Should Detroit spend $250 million on bonds to figh...

Should Detroit spend $250 million on bonds to fight blight? The city’s 2013 bankruptcy offers some lessons

“It’s risky. There’s no other way to look at it.”

Detroiters will be deciding in the upcoming general election whether or not to approve Proposal N, an initiative by the city to borrow $250 million in bonds to pay for blight elimination. Among the many difficult questions voters will have to answer to make a decision, the most obscure is probably the proposal’s impact on the city’s budget.

That’s because municipal budgets are complicated. Not many people know the meaning of unlimited tax general obligation bonds, interest rate swaps, actuarial tables or any number of arcane terms that affect a city’s bottom line. Evaluating the long-term impact of bonds and their accrued interest is even more difficult.

Nathan Bomey knows a thing or two about Detroit’s budget. A former reporter at the Detroit Free Press and now a business reporter for USA Today, he literally wrote the book on Detroit’s bankruptcy, “Detroit Resurrected: To Bankruptcy and Back.” If anyone can walk readers through the weeds of Detroit’s finances, it’s him.

We spoke with Bomey about why Detroit went bankrupt in 2013, what lessons the city can draw from it and the state of the city’s finances today. This interview has been edited and condensed for clarity.

Also, be sure to read our voter guide on Proposal N for more information. 

Detour: What are your thoughts on Proposal N? It’s looking to raise $250 million in bonds, and may cost an additional $240 million in interest

Nathan Bomey: It’s risky — there’s no other way to look at it. But it doesn’t mean that they shouldn’t do it. At some point, the city does need to take more aggressive steps to improve services on behalf of residents. Blight is a major problem in Detroit; it has been for decades. It has a significant effect on quality of life, safety and the value of property, which is directly tied to the wealth of Detroit citizens. 

The question is… is this the way to approach it? I’d say that there are serious concerns about the way the city’s managed its blight remediation dollars the last several years. The FBI investigation into the Duggan administration’s handling of money was very concerning by any account. If this is to be done successfully, you have to impose controls that prevent any sort of corruption from happening in the future because Detroit can’t afford to slip back into some of the practices that have damaged its reputation in the past. 

Can the city afford to issue $250 million in bonds?

I would say they probably can because it’s spread out over a long enough period of time. Interest rates aren’t exorbitant for a city that just came out of bankruptcy seven years ago. You won’t see them get lower than they are right now unless the fed goes to negative interest rates. So in that respect, it’s not a bad time. But you need to approach this with caution — a city that just filed for bankruptcy seven years ago should not approach borrowing lightly. 

But the devil is in the details. My understanding is that these are unlimited tax general obligation bonds, which is fascinating because similar bondholders during Detroit’s bankruptcy ended up taking significant losses. If the city were to spiral downward and end up in bankruptcy again — which is a big if — the people who lended to the city are unlikely to get paid in full. So the bondholders are taking a risk too, which is why the rate is not inconsequential. The fact that the city thinks it can issue these bonds without pledging assets as collateral, likely indicates that the market believes that the city will pay it back. 

Of course the market isn’t always right. If you look at the way rating agencies were assessing Detroit’s finances in the years leading up to the bankruptcy, it’s somewhat comical now — they were way off.

Ultimately, it’s important to look at the city’s finances as a whole and understand that when you borrow to pay for any sort of services, it affects its ability to pay back pensions or pave streets or buy new police cars. It’s a holistic endeavor. Even though the city’s bankruptcy provided it with the financial runway to begin reinvesting in services and set the city on a more sustainable path, you don’t want to tempt fate again. 

Without getting too detailed, how bad was the state of Detroit’s budget on the eve of bankruptcy?

There’s no way to describe the city’s finances in 2013 other than a total disaster. The city was completely broke and any effort to paint it as anything other than broke is misguided. And not just financially, but the state of city services as well. After 60 years of economic decline, the city couldn’t keep its residents safe, provide basic services like operational street lights, didn’t have money to invest in new buses and much more. This was a city in total disrepair. Something had to be done about it. 

There’s going to be a debate for a long time about whether bankruptcy was the best thing, but I think it was almost unavoidable at that point. The bottom line is the city had reached a point of no return from a financial perspective. Bankruptcy allowed it to shed a lot of debt it had accrued including bonds, pension liabilities and retiree healthcare insurance. It was a mess and should be a warning to other cities.

