Detroit Bankruptcy Looms with Deficit of $446 Million in Budget of $1.6 Billion

Detroit has hit the end of the line. It's budget deficit is between $446 million and $466 million (28% to 29%) of $1.6 billion with few ways other than drastic cuts in wages and benefits to address the problem.

If unions will not give in (and they won't), Detroit Faces Bankruptcy.

Mayor Dave Bing and the City Council must reduce the size of government and slash the city's budget deficit to stave off bankruptcy or state receivership, according to a report released Monday.

Without draconian cuts and changes aimed at downsizing government, the city could end up with a "possible" general fund deficit between $446 million and $466 million to its $1.6 billion budget.

"Detroit city government must be restructured," according to the report from the Citizens Research Council of Michigan, a nonprofit that has studied Detroit finances for decades. "The new structure must reflect both the reduced tax base and the limited ability of state government to provide shared revenues."

The report, titled "The Fiscal Condition of the City of Detroit," was prepared at the request of Business Leaders for Michigan, a statewide coalition.

The 60-plus page report outlines much of what officials know: The city's dramatic population loss, high unemployment and other ills have had adverse effects on the city. And now government must respond in a dramatic way to downsize and make sound budget choices, the report argues.

The Fiscal Condition of the City of Detroit

With that introduction, inquiring minds are diving into the Citizens Research Council report on The Fiscal Condition of the City of Detroit

The Economic Base

The deterioration of the economic base of the city has accelerated. There were an estimated 81,754 vacant housing units (22.2 percent of the total) in Detroit before the recession; that number increased to an estimated 101,737 (27.8 percent of the total) in 2008.

The average price of a residential unit sold in the January through November, 2009 period was $12,439, down from $97,847 in 2003. Remaining businesses and individuals are challenging property tax assessments on parcels that have lost value and, in some cases, cannot be sold at any price.

More than half of employed city residents work outside the city limits; the metro area has the highest unemployment rate of the 100 major metro areas in the U.S.

Revenues

All major tax revenues will be below budgeted levels, significantly so in some cases. State revenue sharing was budgeted at an amount equal to the prior year budget, but state budget problems will result in reductions that could add $40 million or more to the projected deficit.

The city budgeted $275 million as revenue from the monetization of assets. Although there is precedent for the sale of future revenue streams in other cities and states (Chicago leased the Chicago Skyway Toll Road and parking meters, and tried but failed to lease Midway Airport), it is highly unlikely that Detroit can sell future revenues from the parking and lighting departments.

Expenses



The Potential Deficit

The city could well end the year with an accumulated deficit that is over a quarter of the total $1.6 billion general fund:

• $280 million - Budgeted prior years accumulated deficit
• $46 million - Estimated increase in prior years accumulated deficit
• $80-$100 million - Estimated current year general fund operating deficit
• $40 million - Potential state revenue sharing shortfall

The possible general fund deficit is $446-$466 million.

Personnel costs are 50.1 percent of all general fund appropriations. The plan for reducing expenditures includes a ten percent wage cut and layoffs. If laid off employees earn salaries in the $30,000 to $50,000 range and if civilian pension and fringe benefit costs are 65 percent of salaries, about $66,000, less unemployment benefits, could be saved per laid off employee in the first full year. One thousand layoffs would therefore produce a savings of $66 million, less unemployment benefits, in the first full year of the layoff.

Potential Solutions

Clearly, the city government cannot afford to remain at its present size. There are four ways the government can downsize:

• The elected mayor and city council can develop and implement required changes.
• The mayor and city council can implement changes specified in a consent greement
reached with a review team appointed by state officials under the Local Government Fiscal Responsibility Act
• An emergency financial manager appointed under the Local Government Fiscal Responsibility Act can negate the authority of the mayor and city council, can implement changes, and can renegotiate (but not abrogate) contracts.
• If an emergency financial manager recommends, and the state approves, reorganization and restructuring can occur under protection of bankruptcy, which does allow contracts to be abrogated. No Michigan municipality has ever filed under federal bankruptcy laws.

In order to address what could be an accumulated general fund deficit exceeding $400 million, Detroit city government must be restructured. The new structure must reflect both the reduced tax base and the limited ability of state government to provide shared revenues. Restructuring will necessitate process improvements, load shifting, load shedding, privatizing, concentrating service delivery on an area
smaller than 138 square miles, and other strategies.

The most recent Crisis Turnaround Team has recommended closing facilities, privatizing services, improving and centralizing processes, renegotiating contracts, improving debt collection, restructuring debt, and other actions. It remains to be seen whether the city’s elected officials will be able to implement these recommendations.

Pensions

While the most recent published actuarial valuations for the city’s pension systems indicate that there were no unfunded accrued liabilities, all public and private
pension systems have suffered the effects of stock market and real estate market volatility over the past two years.

The Auditor General’s analysis notes that the budget includes a third excess funding
credit of $25 million used to reduce the required contribution to the Police and Fire Retirement System, and that no provision has been made for the cost of implementing the defined contribution plan, estimated to exceed $20 million.

Detroit has an unconditional contractual obligation to make debt service payments on the pension obligation certificates. Failure to make payments when due allows the contract administrator to file a lawsuit to force payment. A court judgment could require the city to raise the payment through an unlimited tax levy, for which voter approval is not required by Michigan law.

Privatization

The 1997 Detroit City Charter created new provisions ostensibly authorizing the city to privatize city services. The process created in Section 6.307 of the Detroit City Charter, for the most part, laid out best practices for a meaningful examination of the costs and benefits of privatizing services.

However, interwoven in that section is language that does more to hinder privatization than to facilitate it. The most glaring hindrance is created in subsection 7 requiring a super-majority (2/3) vote by city council to approve the privatization of any city services.

Summary

Detroit city government must be restructured; the organization chart must be more compact. This will require strong leadership and clear lines of authority. The new structure must reflect both the reduced tax base and the limited ability of state government to provide shared revenues. Restructuring will necessitate process improvements, load shifting, load shedding, privatizing, concentrating service delivery on an area smaller than 138 square miles, and other strategies. The most recent “crisis turnaround team” has recommended closing facilities, privatizing services, improving and centralizing processes, renegotiating contracts, improving debt collection, restructuring debt, and other actions. It remains to be seen whether the city’s elected officials will be able to implement these recommendations.

Detroit Should Embrace Bankruptcy

The only legitimate solution for Detroit is shed pension obligations, privatize everything it can including the fire department, and dump unions contracts en masse. Since those items can only happen in restructuring, Detroit should openly embrace bankruptcy.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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