Friday, July 19, 2013

A Quick Thought on Detroit's Bankruptcy

A few hours ago, Detroit filed for Chapter 9 bankruptcy in Federal court. It needs to restructure an 18 billion dollar debt. It is the largest municipal bankruptcy in American history.

The cause is pretty easy to see. After decades of mismanagement by the city's officials, Detroit shrunk from a city of 1.8 million in 1950 to a city of just 700,000. Rising crime, corruption, and profligate misuse of taxpayer dollars all contributed to the decline and fall of one of the greatest American cities. Right now, the city spends half of all its tax revenue just servicing its pension and health obligations of retired municipal workers.

Although it is the currently the largest municipal bankruptcy ever, it will soon be eclipsed by other cities and counties. The tax exemption on municipal bonds created a gigantic pool of easy credit that states and municipalities gorged. They used those funds to build wasteful capital projects to appeal to politicians' vanity and guarantee exorbitant retiree benefits for government workers. Spending rapidly outpaced revenue and now many local governments find themselves drowning in red ink.

This is going to be a closely watched bellwether for the 4 trillion dollar municipal bond market. Depending on how secured creditors get treated by the bankruptcy court judges, this could have a cascading effect on interest rates for other municipal bonds. If that happens, state and local governments will experience higher debt loads and interest payments.

The recession took the biggest toll on state and local payrolls. Detroit could easily be a harbinger of even further cuts in state and local government.

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