What Happens in Detroit, Does Not Stay in Detroit

ripples

Ripple effect

Detroit seems a long way from the Old Dominion, and its bankruptcy woes seem largely irrelevant to a state and its local governments which, whatever else their flaws, have among the strongest bond ratings in the country. But it would be a mistake for Virginians to ignore events in the Wolverine State.

It looks like holders of Detroit municipal bonds will take a proverbial hair cut. That’s inevitable, and even understandable as the city’s emergency manager, Kevyn Orr, fights to shore up basic services for city residents. If that means taking on the public employee unions and the bond holders, he’s willing to do it. And public opinion will be on his side. The unions have been guilty of gross over-reach and bond holders, for the most part, are big boys who understood the risks they were taking when they bought the bonds.

But precedents could be set that could rattle municipal bond markets. As the Wall Street Journal reports today, “A fight over bankrupt Detroit’s sewer system threatens to reshape the nation’s $3.7 trillion municipal bond market.”

Owners of some $5 billion in water-sewer bonds thought they were well protected because their bonds were backed by revenues from Detroit’s water-sewer system, which is solvent. Orr wants to renegotiate the terms of the bond deal in order to free up water-sewer revenue for other city needs.

Bond holders are spooked, even though Orr maintains payments on the water-sewer bonds will be secure. Credit-rating firm Standard & Poor’s declared that Orr’s plan “tantamount to a default” on the bonds. “You really break the foundation” of debt markets if municipalities can freely restructure their obligations, Jim Colby, a muni strategist for Van Eck Global, told the Journal.

The legal structure backing municipal bonds will come under increasing stress as Detroit and other bankrupt cities resort to increasingly desperate maneuvers to stay afloat. It’s not clear such actions will have on states, like Virginia, that have gone to great lengths to preserve their credit ratings. Will such shenanigans sour investors on the entire class of municipal bonds, a bad thing for Virginia? Or will they engage in a flight to quality, which could be a good thing for Virginia? That depends largely upon the rulings of Detroit judges. But Virginians should pay attention — we have a lot riding on the outcome, too.

Update: The WSJ has a follow-up story today on Saginaw County’s decision to postpone a $60 million bond offering, following decisions by Genessee County and Battle Creek to pull bond sales last week. Clearly, the contagion is spreading throughout Michigan. The question is, will it spill beyond Michigan’s borders.

— JAB

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17 responses to “What Happens in Detroit, Does Not Stay in Detroit

  1. the problem with water/sewer debt is that it never assumes the system shrinking.

    It always assumes expansion or status quo at the worst.

    When you look at most water/sewer systems – like, perhaps the one in Henrico, you will see expansion plans on the maps.

    those plans cannot be executed without loans. The loans are “backed” by hook-up fees first, users fees second, and the good faith and credit of the county last.

    If a system starts to shrink with people leaving areas already served, then bad stuff starts to happen because even the user fees won’t pay for the current operational expenses much less the capital facilities debt.

    The companies that loan the money – know this but these bonds are often for 30 years or more.

  2. Jim goes on and on about Detroit’s problems, which may be true enough, but his view does not cover the entire regional picture.

    I don’t know if Jim has ever been to the Detroit area, but I have. When I worked int he Midwest for BusinessWeek, I did some stories about large corporations in my area (Ohio and Pennsylvania and Kentucky) at oine point that led me to Detroit.

    Or, actually, to the suburbs of Detroit which is where a lot of the economy is still thriving. At the time, I was visiting TRW’s auto parts operations north of Mo-Town. The ‘burbs were doing well then and are doing well now after a downturn at the end of the last decade and before the auto industry revival.

    Here’s a link:

    http://business.financialpost.com/2013/07/29/detroit-bankruptcy-underscores-rift-between-city-and-suburbs/

    OK, we know the city’s a mess. It has been since the 1960s. It is defaulting. But to not acknowledge the Detroit REGION and its strengths is to be somehow dishonest in analysis. I know this hurts Jim’s “Boomergeddon” take on the world, but he really should consider the entire picture.

    It is similar to saying that Hampton Roads is going down the tubes because Portsmouth is troubled.

    If Jim had the opportunity to actually visit the Detroit area, he might have a different perspective since it is a good journalist.

  3. the best selling vehicle in the US is the Ford F-150 which is made in two places and one of them is Dearborn, Michigan.

    here’s a map: http://goo.gl/maps/rGYyH

    tell me how far Dearborn is from Detroit?

  4. The holders of General Obligation bonds which are backed only by the city of Detroit will and should take a hit. Bonds issued by tax exempt entities guaranteed by a specific cash flow are contractual obligations between the bond holder and the entity . Any attempt to break this type of contract would be the end of municipal finance as we know it.

    • I agree completely. I think it would extremely odd for the courts to break a contract between the bonholders and the entity.

      Orr is widely seen as an astute businessman. I am surprised he is even talking about this. Maybe his comments have been misunderstood.

  5. re: ” Any attempt to break this type of contract would be the end of municipal finance as we know it.”

    agree.

    and it won’t mean the end of municipal loans but it pay present heft loan rates in the future.

    to this point – conventional wisdom was that municipal bonds were a safe, tax-free/reduced way to invest.

