Bankrott Verschränkung: A Copenhagen Interpretation of Municipal Insolvency
I think of Detroit as the municipal, financial, legal equivalent of Schrödinger's cat.
It is at once alive and dead. It is locked in a strange twilight zone between the two.
But few people really care enough to try to understand why.
If you care, read on.
The next thirty days will be the most important in Detroit’s history.
To a city French by birth, industrial by identity, and perilous by financial design, the last fifty years have not been kind. Adventurer Antoine Laumet de La Mothe noted in his journals that it would require many promises to develop Detroit from a lakeside outpost into a metropolis of any description. And Detroit received promises from the French and from the Church between 1708 and 1715 to develop improvements around Ste. Anne de Détroit and the surrounding three parishes, which hosted merchant middlemen, wholesalers in the Parisian tradition.
But the problem today is not the promises Detroit has received, but rather the promises it has given. Specifically, it has $11 billion of unsecured debt. On top of this, it owes something in the neighbourhood of $5.5 billion in bonds secured by its utilities revenue and an additional $3.5 to $4.1 billion (depending upon how you do some of the intermediate accrual calculations) to creditors with direct claims against infrastructure revenues or taxes. In total, this approximately twenty billion dollars is significant.
How significant?
If Detroit were a country, its national debt would be larger than Ecuador’s, but smaller than Cuba’s. And Ecuador is not a bad analogy – a 2005 PricewaterhouseCoopers study suggested Detroit’s GDP might be in the neighbourhood of $200 billion. Most economists agree the number has shrunken substantially since 2005 (recall this was prior to General Motors’ bankruptcy and other events of the financial crisis), at the high mark perhaps as much as 10% year-on-year. If so, that would put current-year Detroit GDP at around $85 billion. Ecuador’s current GDP is around $80 to $85 billion.
There are tempting analogies, too, joining Kevyn Orr (who will negotiate with creditors on behalf of Detroit this month) and Rafael Vincente Correa Delgado (who led Ecuador through its debt crisis of 2008-9). Rafael Correa threatened creditors with nonpayment, and followed through.
But Correa, an economist by training, had oil to pump (not a bad thing to have, as we hover around $100/barrel) and friends to lean on (Venezuela). Detroit has no resources to bring out of its soil and no friends. If anything, it has enemies: banks, municipal bond funds, and neighbouring large cities like Chicago that have successfully sucked human capital from Detroit for decades.
Orr has two choices available, neither of them particularly palatable to creditors (or to the people of Detroit).
He can attempt to negotiate with creditors, which would require the unsecured bondholders carrying over $2 billion ($2.5 billion by Dolan, Nolan, and Glazer’s estimate in today’s Wall Street Journal) to take pennies on the dollar. Looking at the financing gap Detroit faces, I don’t think Orr can promise these creditors more than eight cents on the dollar. Secured creditors would have to be rolled over into a new series of bonds, which would include substantial “adjustments” in terms. Orr would likely need to compromise as to a range of assets, including leasing the city’s water infrastructure and selling off museum buildings, park space, airport hangars, and other properties owned by the municipality.
The other option is Chapter 9 bankruptcy proceedings, where Detroit would enjoy temporary protection from some of its most aggressive creditors and would be allowed to more completely restructure its obligations. Municipal bankruptcy has changed little since Michael W. McConnell and Randal C. Picker’s excellent primer on the topic was written twenty years ago (see When Cities Go Broke: A Conceptual Introduction to Municipal Bankruptcy, Michael W. McConnell and Randal C. Picker, University of Chicago Law Review, 60(1), pp. 425-95 (1993)). The reality for a city the size of Detroit, however, has not been fully-explored. No doubt the restructuring, particularly of social services and benefits, would be painful for a city where annual per capita money income is less than $15,000 by most estimates, barely one in ten residents holds a university degree, and nearly 42% of the population lives below the poverty line.
Orr himself describes the city’s current trajectory as a “death spiral” when referring to its shrinking revenue and ever-increasing demands on available cash. But, no bankruptcy has yet been filed. So, for the thirty-day negotiation period, Detroit is both alive and dead – it is Schrödinger’s city.
