Detroit: A Lesson in Bankruptcy
Which one of these entities is in Bankruptcy?
United States Detroit U.S./Detroit
Number of Citizens 316,300,216 706,585
Unfunded Liabilities(PV) $56,000,000,000,000 $9,200,000,000
Unfunded Liabilities(PV)/Citizen $177,047 $13,019 13.6
Debt $16,900,000,000,000 $8,800,000,000
Debt/Citizen $53,430 $12,454 4.3
Obligation $72,900,000,000,000 $18,000,000,000
Obligation/Citizen $230,477 $25,473 9.0
Obligation=Debt+Present Value of Unfunded Liabilities
Data as of July 2013
Table 1: United States and Detroit; Their Debt and Unfunded Liabilities
Why did Detroit go Bankrupt?
Much has been written about the demise of the city of Detroit due to the dramatic change in where the automotive industry is producing their products. The cost of vehicle manufacturing in the Detroit area became prohibitive due largely to the cost of labor becoming uncompetitive because of union demands for employee pay and benefit increases and lucrative retiree pension and benefit plans. This dramatic reduction in employment and general economic activity has caused major flight from the Detroit area and as a result the population of Detroit has dropped from about 1.8 million in its heyday to now about 700,000. As a result the cost of providing services to the city, paying retirement benefits to former city employees, and paying off their debt cannot be economically supported by the reduced population and reduced economic activity.
I hear a lot of discussion that the mismanagement of the city by government officials was a major contributor to the fiscal problem and I would agree that this is a problem but the massive economic shift away from Detroit has dealt them a tough hand. That said, city management's granting of unsupportable pension and healthcare payouts and then not being able to fund these pension and healthcare plans adequately was a serious mistake. As I have said many times on this website, defined benefit plans have been the death knell for corporations, industries, local governments, and national governments.
Lucrative retirement pension and healthcare plans were a major contributor to the economic demise of the automotive industry in the Detroit area so it is not surprising that the city is now suffering from a similar malady but dramatically intensified by the loss of the city tax revenues required to finance the city services and pay for retiree benefits.
As a result of this fiscal situation, the city of Detroit has amassed $9.2 Billion of unfunded liabilities and $8.8 Billion of debt which they cannot repay and have chosen the bankruptcy route to resolve this $18 Billion total obligation problem. This total city obligation has therefore created an obligation of $25,473 for each citizen of the city.
The United States Fiscal problem is 9X that of Detroit!
What these citizens of Detroit may not realize is that this $25,473 obligation to the city of Detroit is only 1/10th of their total obligation since each citizen of the United States, on average, has an obligation to pay $230,477 for the Federal Government's unfunded liabilities and debt. The United States Government does not have a plan to pay our Federal obligation any more than does the City of Detroit and the hurdle is 9 times higher on a per citizen basis.
What then would make the Government leaders in Washington think they can help with the city of Detroit problem? But such an attempt would be consistent with prior actions by the Washington leadership as they seem to think that we can continue almost unlimited deficit spending and committing. The leaders in Washington have almost no concept of what it means to be fiscally accountable.
Hypocrisy in Washington!
One difference between the United States and Detroit is that Detroit is bankrupt and knows it; the United States is bankrupt and does not know it. The media and Washington leadership are quick to point to the mismanagement in Detroit that created this mountain of fiscal obligations which the city cannot support. While at the same time, Washington has been mismanaging our fiscal situation for 45 years even intentionally misleading the entire country with inappropriate accounting techniques and financial reporting. How can they possibly point an accusing finger at the leadership in Detroit for the way they have managed the city finances.
When it comes to dealing with these fiscal problems, a major difference between the city of Detroit and the United States is that it would be unlawful for the city of Detroit to print dollars to pay their bills. The only way the United States can possibly meet the $73-$85 Trillion financial obligation that we currently face is massive money printing and by massive I mean printing as much as $5 Trillion a year (see Devaluing the Dollar!). The only other option is to reduce this Federal Financial Obligation by increasing taxes, reducing spending, and reforming (defaulting on) our entitlement commitments to the levels required to balance the GAAP-basis budget.
A lesson in Bankruptcy!
The bankruptcy of Detroit should give us a model as to how to resolve the coming bankruptcy of the United States. The issue, however, is that the U.S. fiscal situation is dramatically more dire than that of the city of Detroit; 13.6 times more severe due to unfunded liabilities, 4.3 times more severe due to debt, and 4000 times larger. For the city of Detroit, when the population dropped and the economic activity slowed, city tax revenues fell compounding the fiscal problems for the city. Similarly, as we as a country begin to close our fiscal deficit, economic activity will contract and tax revenues will fall, compounding the fiscal problems for the country. The U.S. is also seeing the shift of economic activity away from the United States (outsourcing) due to the cost of labor so we too will see a shrinking of our tax revenues much as did the city of Detroit. We hear talk all the time about how Congress will have to come up with a "grand bargain" to resolve our fiscal dilemma, but the plans that are being discussed are woefully short of what is required to get us to a sustainable fiscal model. How in the world can Congress come up with a plan to fill in a $60-70 Trillion hole. It may in fact take a bankruptcy petition to force us to finally come to grips with the gravity of the U.S. fiscal situation.
But when we finally come to our senses, I have laid out what I feel is a sustainable plan for the country in My Recommendations. We have already seen one crystal clear model for what is required when a country (Greece) over committed on it's promises to their citizenry but we have been consistently in denial that we could every reach that point. Maybe when we see what happens to Detroit that will bring both Congress and the U.S. citizenry to realize that we have little choice in the matter and we will start making the difficult decisions. But it will be difficult for Congress to act on our problems until the citizens are convinced of the need to stop this Ponzi scheme. Reporting the problem accurately (GAAP accounting and reporting) is a must happen first step but even that will be hard since the Government will have to step up and say that they have been fibbing to us for 45 years. That will be a tough pill to swallow.
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