  6. Jim,
    Where is your rebuttal or have we totally demolished your argument?
    (BTW, you really should visit some places in person before you try to write with authority about them).
    PG

  7. Demolish my argument? Hah! Hah! Hah!

    I did not rebut your comment because I felt it did not address the point of my original post, which was, very simply, that the fall-out from the Detroit bankruptcy could roil municipal bond markets nationally and have an impact on Virginia. Do you really want to take issue with that?

    As for “writing with authority” about Detroit, I didn’t pretend to do any such thing. I was quoting the Wall Street Journal in a short blog post. That’s what bloggers often do — quote news stories written by others. I believe that even you have done so from time to time.

    Finally, I don’t know where you got the idea that I believe the Detroit region (as opposed to the city) is in trouble. I never said such a thing. If you believe otherwise, please quote me back to myself so I can respond.

  8. Detroit has nothing to worry about. Jim Bacon has decreed that the population in the suburbs will be moving en masse to the urban core. All Detroit has to do is wait for the mass exodus back into the city from the horrible sprawl of Oakland County.

    More seriously, Jim’s theory has some academic merit. As the population ages there will be more and more “empty nesters” who don’t need the big house in the suburbs. Additionally, the Echo Boomers should continue to graduate from college for a few more years fueling the demand for the urban housing favored by young adults.

    However, there are two problems with the theory …

    Most American cities are badly broken. High school graduation rates across America reached the highest point since 1973 last year – 75%. Atop the list of big school systems with the highest graduation rate was good ole Fairfax County, VA at 85%. However, the graduation rate in the city of Washington, DC was 57%. The City of Richmond schools have the highest dropout rate among the 131 school districts in the state.

    Retirees may not care about the quality of K-12 education since their own kids have presumably finished school. However, they do care about safety. What will these high school drop-outs be doing as the years roll by? For too many crime will be a big part of their adult life.

    First Things First, an organization dedicated to keeping dads involved in kids’ lives, reports that 60 percent of all families in Richmond, Va., are single-parent households and 86 percent of black families are single parent. “We have a major father absenteeism issue in Richmond,” First Things First executive director Truin Huntle said. “I wish more people were discussing why this is such a major issue. We see more people beginning to give some credence to it because they are looking for the root cause of other issues like childhood poverty and poor performance in school. Father absenteeism, broken homes, broken marriages and teen pregnancy are continually being found as the root cause of those problems.”

    • As usual we agree more than we disagree, although you can’t resist taking a poke at ol’ Bacon with the comment about the “mass” movement back into the urban core of Detroit. Some cities are so broken that the mass movement may be only a trickle. But read about what’s happening to Detroit. There *is* a trickle of investment and young people back into the core.

      Meanwhile, most cities are not as badly broken as Detroit. As you rightly observe, demographic trends do favor moving back into the urban core. Crime rates have fallen dramatically, which makes cities far more hospitable to the middle class and professional classes.

      You also allude to the pathologies of poverty arising from broken families. I totally agree — that’s a root cause of poverty and social dysfunction. The point you neglect is that as cities gentrify, many poor people are getting pushed into older suburbs. I heard a figure today — don’t know if it’s true — that 40% of the school kids in Henrico County participate in federal breakfast and lunch programs. Poverty is not just a city-of-Richmond problem any more!

      • Maybe. I think things could get rough. I hear a lot of loud complaining from the longtime residents of DC about the gentrification. DC is now the most economically segregated city in America. It has the greatest wealth gap among its citizens and that’s not going down well with many. People are starting to feel priced out of the neighborhoods where their families have lived for generations.

        • interesting that you have a boundary and on one side is a hugely different demographic than the other side – even though both are in the same MSA.

          not only Detroit, Washington/NOVA, Richmond/Henrico, etc.

          how does that happen?

          what makes the difference?

  9. DJ has aimed a missile unfailingly right between Jim Bacon’s “smart growth’ eyebrows!

    Smart Growth is not for undereducated, fatherless, kids.

    to be entirely fair:

    1. – how come we don’t have a ton of fatherless hispanic moms living in cities?

    2. – how come no matter where asians live – their kids usually have fathers?

    3. how come Hispanics tend to live in suburbs 10 to a house?

    ok.. I’m now retreating to my internet bunker…

    • 1. – how come we don’t have a ton of fatherless hispanic moms living in cities?

      Simple, they realize their children can get a better education in suburban schools than in those within central cities. Unless a parent is a drug addict, hopeless alcoholic, etc., they realize virtually every central city school is run exclusively for the employees and, as such, their kids will be better off in the worst suburban schools.

  10. and why doesn’t that same strategy work for blacks?

    • Good question. I can speculate, but don’t know what the answer is.

      • so we have “white flight” and “hispanic flight” but no “black flight”.

        hmmm….

        earlier it was shown just how close the boundaries of the suburb jurisdictions are to Detroit.

        pretty close.

        of the people that left Detroit – are we sure that most were not black
        and the ones left behind were the poorest of the poor blacks?

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