Business Ethos Blog

Detroit: Is Bankruptcy Better?

Dr. David Mielke is a retired Dean of the College of Business at Eastern Michigan University

 

Dr. David MielkeTwo big events occurred this week.  The first is that the Detroit City Council appealed the governor’s decision to name a financial manager and a hearing was held on Tuesday.  The governor rejected the appeal and named Washington DC bankruptcy attorney Kevyn Orr as the Emergency Financial Manager on Thursday.  This brought on threats of suits, in particular by the City Council,  and civil disobedience and a group of protests already.  How did we get to this point?  The Governor had appointed a Financial Review Team to assess whether or not the city faced a financial crisis.  According to their findings, the city has a budget shortfall of $327 million last year and long term debt of $14 billion with no effective plan to deal with these 2 issues.  In addition, they noted that if the city had not sold bonds, the budget deficit would have been $937 million.   They declared a financial emergency.  The Governor then decided to appoint a financial manager.  The City Council had the right to appeal, which they did, and the Governor did not agree with the appeal and appointed Orr.  We must also note that Mayor Bing did not join the appeal.  The question is, was naming of the financial manager the “Right Thing to do?”  Let’s look at the three possibilities to deal with the financial crisis in Detroit.

1. The Governor could have agreed with the appeal and continued to follow the Detroit City Council and Mayor’s so-called plan to deal with the financial crisis.  The City Council said that the state’s assessment of the financial problem was exaggerated.  The city officials said that the existing consent agreement was working between the state and city and they project a $6.5 million cash surplus at the end of the fiscal year—not a $114 million shortfall that previously was forecasted for the fiscal year ending June 30.  Some refer to Public Act 4, the emergency manager law passed in 2011 and repealed in November 2012–how can the Governor apply a law that was defeated?  The fact is that the Governor is applying Public Act 72 approved in 1990.

 

Opponents argue that this appointment is undemocratic, that the Governor is replacing elected officials and usurping local control.  The other side of that coin is—if elected officials are unable or unwilling to deal with the financial issues, the alternative is bankruptcy.  There is no doubt that the financial problems have been building for years—but many of the City Council members have also been serving for years and have obviously been unwilling or unable to correct the problems.  This is the same City Council unable to keep the street lights lit, deal with the crime issue and keep the fire houses operating.  This is the same City Council in charge of an accounting and tax system that can’t effectively collect city income and property taxes and hasn’t been able to file the appropriate accounting reports to the state for years.

2. If and when the city runs out of money and is unable to pay its bills, creditors could force the city into bankruptcy.  In this scenario, we have a single person, a judge who makes the decisions for the city.  The judge is not called a financial manager, but in effect has that role.  Would those who object to an emergency financial manager prefer to have a judge deal with the restructuring or an attorney who has years of professional bankruptcy experience?  As an example of what occurs, we can look at Stockton, California.  Here the City Council proposed eliminating the retirement health care benefits, but to leave the pension plans untouched.  They were afraid to touch the pensions because of possible legal challenges.  I have often wondered why public sector retirees should expect gold plated health benefits while those of us in the private sector apply for Medicare, pay our premium and also buy supplementary health insurance.  The main contributors to balance the budget will be the bondholders.  The city will default on its debt.

 

3. An emergency financial manager will have the responsibility for overseeing all of the city’s spending—this is a full-time job, not part-time as it would be with a judge.  The mayor and city council will keep their jobs, but the manager will decide all financial matters, including filing for bankruptcy.  The manager can renegotiate all contracts, including union contracts, sell off assets and even suspend elected officials salaries.  The Flint emergency manager did just that.  Is this why the City Council opposes the manager—they want to protect their salaries?

 

There are extenuating issues associated with this alternative.  The city has no money to clean up its accounting system and to collect the taxes.  Will the Governor push the legislature to provide funds to Detroit to fix some of the problems—like accounting, street lights and perhaps an approach to crime by bringing in the State Police?  This would certainly help in the short run.

 

Kevyn Orr has a set of credentials that certainly position him to turn the city around.  A U of M undergrad and law school graduate who has years of experience dealing with bankruptcy—including his work on the Chrysler turn around.  He is making a huge personal sacrifice, leaving his partnership position at a very prestigious law firm and I am sure a salary much higher than the $275,000 he will receive from the state.

What is the “Right Thing to do?”  We need to give Detroit one more chance to turn things around before filing for bankruptcy.  Kevin Orr only has 18 months to do it–perhaps too short a time, but at this point Detroit has no more time to waste and must move ahead.  We need to have the partnership and support of the state to some extent to begin to bring back basic services and to get the city on a firm financial footing.  Comments like those of the Michigan Democratic Party Chairman, do nothing to solve the problem or suggest solutions—“Kevin Orr may have an impeccable corporate background, but if Rick Snyder wants him to run Detroit, he should move to Detroit and run for mayor.”  Does he honestly think Rick Snyder wants to run Detroit?  And does he think bankruptcy is better?