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Detroit is Not Too Big To Fail

Detroit is not too big to fail.

The city of Detroit must take its lumps, as difficult as they may be to swallow. But the city of Detroit is to blame. They made a very bad calculated error. They thought their decades of cronyism and sweeping promises were good and economically viable. The people didn’t realize, or really didn’t care, that they were sold a lot of snake oil from public service sectors and unions that were promised too-good-to-be-true benefits and rewards.

But Detroit must not be bailed out because there are a great many other localities in the same boat as Detroit, that operated on the same premises. We simply cannot afford this financial baggage. Thatcher warned us decades ago, “The problem with socialism is that you eventually run out of other people’s money.”

One of the most difficult facets of Detroit’s economic woes is the fact that the state of Michigan constitutionally protects the rights of public service pensions. But pensions systems function as a vendor as a budget item to be paid; therefore, there should be no (other) protection for them than any other vendor — to do so is a clear form of cronyism. It is typically very difficult to get constitutional provisions passed at all, and yet some states, like Michigan and New York for example, managed to get it done. So this mindset of economic self-protection has clearly long been pervasive; these states have had the constitutional pension protection in place for some time.

The constitutional protection for public pensions is rather duplicitous because of how such money is protected when finances or the economy sours. You see, when states and cities raise money via taxes, the purpose is not for profit-making, and they don’t make decisions based on profits and such. First and foremost, their job is to take care of citizens. You would think with that being the case, it would therefore be really important to the elected leaders to make certain that the bondholders (who execute money in large quantities to help finances projects to benefit the citizenry) would know that their bond money is protected first and taken care of first. This is common sense.

A lot of the time in municipalities, the bonds that are issued are General Obligation (GO) bonds. GO Bond money is usually considered first in line for protection because of the enormous sums of money issued. Bondholders have to be promised by the locality that they get paid back first as an element of protection, a form of collateral if you will. In exchange for that guarantee, the GO Bonds are usually issued at lower rates than other types of bonds. That iron clad arrangement enables the GO Bonds rates to be very affordable for projects (think “smart money”), specifically because the bond has the guarantee of the locality that the money is financially protected. Other bonds don’t have that guarantee and therefore have a higher rate.

But if there are constitutionally protected items (like a pension system), they get put at the top of the list for protection, even ahead of GO bonds. This is an enormous problem. GO bonds have no actual and true collateral — only the “full faith and credit” of the borrowing locality. What kind of hypocrisy is it now to say to the bondholders that the money which was was borrowed to pay for education and teachers and government projects for the betterment of Detroit citizens now won’t get paid back — because we have to first pay for the teachers and unions and public service retirement pensions?

Detroit must be allowed to go through the proper process and not be propped up. This is a city that continuously and consciously made outrageous and untenable financial decisions with no accountability. A bailout for this behavior and operation will have a rippling effect on other localities which practiced this same kind of cronyism. Why should other taxpayers now be responsible for shouldering such gross economic negligence of a city rife with economic corruption?

Crossposted at alanjoelny.com

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