Tuesday, June 18, 2013

Panic in Detroit

The end game is nearing for Detroit's bondholders and retirees.  The city skipped a debt payment last Friday.   Retirees will face either sharply reduced benefits or whatever judgment they get from a bankruptcy court (for details, see these accounts in today's NYT and last week's WSJ), depending on how negotiations play out over the next 30 days.  

Look for the final outcome to result in a reassessment of the safety of municipal bonds overall, as well as the risk premium associated with different types of bonds.  Much of the debt is insured, good news for debtholders but not so good news for cities that will have to pay higher insurance premiums in the future.  As for the retirees, those 65 and over will have Medicare and the remainder will have Obamacare; both groups will have higher medical expenses and, in all likelihood, smaller pension checks. 

It took decades for Detroit to get into this mess and it will take a long time for it to work through any solution.  The city's population and tax base have shriveled; crime rates remain high and large swaths of the city have been abandoned.  Public employee unions focused on the present and ignored the inevitable future.  The state of Michigan has provided some assistance but it is politically naive to expect that to continue forever; as Detroit has shrunk, so too has its political clout.

This is what happens when governments allow public services to deteriorate and rely on excessive borrowing over prolonged periods.  Do not expect Detroit to be the last chapter in this story; other cities and some states will experience the same thing. 

1 comment:

  1. This is a huge problem, Detroit is just the tip of the iceberg. Look at China too by the way, local governments there borrowed huge amounts of money.