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Global Interdependence Center (GIC) “Banks, Central Banks and Policies” October 9-11, 2013 Hamilton, Bermuda Dennis W. Archer Can Cites Be Saved? Given my professional experiences, I can declare, “Yes, Cities Can Be Saved!” But they cannot be saved without recognizing, and addressing, the causes of their financial distress. “A moment’s insight is sometimes worth a life’s experience.” -- Oliver Wendell Holmes (1809-1894) In 1975 the City of New York was $14 billion dollars in debt and had a deficit of about $2.2 billion dollars. New York City was facing bankruptcy. Congress and President Gerald Ford approved $2.3 billion dollars in short-term loans and required dramatic fiscal restructuring to get the city’s books in order. Through those federal actions, the threat of a bankrupt New York was avoided.1 Today, we do not have a Congress like the one in 1975. A number cities are currently facing fiscal challenges. Cities such as Chicago, Los Angeles, and Baltimore are reportedly facing major financial problems in part because of large unfunded liabilities in pension and health care payments to retirees.2 According to the New York Times, the pension fund for retired Chicago teachers is on the brink of collapse. Moreover, “the city’s four funds for other retired city workers are short by $19.5 billion,” and “at least one of the funds is in peril of running out of money in less than a decade.” Worse yet, starting in 2015, the city will be required by the state to make far larger contributions to the funds, which could leave it hundreds of millions of dollars in the red – as much as it would cost to pay 4,300 police officers to patrol the streets for a year.”3 Time magazine’s August 5, 2013 issue focused on “Detroit’s fight to survive” and asked “Is Your City Next?” It reported that Fresno had a budget shortfall of $4.2 million; North Las Vegas had a budget deficit of $18.8 million; Philadelphia had a debt obligation of $9 billion; Birmingham had a budget deficit of $30 million; and New Orleans a debt obligation of $1.9 billion.4 According to James Spiotto of the law firm of Chapman and Cutler, there have only been 302 local government Chapter 9 filings in the United States since 1954. 62 were by cities, towns, villages or counties and the rest involved special tax districts, utilities, hospitals and school districts.5 1

There have been eight (8) general purpose local government bankruptcy filings between 2010 and September 1, 2013. They were: (1) Boise County, Idaho (Dismissed); (2) City of Central Falls, RI; (3) City of Harrisburg, PA (Dismissed); (4) Jefferson County, AL; (5) City of Stockton, CA; (6) Town of Mammoth Lakes, CA (Dismissed); (7) City of San Bernardino, CA; and (8) the City of Detroit, MI. When Detroit filed for bankruptcy on July 18, 2013, it was the largest city to file for bankruptcy protection. When Detroit filed for bankruptcy, it reported $18 billion in liabilities. Most people were aware of Detroit’s $3.5 billion unfunded pension liability. However, many were surprised to learn that Detroit faced $6.4 billion in post-employment benefits (OPEB), which were mostly obligations to pay healthcare premiums for retired public employees. The Pew Charitable Trust in January of 2013 examined the pension and OPEB shortfalls of the 30 largest cities in the United States. The unfunded pension deficits for those cities was $99 billion, but the deficit of unfunded retiree healthcare benefits was $118 billion. Part of the reason that OPEB deficits are higher than pension deficits is that OPEB liabilities were, for many decades, simply not reported by municipalities. In 2006, the Government Accounting Standards Board (GASB) required local governments to report their OPEB liabilities. However, GASB did not require cities to fund their OPEB deficits. Thus, almost all cities have only minimal advance funding for their healthcare obligations. These obligations are almost always financed on a pay-asyou-go basis.6 “Character is doing what’s right when nobody’s looking.” -- J.C. Watts, Jr. In my view, there were at least six major, and two contributing, reasons the City of Detroit, through Governor Rick Snyder and his Emergency Financial Manager, Kevyn Orr, filed for Chapter 9 bankruptcy protection. The major reasons are: (1) failure to regularly monitor the revenues of the city before authorizing expeditures; (2) failure to have realistic budgets; (3) the mortgage debacle, which substantially reduced the property values in the city and thus its property tax revenue; (4) the loss of manufacturing jobs, which started when gasoline rose to over $4 per gallon, and which severely impacted the income tax revenue; (5) the failure of Mayor Dave Bing and the Detroit City Council to satisfy the Consent Decree by not presenting Governor Rick Snyder with a plan that would balance the budget and eliminate the city’s deficit and (6) the continued loss of the city’s population, which was 25% from 2000 to 2010. The two contributing reasons are (1) the state’s violation, under Governors John Engler and Jennifer Granholm, of an agreement to keep the city’s revenue share at the same amount for a period of years, in return for the city reducing its income taxes on its residents and non-residents; and (2) the 2

