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Lessons of Detroit's Bankruptcy

NEW YORK ( TheStreet) -- Cities went bankrupt before Detroit, and others will go bankrupt in the future.

Governing Magazine has created a handy chart of all this.

Jefferson County, Alabama, which includes the city of Birmingham, was allowed to go bankrupt in 2011 and laid off workers. Harrisburg, Pennsylvania, had its bankruptcy application rejected and defaulted on loans. San Bernardino, California, declared bankruptcy last year after finding it had almost no cash with which to pay the bills.

Detroit's Chapter 9 filing just happens to be the largest to date, $18.5 billion. The city's population has declined by more than half since 1950. Whites moved to the suburbs, the auto industry imploded then moved away, and the city had a series of inept leaders, culimating in the era of Kwame Kilpatrick, whom the Detroit Free Press wrote in June may now face decades in prison for racketeering.

The biggest problem is that Detroit was allowed to become an island of poverty in southeast Michigan. Grosse Pointe, to its east, is a synonym for wealth. Dearborn, to the west, has been re-born as a haven for Middle Eastern immigrants. Ann Arbor, further to the west, is doing great.

At the heart of a solution, state officials say, are city pensions. Governor Rick Snyder and his appointed emergency manager, Kevyn Orr, say city pensions are underfunded by $3.5 billion and made the filing, in large part, to force cuts, writes the Free Press. The bankruptcy bar is also lining up to represent both sides in a fight over city bonds. Orr wants to call those notes secured by city taxes unsecured, and only pay in full on those secured by city assets.

The larger question is whether this is an isolated case, or the start of something much nastier. An analysis in April by Standard & Poor's showed the general default rate on municipal bonds in 2012 to be just 0.144%, and for high-yield municipal bonds it was 1%. Contrast this with the 2.6% default rate on corporate bonds. While the trend on corporate defaults was up, that on municipals was down.

Still, the Pew Center for the States says many cities face underfunded pension liabilities that could result in bankruptcy down the road. Some 30 large cities face gaps of over $192 billion, most of it for retiree health care costs, with New York facing the largest gap on a cash basis and Pittsburgh facing the largest one on a percentage basis.
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