One of the biggest obligations for the city were for COPs issued by the Kilpatrick administration in 2005. What exactly are they and why was it so disastrous for Detroit?

They’re called Pension Obligation Certificates of Participation, or COPs for short. It’s essentially borrowing to pay the bills. The city had pension obligations it had to pay, had a huge shortfall, and decided to issue $1.4 billion in COPs to plug the gaps. In a series of extremely unfortunate events, the city’s finances continued to decline almost immediately after. Then it ended up using swaps to lock in 6% interest rates on the COPs. Which turned out to be a very bad decision because right after rates sunk, the financial crisis happened, and the city was stuck owing about $50 million per year in payments to Bank of America, Merrill Lynch, and UBS on swaps alone. That’s 5% of the city’s budget just for swaps that had nothing to do with city services — it was a secured obligation. The swaps and COPs deal played a huge role in plunging Detroit into bankruptcy. 

That whole deal illustrates why it’s crucial to be careful about borrowing when you’re in a tough financial position. To be fair, it was 2005 and nobody foresaw the financial crisis or the auto industry nearly collapsing. When you try to spread out an obligation over many years, you may be able to temporarily avoid tough decisions, but someday someone has to pay the bill, and that’s what happened in Detroit’s bankruptcy. 

How sizable were Detroit’s pension obligations?

On an individual level, Detroit’s pensions were standard and not lucrative at all. But in the aggregate, the city’s pension obligations were significant because the city had decades of retirees that they had to compensate. Essentially, the city was paying for the fact that it used to be rich. Detroit had a big number of pensioners because it used to be a much bigger city [with a much larger workforce, and more tax revenue]. It had contracted so much and lost so much revenue, but that doesn’t mean you can stop paying for pensions. 

Retirees ended up sacrificing parts of their pension and health care benefits because of the city’s financial problems. That’s a really sad thing because the city’s pensioners were not living the big life — the average pension was about $18,000 per year and $30,000 for police and fire, but they didn’t get social security. While people tend to have less sympathy for bondholders, they also lost.

Did bankruptcy restore balance to Detroit’s budget? What were its debt obligations like afterwards?

Almost immediately after bankruptcy, it was discovered that the pension deficit was more significant than Emergency Manager Kevin Orr had estimated due to inaccurate mortality tables. (Editor’s note: the city used outdated data to estimate how long retirees would live.) Maybe they didn’t notice it or didn’t have time to fix it. Actuarial science is not a science, it’s an art. No one can really know what’s going to happen to the markets or how long people will live. People did not anticipate the opioid crisis reducing American’s lifespan or the pandemic temporarily crashing markets. It’s very hard to see what pension obligations will actually be, which means you have to be conservative in your assumptions. You can’t assume you’ll have outstanding returns every year because if you don’t, then you’re stuck with less money than you need to pay pensioners. In an extreme situation, you end up in bankruptcy.

The city still faces challenges in paying its pensions and the pandemic is going to, in all likelihood, make that even worse. But that’s going to be the case for pretty much every city in this country. Lots of municipalities are waiting to see if Congress will provide funding to ease those deficits. 

Is Detroit still carrying bad debt?

I’m not too concerned about the amount of traditional bonds the city has right now. What is concerning is the city’s revenue continues to be low. I haven’t looked at actual budgets versus projections, but the mayor probably hoped to have more revenue by now. It’s tough because if you rely a lot on casino revenue, and it is affected by the pandemic, that’s not good. 

It’s really positive that the city’s real estate market improved dramatically, which will help with property taxes. The city has also made significant improvements on tax collection rates — that cannot be underestimated at all. When the city fell into bankruptcy, it was collecting an absurdly low percentage of the taxes owed. It had both a revenue and debt crisis then. Now, I don’t think the city has a debt crisis. And I wouldn’t say it has a revenue crisis either, but it’s definitely a challenge. 

What lessons can the city draw today from the bankruptcy?

The main lesson is to approach borrowing with caution. For all the reasons we just talked about, I don’t think that they should borrow without extreme care. Because the more debt you accumulate, the greater the risk that you’ll find yourself back in a situation like 2013. They have to be careful. Detroit is not a city that’s flush with cash — it can’t go on a spending spree.

Top image credit: puzzleboxrecords from Pixabay

Aaron Mondry is the editor of The Dig and a reporter who covers development, housing, architecture, real estate and land use in Detroit. He was previously the editor of Curbed Detroit.