reduction of the city’s workforce by both Mayor Kwame Kilpatrick and Mayor Dave Bing, 4000 each, in an effort to balance the budget and avoid a deficit, which resulted in the city having two retirees for every one working city employee. Before I was sworn into office in 1993, Jay Alix, the Chairman of my Transition Team’s Finance Committee, discovered that I was going to inherit a projected $88.5 million dollar deficit with six months to balance Mayor Coleman Young’s budget. By regularly meeting with my Finance Director, Ed Rago, and Budget Director, Ed Hannon, along with my department directors, we balanced Mayor Young’s budget. We produced a realistic budget thereafter each year and balanced our budgets going forward, and had a modest surplus each year. There are two principal sources of revenue of the city’s General Fund Budget -- city income taxes and property taxes. We constantly monitored both to assure the revenue before we authorized expenditures. The city’s overall budget, including federal funds, was about $3.1 billion dollars a year. After Mayor Kilpatrick, who succeeded me, took office, his administration issued $61.07 million in “fiscal stabilization bonds.” It was the first of several bond issues that Kilpatrick urged to support the city budget. Kilpatrick never built realistic budgets. He added city workers, but later had to cut them. His first response to budget challenges was to borrow. And chronic annual deficit spending started under him.7 In 2005, Mayor Kilpatrick lobbied City Council to borrow money -- $1.44 billion -- to eliminate the city’s underfunded pension liabilities. The mayor said that if Detroit’s pension obligations were not addressed, he would be forced to lay off 2,000 employees. He estimated the city could cut $277 million a year from its pension obligations and prevent these layoffs. By selling pension obligation certificates of participation and putting that money into the city’s pension funds, he sought to render them nearly 100% funded. In addition, the city also bought derivatives (or “swaps”) in a complex Wall Street financial transaction that permanently locked in steady interest rates at around 6%, which at the time was a reasonably good rate.8 Three years later, in 2008, interest rates tanked and the stock market essentially collapsed. With its credit rating downgraded and in desperation, Detroit pledged its casino tax revenue as collateral to creditors to avoid a $400 million payment that, in 2008, would have forced Detroit to file for bankruptcy.9 Detroit owes $2.8 billion for principal, interest and insurance payments over the next 22 years, based upon a review of the city records by The Detroit Free Press. That bill is enormous in part because, for about 5 years, the city made only interest payments. “Things really got ugly as a result of that,” said Rago, the former budget director. “In the end, as you really look back on it, it was the worst thing they could have done.”10 The Kilpatrick Administration borrowed another $6 billion dollars for water and sewerage infrastructure.11 3

Mayor Dave Bing inherited a $315 million dollar city deficit. Worse, Mayor Bing faced the challenges of a national recession, a mortgage crisis that substantially reduced property tax revenue to the city’s general fund, and a loss of manufacturing jobs that substantially reduced the income tax revenue to the city’s general fund. In 2009, at Mayor Bing’s urging, the city issued $250 million in fiscal stabilization bonds. At that time, the city was almost out of cash and borrowing couldn’t be avoided.12 “We cannot direct the wind, but we can adjust the sails.” -- Bertha Calloway Mayor Bing and City Council could not erase the deficit that had accumulated. Perhaps their efforts would have worked if the city had not lost 25% of its population from 2000-2010, and along with its residents who would have paid income and property tax into the general fund.13 In 1998, Governor John Engler and I agreed upon a deal in which the State of Michigan would freeze Detroit’s $333.9 million revenue sharing funds for nine years, if the city would reduce its income tax on residents and non-residents, which was then the highest rate in the state. Kenneth Cole, the city’s longtime lobbyist, former reporter for The Detroit News, and current member of the Bridge Board of Advisors, summed it up this way: “The state of Michigan broke its promise to Detroit.” According to Cole, Detroit lost $220 million in revenue sharing, as well as $433 million to $508 million in income tax it was not permitted to collect. Governor Engler, who is now president of a Washington, D.C.-based business group, says he was forced to cut revenue sharing a decade ago when he was confronted with the worst state budget crisis in 20 years. These revenue sharing cuts occurred annually after Democrat Jennifer Granholm became Governor of Michigan and she had to deal with a succession of budget deficits.14 Although it is easy and convenient to blame Detroit’s financial problems on corruption, unions and overly generous pension benefits, none of those factors was the primary cause of Detroit’s bankruptcy.15 The primary cause was the steady erosion of the tax base through the loss of population, and the city’s need to borrow money to pay for even minimal levels of public service.16 What lessons can other cities learn to avoid financial challenges? They can learn from Detroit what not to do. They can learn to make the needed changes now, while they are small and less painful. “Don’t wait till the crisis happens to get advice, if you wait too long, its disaster recovery. The sooner you realize you might have a problem, the sooner you address it, 4

