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August 5, 2013

Detroit Bailout Would Reward Bad Decisions

By

I had just gotten to work one December morning in 1994 when my boss called an urgent, unscheduled meeting to announce we were filing for bankruptcy. Orange County, Calif., had just initiated what was then the largest municipal bankruptcy in the nation. Most of the taxpayers and workers in this large and prosperous county didn’t see it coming.

Fast forward almost 20 years to Detroit. Far from a surprise, many wonder why the city waited so long to declare bankruptcy. Its $18 billion in debt is just the latest in a downward spiral of bad economic news coming from a deeply troubled city. Fully half of its debt stems from unaffordable pensions and health care retirement benefits.

Detroit perpetuated some of the mistakes the automakers made, rather than learning from them. Government growth was fueled not by new tax revenues, but by unaffordable future promises to its copious municipal workers. At the same time, the city pursued an anti-growth agenda through tax increases, expanded regulation and abysmal services. No wonder families and businesses fled, taking their tax dollars and payrolls with them. Now the city cannot keep the lights on or pay its debt.

It is sad that it has come to this for those 700,000 left in a city which once held more than 2 million. Detroit’s leaders could have pursued growth-oriented reforms to create an environment that would allow entrepreneurs to flourish. But Detroit automakers went to Washington to demand bailouts and threaten further job losses rather than getting their houses in order. It’s not hard to understand why the city fathers continued to double down on failed policies.

No doubt some will call for Washington to come to the rescue. That would be wrong. It would not force Detroit’s leaders to come up with a sound solution, but simply enable continued bad policy. It would reward bad management at a tremendous cost to taxpayers in cities, counties and states who have made the right policies. And it would set a terrible precedent, opening the floodgates for other troubled state and local governments.

Two elements of Detroit’s debt will take center stage during what will likely be a long bankruptcy process: Unfunded retirement promises and the treatment of municipal bonds.

Municipal bonds are typically regarded as very safe investments, with the full faith and credit of the municipality standing behind it.

Yet treating these bondholders as any other creditor could be a new and unwelcome development in public finance. It would raise costs of debt for state and local governments across the nation, just at the time when many are struggling to dig out of their own budget messes.

But pensions and retiree health care will be the more difficult. The employee pensions system has $3 billion in unfunded liabilities. Retiree health benefits are $6 billion in the red. Thousands of retirees depend on their pensions for a living and more are approaching retirement.

Finding a way to restructure benefits without sending retirees to the poorhouse while still reducing the city’s unfunded liability will be grueling. But it is necessary. Bankruptcy is the last chance for Detroit’s leaders to restructure their debts and government services to save the city. In fact, it will force them to do so.

Some have compared Detroit to Greece: High ratio of government workers, high taxes, big government, massive retirement programs and unsustainable debt. But the more likely scenario is that as Detroit goes, so will the nation.

The federal government is $17 trillion in debt — making it larger than the entire U.S. economy. Social Security’s excess costs are $12 trillion. Medicare’s are $43 trillion. State and local bailouts are bad because they reward and enable further fiscal misbehavior. But, they would also push the nation closer to a big debt tipping point.

Detroit’s problems are more deep rooted and dire. The way out will be tough. Rather than vague comparisons with Greece, Washington should look to Detroit and not wait to fix its own fiscal mess.

- Alison Acosta Fraser is director of government finance programs at The Heritage Foundation.

First appeared in The Detroit News

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