Detroit bankruptcy filing a warning to other cities

NEW YORK - Many US cities have a much better economic outlook than struggling Detroit, but the Motor City's bankruptcy filing on Thursday should still set off alarm bells elsewhere as the cost of paying retirement benefits swells.

In recent decades, many municipalities have provided their workers with generous retirement benefits, both pensions and health coverage, often in lieu of pay increases.

But this has created an unsustainable future burden for budgets that has only been exacerbated by the loss of real estate and other tax revenue in the financial crisis.

In particular, cities like Chicago and Santa Fe, New Mexico, have worryingly high pension liabilities compared to revenue, investors and analysts say.

Detroit's bankruptcy was years in the making, a result of severe financial mismanagement and a unique decline in Detroit's population triggered by job losses in the auto and other manufacturing industries, and the exodus of many residents to neighbouring areas as the crime rate soared.

The ranks of retirees outnumber the city's active workers by more than a 2-1 ratio. With so many retirees receiving pension benefits as the population shrinks, the city is caught in a perpetual knot, one that other cities with high retiree costs relative to revenues - such as Chicago - might have to face in coming years as well.

"This could be kind of a precedent for other municipalities. Anyone concerned about some other cities like Chicago, cities in California, what this could do is accelerate a trend where states begin to withdraw their support for cities," said Jack Ablin, chief investment officer at BMO Private Bank in Chicago.

"We could potentially see more filings, not on the same scale of Detroit, but certainly some other ones coming out of the woodwork," he said.

Michigan's reluctance to provide a financial lifeline to Detroit may be establishing a new pattern.

"Detroit getting into trouble? Not a surprise. State of Michigan not coming to help? It is a big surprise, and I think I am not the only one to say that," said Richard Larkin, director of credit analysis at HJ Sims.

Municipal bankruptcies in the past have been mostly the result of problems unique to a particular locale - expensive public works projects that fail to deliver on promised revenues, ill-conceived derivatives agreements with Wall Street firms - but pension debt is one that affects cities nationwide as the population ages.

Public worker contracts are often protected by law against attempts to cut costs. That's a common link between Detroit, the California cities of Stockton and San Bernardino which filed for bankruptcy in 2012, and other local governments across the United States.

Chicago, for example, has to comply with a state law that requires the city to set aside more funding for pension obligations, a key reason for a recent downgrade by Moody's Investors Service, but it cannot cut retiree benefits.

Among US cities with high pension costs, Moody's notes that Santa Fe, New Mexico, has net pension liabilities equal to six times its operating revenue, worse than any other city.

The city of Virginia in Minnesota follows at a ratio of 5.9. Las Vegas also in New Mexico at 5.5 ranks third, while Chicago occupies the fourth spot with 5.4.


Earlier this week, Moody's Investor Services downgraded Chicago's credit rating by three notches to A3 and Cincinnati to Aa2 due to mounting pension costs.

Like Detroit, Chicago has seen its population decline, with the number of residents falling by 7 per cent between 2000 and 2010, but that's nowhere near the 25-per cent decline in Detroit in that time period.

From California to Detroit, there is an attempt to reduce the cost of debt and pensions through bankruptcy that, if successful, might serve as an incentive for other cities, said Timothy Blake, managing director at Moody's Investors Service.

"We have to acknowledge that there is a trend," Blake said. "We still do not know what the outcome will be, but if the outcome is that they do reduce some of these liabilities that could be an incentive for the filing."

Resorting to a bankruptcy filing is the nuclear option when negotiations with creditors and labour unions to reduce debt and spending have not succeeded. However, bankruptcies are expensive and not easily resolved. Jefferson County, Alabama, until now the largest municipal bankruptcy, filed for protection from creditors in November 2011 and finally presented an exit plan in June.

The pressures some cities have felt in recent years are beginning to ebb as well, as the US economy picks up and revenues flow more quickly into municipal coffers.

"Detroit should not be seen as emblematic of cities or as a harbinger of what's to come," said Clarence Anthony, executive director of the National League of Cities.

James Spiotto, head of the bankruptcy group at Chapman and Cutler LLP in Chicago, said filing for bankruptcy is very expensive and takes long time, and reaching an agreement without it is always preferable.

Jean-Pierre Aubry, assistant director at the Center for Retirement Research at Boston College, said that Detroit pension costs are average for the country but that the city made a particularly bad bet with the sale of two pension obligation bonds in 2005 and 2006.

"Things were going well, until 2009 when the bottom fell out. Then Detroit was saddled with increased pension costs," Aubry said.