the better,” observed bankruptcy attorney Douglas Bernstein at the annual three-day conference of the Michigan Municipal League in Detroit last month.17 Given my past involvement and my recent visits with both, I know the leadership of the National League of Cities and the U.S. Conference of Mayors are focused on what happened to Detroit and how to prevent or avoid similar problems happening to their cities. And what of Detroit’s future? “We must stimulate and encourage the creative mind.” -- George Washington Carver The United States Bankruptcy Code has two fundamental goals. The first is to provide debtors a “fresh start.” The second is to guarantee that creditors are treated fairly and equally.18 Should Bankruptcy Judge Steven Rhodes find that the City of Detroit has proven that it merits Chapter 9 Bankruptcy protection, then the City of Detroit will have a successful fresh start. Harvard Business School Associate Professor Eric Werker made the following observations about the differences between corporate and municipal bankruptcy: “Cities almost never die. A bankrupt firm’s assets can be sliced up and repackaged and sold off to partially repay the firm’s creditors, and once that process is complete, the entity becomes dissolved. But cities cannot just be dissolved. Places recover from all sorts of catastrophes including natural disasters and wars. Along the spectrum of catastrophic events, a fiscal crisis is not the worst of these; in fact, a fiscal crisis is often an essential ingredient of recovery. Detroit has a precedent in Pittsburgh and a variety of other cities and jurisdictions that have seen their trajectory fundamentally shift in the wake of precipitous economic and fiscal decline. “Long before the American automobile industry was in crisis, American steel producers began to lose out to foreign competition. In the Pittsburgh region, which is to steel what Detroit is to the automobile, some 150,000 jobs disappeared, devastating the region’s population of 2.2 million. “Pittsburgh’s recovery offers a potential model for Detroit. It went on to become a technology hub, anchored in the 5

computer science and robotics coming out of Carnegie Mellon University. It also became a medical hub, driven by the brisk expansion of the University of Pittsburgh Medical Center. The education centers of Carnegie Mellon and Pitt attracted students from all over the world, and the city helped to retain them through its new economy sectors and affordable home prices.”19 Americans and foreign banks are riveted by Detroit’s municipal bankruptcy, which will have serious implications for Detroit’s citizens and businesses, pensioners and creditors. “There is some room for optimism, optimism that may sometimes be overshadowed by headlines decrying Detroit’s bleak and pessimistic future. One point of optimism is that market momentum in Detroit’s core is real and palpable and can provide a strong foundation for future growth. For example, the Detroit Future City plan is an excellent blueprint for growth and investment. Detroit’s core, which is 7.2 square miles that encompasses Downtown, Midtown, New Center and a few other neighborhoods in a city of 138 square miles, is experiencing private and civic investment and business and residential growth. There are approximately 5,400 businesses in that small area of the city, which employ over 135,000 people. “Detroit is also being transformed by entrepreneurs like Dan Gilbert, founder of Quicken Loans. In 2007, Gilbert moved the firm’s headquarters from Farmington Hills to downtown Detroit and now has 7,000 employees downtown, and purchased more than 18 buildings and two parking garages in downtown Detroit. That is part of his Detroit 2.0 revival vision, which he describes as “a lively live-work-play district in the heart of the city based around entrepreneurial companies in the digital economy. “Gilbert’s confidence and actions have convinced other firms to expand their downtown presence, and an entire subculture of tech-oriented start-up companies, such as Digerati, Detroit Labs, and Stik, have come to Detroit. “The Kresge Foundation contributed $50 million to a large public-private reclamation and redevelopment project along the Detroit riverfront. “In a like vein, Sue Mosey, president of the community development organization Midtown Detroit Inc., is trying to revive Midtown Detroit by focusing on four major institutions – Henry Ford Hospital, the Detroit Medical Center, Wayne State University, and the College for Creative Studies. “Henry Ford Hospital just completed a $300 million renovation, and announced a $1 billion expansion with commercial, retail, and housing space. “The Detroit Medical Center, which employs about 3,000 physicians and numerous other employees, has invested $850 million in a new heart hospital and an outpatient pediatric facility. 6

