily basis. Bankruptcy means laying off hundreds of city workers, selling off assets, raising property taxes and cutting public services to the bare minimum to get by.

One of the biggest controversies surrounds the city’s handling of pensions of city workers. With the city on the hook for $18 billion in long-term debt, it simply can’t afford to pay pensions in full. Months ago the city offered its workers pennies on the dollar, which unions turned down. The city says federal law allows them to wipe the books clean of pension obligations. Unions don’t see it that way and claim that pension and retiree benefits are guaranteed under state law.

One of the biggest fears of workers with pensions is that their company will go bankrupt. It will be interesting to see how this plays out in the public sector, where workers take their pensions for granted since the chances of the government defaulting is very remote – until now.

 

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