Bad Bets, Costly Promises Put Detroit On The Brink Of Bankruptcy

The state of Michigan is taking over its largest city's finances. Washington, D.C., attorney Kevyn Orr's job is to reverse a death spiral in Detroit, brought on by an eroding tax base, and years of unwise financial decisions — like promising generous retiree benefits with money that wasn't there, and a pension financing deal that backfired in a big way. Now, massive debt service that threatens the city's ability to provide even a modicum of services.

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Detroit has a more spotty record, as far as city management goes. The state of Michigan has taken over Detroit's finances, and the city is deep in debt. Sarah Hulett, of Michigan Radio, has this story about the bad bets, costly promises and deficit spending that has sent Detroit to the brink of bankruptcy.

SARAH HULETT, BYLINE: Let's say you're an auditor, and you want to take a peek at Detroit's books.

(SOUNDBITE OF MOVIE, "THE SHINING")

SHELLEY DUVALL: (as Wendy Torrance) Jack?

HULETT: You might feel like Shelley Duvall's character in the horror movie "The Shining," the part where she stumbles upon what her husband has been writing all winter and realizes he's completely unhinged.

(SOUNDBITE OF MOVIE, "THE SHINING")

JACK NICHOLSON: (as Jack Torrance) How do you like it?

DUVALL: (as Wendy Torrance) (SCREAMS)

HULETT: For the purpose of this story, Joe Harris is our Shelley Duvall. He spent a decade as Detroit's auditor general. Shortly before he quit in 2005, he asked an outside consultant to look at the city's pension and retiree costs.

JOE HARRIS: This is his presentation to the council.

HULETT: The consultant's report was a shocker. It said the city was looking at more than $7 billion in retiree health care and fringe benefit costs it had not projected, let alone budgeted for - $7 billion, seven times the city's annual operating budget. So what was the response to this bombshell of a report?

HARRIS: There was no response. There was no follow-up. There was no concern. There was no - not only by the council; there was no response by the administration, either.

(SOUNDBITE OF CLASSROOM CHATTER)

HULETT: One of the city council members at the table that day was Sheila Cockrel. She says she was concerned about what the report found, but few of her colleagues wanted to follow up. Cockrel left the council in 2009, after serving four terms.

SHEILA COCKREL: OK, folks...

HULETT: She now teaches urban policy and Detroit history at Wayne State University. Today, she's giving the class a primer on the city's financial problems.

COCKREL: One of the questions I get asked often is, how did this all happen? When did it start?

HULETT: Cockrel says the city's financial problems did not start with Mayor Kwame Kilpatrick. You've probably heard of him. He's in federal prison, awaiting sentencing on charges that he ran the mayor's office like a criminal enterprise. Cockrel took office several years before Kilpatrick, in 1994, and she says the city was not in great financial shape then. But there was a little surplus that year. By the next decade, though, things had changed dramatically.

COCKREL: There seemed to be a lot of what looked to me like robbing Peter to pay Paul - like moving, you know, funds around; and that the trends in our estimates on revenues were beginning to be off; expenditures were always greater than projected.

HULETT: So if you've ever run out of money at the end of the month and put the groceries on your credit card, that's essentially what the city was doing - again and again, year after year. The deficit ballooned, and Detroit was falling way behind on payments to its pension fund.

So Cockrel says a plan was hatched, and it made sense. The city would borrow $1.5 billion. The pension fund would be flush, and it would free up cash to pay for things like streetlights and cops. But that's not quite how things worked out.

COCKREL: Those were variable-rate transactions. The rates went in the wrong direction. So the gamble, in that sense, absolutely didn't pay off. It backfired.

JOHN POTTOW: The - I don't know what the metaphor is - the chickens are coming home to roost now.

HULETT: That's John Pottow, a bankruptcy expert at the University of Michigan. He says borrowing money to cover structural deficits was not a smart move; neither was the city's practice of pushing costs into the future at a time when middle-class residents were fleeing, and revenues were shrinking. Remember that $7 billion time bomb we heard about earlier? It was created, in part, by the city's promises to sweeten retirement benefits as a way to placate unions when there wasn't any money for raises.

POTTOW: Making matters worse is, as they do try to shrink the workforce, that pushes more people onto the retirement rolls. And then we expand that number of retirees.

HULETT: But Pottow says Detroit's hardly the only city that made these kinds of bad bets. He says municipal leaders across the country are watching Detroit, to see what concessions labor unions and bondholders will be forced to make. So the state has effectively benched Detroit Mayor Dave Bing and the city council and instead, turned to this guy...

KEVYN ORR: Kevyn Orr, the emergency financial manager for the city of Detroit.

HULETT: ...to make all kinds of decisions about the city's finances. He can cancel contracts, rewrite labor agreements and sell assets. Orr says the herculean task is to deliver services, get a handle on retiree costs, and figure out how to meet the city's credit obligations.

ORR: You know, my billet is 18 months, and I'm not going to be able to do all of that in 18 months. But what I can do is provide the architecture and the foundation, and then return the city to the city fathers and mothers - the elected officials - so they can build a stronger, more secure and more sustainable house.

HULETT: The big question is whether Orr can build that foundation without resorting to bankruptcy. While he says he'd like to avoid that, he won't rule it out. And that's something the city workers, retirees and bondholders he's negotiating with, are acutely aware of.

For NPR News, I'm Sarah Hulett.

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