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Is Detroit’s Bankruptcy Foreshadowing a Looming Crisis?

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Today, Detroit made history, but unfortunately not in a good way. The beleaguered Michigan city became the largest to ever declare bankruptcy. While Detroit’s bankruptcy is worrisome enough on its own, the situation also calls into focus the massive levels of public debt held by city and state governments across the country.

Is Detroit's Bankruptcy Foreshadowing a Looming Crisis?

While the bankruptcy of Detroit comes as no surprise, the city has been fiscally insolvent for months, it may point to an increasing trend of municipal bankruptcies. In 2005, total municipal debt levels rested at about $1.9 trillion. Now, after several years of recession, debt levels have skyrocketed to $3.8 trillion. Further, with tax revenues still hurting, debt levels may be set to climb to all new record highs. And while Detroit is the largest city to declare bankruptcy, it is by no means the only city to have done so in recent years. In 2012, three cities in California alone declared bankruptcy.

Detroit Government Throwing In The Towel

Once the shining jewel of America’s manufacturing prowess, Detroit has fallen on tough times in recent decades as the big 3 auto companies moved their manufacturing facilities to the suburbs and many other manufacturing jobs went overseas. The city has been under emergency management for the last several months, and now the local and state government appear to be throwing in the towel and admitting that bankruptcy is the only way forward.

Detroit’s bankruptcy may cause bond costs to rise dramatically for cities across Michigan and the United States. Municipal bonds have long been viewed as a safe investment. Backed by the promise that revenues could also be raised through increased taxes, many investors have viewed such bonds as a safe place to park money and protect against inflation. With Detroit’s bankruptcy threatening to wipe out the value of hundreds of millions of dollars worth of bonds, investors may start to be more cautious.

With the repayment of municipal bonds looking less and less like a promise and more like a gamble, many investors may demand higher interest rates in return for loans. Of course, higher borrowing costs will increase the risk that a city itself may go bankrupt. At a time when financial markets are already suffering from extreme turbulence, city bankruptcies could cause investors to panic, or at least withdraw funds from the market. With the United State’s economic recovery already on shaking ground, even minor interruptions in markets could have dramatic effects.

Detroit City Heads Into Chapter 9 Bankruptcy

Further, bonds only made up a portion of Detroit’s budget woes. Pension plans and health care made to retirees total some $9 billion. Now, these promises may be on the chopping block as the city heads into Chapter 9 bankruptcy. Under bankruptcy protection, Detroit will be able to adjust its contracts with employees to make them less burdensome. Now, many former and current Detroit city workers are fearing benefits cuts.

If city-wide bankruptcies continue to rise, thousands of people could be affected. Fortunately, tax revenues have rebounded in many places from lows in the midst of the Great Recession. The state of Michigan as a whole has seen tax revenues grow from $22.75 billion in 2009 to nearly $24 billion in 2012. So long as the recovery continues, city and state governments should see increasing tax revenues. Though it is possible that other heavily indebted municipal governments will go bankrupt, there is no reason just yet to fear an all-out crisis.


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