Learning from the Detroit bankruptcy
Detroit firefighters protest outside a bankruptcy hearing; city officials want a judge to invalidate Detroit’s pension contracts. (July 24, 2013) Credit: Getty Images
On July 18, Detroit filed for Chapter 9 federal bankruptcy protection. At over $18 billion in liabilities, it is the country's largest-ever municipal bankruptcy case. Although there have been rampant accusations of financial mismanagement and scapegoating, the main culprit for Detroit's woes was demographic: The city's population, which peaked at 1.8 million in the 1950s, now stands at 700,000 after many middle-class workers and businesses fled the city, taking their tax dollars with them.
Despite making severe cuts to its spending -- in the first quarter, the city's police force was operating at bare-bones levels, about 40 percent of the city's streetlights were not functioning and only a third of its ambulances were in service -- the city collapsed under the weight of its obligations.
Of the $18 billion owed, $11 billion is unsecured, which includes almost $6 billion in health and other benefits for retirees, more than $3 billion for retiree pensions and about $530 million in general-obligation bonds.
The 100,000-plus unsecured creditors will now begin the arduous process of negotiating for their slice of Detroit's diminished pie.
What can we learn from this tragic collapse?
But municipalities don't have to go broke to renegotiate future benefits. Unions all over the country that are fighting to maintain pay and benefit packages for their members must deal with the cold reality of the financial pressure under which many towns and cities are operating.
If Detroit is allowed to cut payments to its retirees, city and state workers in states like California and Illinois, which also have large, unfunded pension liabilities, could use Detroit as leverage to reduce future benefits.
The one action that any municipal employee can take is to sock away extra money in tax-deferred retirement plans. Most towns and cities offer Section 457 plans, which allow workers to contribute a portion of income on a pretax basis. I know that many people have a hard time scraping together money to do this, but if possible, it's a good way to build up an extra source of retirement income.
One final note: While Detroit grabs headlines, it's important to underscore that municipal bankruptcies are rare. Congress enacted a revised Municipal Bankruptcy Act in 1937, and since then, there have been only 627 municipal bankruptcies, including Detroit's. For those worried about more municipal bankruptcies to come, the economic recovery has certainly improved the outlook for most American cities. And in terms of spillover effect, the Detroit bankruptcy represents just a fraction of the $3.7-trillion municipal bond market.Jill Schlesinger, a certified financial planner, is a CBS News business analyst. She welcomes e-mailed comments and questions.
