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.

The biggest problem lies in retiree health care, the analysis concludes, with many cities having set aside no money to pay these costs. Cincinnati has done the best job, funding 85% of retiree health costs, with a 2009 plan that raised deductibles, co-pays, and beneficiaries' out-of-pocket costs.

Detroit's situation is going to be muddled in questions of race and class, as has always been the case there, but the bigger question is how much of the pain will be borne by workers, how much will be borne by bondholders, and whether the city that emerges from the process becomes a worthwhile investment again.

While the Brookings Institute claimed a few years ago that cities are now growing faster than suburbs a more recent Trulia analysis, based on census tract density, indicates that, while the most densely populated urban centers are growing faster than other areas, low-density suburbs are still growing faster than cities.

So Detroit may have a long way to go. But for now it's an awesome bargain, with tons of family-sized homes being offered, even at the city's edge, for under $60,000. I took that kind of deal in Atlanta 30 years ago next week, and came out fine. Maybe you will, too.

At the time of publication, the author had no investments in Detroit.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Dana Blankenhorn has been a business journalist since 1978, and a tech reporter since 1982. His specialty has been getting to the future ahead of the crowd, then leaving before success arrived. That meant covering the Internet in 1985, e-commerce in 1994, the Internet of Things in 2005, open source in 2005 and, since 2010, renewable energy. He has written for every medium from newspapers and magazines to Web sites, from books to blogs. He still seeks tomorrow from his Craftsman home in Atlanta.

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