“Wayne State University which is the largest public research university in Detroit, is building a $90 million biomedical research facility to connect with the Henry Ford Health System. Wayne State is also home to TechTown, a technology research center and business incubator. “The College for Creative Studies, which is one of the top design colleges in the world, spent $145 million in 2008 to redevelop of the historic Argonaut Building. “The most recent infusion of capital into Detroit will involve building the M1 Rail, a 3.3 mile light-rail line from downtown to Grand Boulevard at the upper edge of Midtown Detroit, is a consortium of many public, private, and philanthropic institutions – including General Motors and Chrysler, the Kresge Foundation, and individual investors have committed more than $100 million to the project. U.S. Secretary of Transportation Ray LaHood said, “Nobody in America, no community, has ever raised $100 million for a project like this. That is unprecedented. “Lastly, a consortium of entities has pooled resources through a $100 million New Economy Initiative.”20 There is currently a plan to build a new hockey arena for the Detroit Red Wings with an investment of $444 million, and retail office, residential and hotel space with an additional investment of $206 million, all within walking distance of Comerica Park (Detroit Tigers) and Ford Field (Detroit Lions). “The Arlington, VA.-based NCB Capital Impact and the Troybased Kresge Foundation announced a $30.25 million fund for developments along or near the Woodward corridor in Detroit, essentially the neighborhoods of Midtown, North End, New Center, Woodbridge and even Eastern Market. “The Woodward Corridor Investment Fund will make loans of $500,000 to $5 million and is expected to result in the development of 450 to 600 rental units in Midtown and surrounding areas, which are at least 95 percent occupied. The projects will most likely be buildings with six to 75 units each and feature a mix of market-rate and moderate income housing.”21 Condo, loft and apartment housing in the Downtown and Midtown (Wayne State University District) areas are essentially sold out. Young professionals with bachelor degrees living in downtown Detroit has increased by 59%. President Barack Obama sent members of his administration and his Cabinet to Detroit on September 27th. They announced $300 million dollars in grants from the federal departments along with commitments from the State of Michigan and foundations to be used for residential 7

and commercial demolition, neighborhood revival, hiring of police officers, hiring of new firefighters, repair and rehabilitation of city buses and money for other transportation needs. In conclusion, Detroit and our financially troubled American cities can be saved. They will have bright futures. ****

ENDNOTES

The Detroit News, Wednesday, August 7, 2013 p.5A “NYC’s Bloomberg: Every City Should Heed Detroit’s Lesson,” by David Shepardson.

Detroit Free Press, Sunday, July 31, 2013 p. 1 & 9A, “Detroit Not Alone with Debts Built on PromisesMany Cities are Buried Under Pension Burden,” by Todd Spangler.

The New York Times, Tuesday, August 6, 2013 p. 1 & 3A, “Chicago Sees Pension Crisis Drawing Near – Politics and Downtown Put a City at Risk,” by Monica Davey and Mary Williams Walsh.

Time, “Is Your City Next? Lessons From Detroit’s Fight to Survive,” p. 23-31, August 5, 2013 by Rana Foroohar.

The National Law Journal/www.NLJ.com, July 22, 2013, p.7 “Detroit Bankruptcy Sets Record for Insolvency” by Claire Zillman.

Harvard Business School, Tuesday, July 23, 2013, Taking the Measure of Detroit, p.6-7 by Senior Lecturer Robert Pozen.

Detroit Free Press, September 15, 2013, How Detroit Went Broke – A Free Press Investigation, p.1A-12A15A by Nathan Bomey and John Gallagher.

Detroit Free Press, September 15, 2013, How Detroit Went Broke – A Free Press Investigation, p 1A-12A15A by Nathan Bomey and John Gallagher.

Detroit Free Press, September 15, 2013, How Detroit Went Broke – A Free Press Investigation, p.1A-12A15A by Nathan Bomey and John Gallagher.

Bridge magazine, March 15, 2013, updated July 19, 2013, pp 1-3, “Detroit Bankruptcy: Handshake Deal Between Gov. John Engler and Mayor Dennis Archer Haunts City,” by David Ashenfelter.

Detroit Free Press, September 15, 2013, How Detroit Went Broke – A Free Press Investigation, p. 1A12A-15A by Nathan Bomey and John Gallagher.

Detroit Free Press, September 21, 2013, p. 5A, Bankruptcy Experts: Stay Ahead of a Crisis,” by Tammy Stables Battaglia.

Diversity & The Bar, a July/August 2013 publication of the Minority Corporate Counsel Association, p. 44, “An Ounce of Prevention is Worth a Pound of Cure,” by Jennifer Hoover.

Harvard Business School, July 23, 2013 Taking The Measure of Detroit, p.10-11, “The Long View,” by Associate Professor Eric Werker and Benjamin Kennedy (MBA 2009), Senior Program Officer The Kresge Foundation. http://www.hbs.edu/news/articles/pages/taking-the-measure-of-detroit.

Brookings, July 19, 2013 p.1-5, “A Growth Strategy for Post-Bankruptcy Detroit,” by Bruce Katz and Jennifer Bradley of the Brookings Institution and Co-Authors of “The Metropolitan Revolution.”

Crain’s Detroit Business, September 23, 2013, p.10 “Woodward Fund Backers: New Midtown Apartments a Top Priority,” by Amy Haimerl.