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Belmont Club

The Wages of Sin

July 18th, 2013 - 3:05 pm

Detroit, in going bankrupt, is threatening to pull down with it two pillars of the current economic model. The first is municipal pensions. “Pension-related costs and other post-employment benefit obligations make up about $7.5 billion of the city’s at least $15 billion long-term debt.” Some believe “a bankruptcy judge could trump the state constitution by slashing retiree pensions, ripping up contracts”.

However “the General Retirement System and the Police and Fire Retirement System of the City of Detroit filed the lawsuit yesterday in state court in Ingham County, Michigan, seeking a judgment that Governor Rick Snyder can’t authorize a bankruptcy filing that could reduce pension benefits.”

That still leaves the question of where the money is going to come from. Clearly it can’t come from Detroit. The hope is that it will come from the Federal Government. “A city official notably said the federal government should bail out Detroit, though the president has made no indication that’s a possibility.” If not the Federal Government, then some officials hope it will come from those “who can actually afford to pay taxes”. One Detroit official claimed that bankruptcy was unnecessary. All someone needed to do was go out and collect the vig.

“The whole foundation that brings him here is false,” Crittendon said. “We do not have a $15 [billion] or a $20 billion debt problem. We have less than a $2 billion short-term debt problem that we could manage if we just went out and collected revenues that are owed to the city; stop giving, you know, tax abatement to people who can actually afford to pay taxes.”

U.S. Rep. Dan Kildee (D) actually hopes help will come from the Federal Reserve. “Dear Chairman Bernanke,” Kildee wrote, “in response to your testimony before the House Financial Services Commission … I raised the issue of how widespread municipal failure, if unaddressed, could result in the next economic crisis.”

U.S. Rep. Dan Kildee wants to know what the Federal Reserve Board of Governors and Chairman Ben Bernanke are doing to address the prospect of municipal failures — including the one facing Detroit — and its potential impact on economic growth and the bond markets.

“For too long, lawmakers and regulators have stood aside as cities grapple with budget deficits, unfunded pensions and crumbling infrastructure,” Kildee, D-Flint Township, said in a letter sent to Bernanke on Wednesday.

The second pillar under threat is faith in government to pay. Kildee’s argument is simple, if circular. Unless somebody pays Detroit’s bills, the interest rate charges on all munis will go up. The New York Times had already sounded a similar alarm after Alabama’s Jefferson county went bust. The faustian bargain had been that corruption in the municipalities would be tolerated in exchange for the implicit assurance that “someone” — maybe Bernanke — would pick up the tab.

The Jefferson County bankruptcy may serve as a precedent for forcing bondholders to take losses in bankruptcy. Despite lots of legal protections, loans to municipal governments can be just like loans to people and companies: if the borrower truly can’t afford to pay what was promised, it won’t be paid….

Jefferson County’s problems involve corrupt politicians and bad luck, but they also include a longstanding reluctance to face facts about the county’s sewer system — and a bond market that failed to face the facts about the county and kept lending money long after it was prudent to do so.

The corruption involved was breathtaking. More than 20 people, including politicians, contractors and influence peddlers, have been convicted. JPMorgan escaped criminal charges, but the Securities and Exchange Commission penalized it for paying bribes through local middlemen.

That corruption was important and no doubt raised the financing costs for the county. But the basic financial decisions about the structure of the county’s debt were different only in scale from what many other municipalities did.

The Detroit bankruptcy shreds this implicit contract with the bondholders, just as it threatens to smash the assurances to the pensionholders. As Bloomberg News put it: “emergency Manager Kevyn Orr’s plan to suspend payments on $2 billion of Detroit’s debt threatens a basic tenet of the $3.7 trillion municipal market: that states and cities will raise taxes as high as needed to avoid default.”

By calling into question the safety of any security backed by a government’s general obligation to pay what it owes, Orr, 55, imperils similar debt across Michigan, the eighth-most-populous state. As local governments strive to rebound from the longest recession since the 1930s, they may confront higher borrowing costs.

Indeed another article from Bloomberg points out that “the yield penalty on Michigan’s debt has climbed 40 percent in less than two weeks as defaults by Detroit and two school districts lead investors to question the state’s commitment to protect bondholders.” This would trap some municipalities in the same bind that doomed Greece. The more they owed, the shakier they became. The shakier they became the higher the interest charges and the more they owed.

The exit from that trap is known as a “bailout”, another way of saying that somebody else has to pick up the tab for municipal mismanagement and corruption so municipal mismanagement and corruption can go on. Exporting the wages of corruption was an option during the long postwar boom because there was always a surplus somewhere to pick up the slack. The problem now facing governments in Europe and in the United States is that the Design Margin is gone. The markets no longer believe that “that states and cities will raise taxes as high as needed to avoid default”. Nor may they believe for too much longer that Bernanke will keep the presses running to achieve the same result.

That leads to the conclusion that something has to give. The only question is what. Detroit is in its own way “the canary in the coalmine”, the leading indicator of a tsunami that is still out of sight of the shore, but which is nevertheless approaching at jet speeds. The logic of the Blue Model is that the music must keep playing because it can’t stop.


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Top Rated Comments   
The paradigm that Detroit illustrates is destruction of capital. By willfully squandering the inherited capital of the previous generations such as the buildings, houses, factories and other resources of the city, of driving out the intellectual human capital for years, they have reduced themselves to paupers. And this is the paradigm of a certain type of politician, found everywhere in the world. What the "city fathers" of Detroit would like to do would be to extend their reach into the somewhat more prosperous suburbs, where many former Detroiters fled when the going got tough in Detroit. And find more capital to loot.

They will promise to be your best friend and benefactor today, to give you things you have not earned, in return for your vote and moral sanction to run the government as they see fit, regardless of laws or convention. Because, they care about you.

They care not about you, the future or anything else, except this moment in time when they wield power. And they want this existential moment to remain, like an insect in amber, forever. This is the philosophy of the cannibal. They expect the rest of us to offer ourselves up in sacrifice to their mistakes, so they can hang on to power just one more day, month, year, whatever.

At some point in time, a critical mass of opinion will be created among the American polis that either vigorously rejects the philosophy of the political cannibal, or the great majority of the populace will go "all in" on this, and embrace it. And then the argument will be who gets eaten first, and who gets eaten last.

If you're skinny and chewy, you may get to run away for a while.
38 weeks ago
38 weeks ago Link To Comment
When Detroit's police and firefighters come down to Kansas City and stop crime in my neighborhood or fight my fires, we can talk about whether or not it's my obligation to fund their pensions.

How much you want to bet they start talking about nationalizing the social services to get around this?
38 weeks ago
38 weeks ago Link To Comment
"Math doesn't lie." Now there's a revolutionary idea, alongside its functional equivalent, "nobody beat arithmetic." Interestingly the Founding Fathers knew this. The great discovery of the age was that the idea that all true answers came from God -- or Reality, the Creator, the Universe -- and not from men.

Thus if we wanted to know the temperature at which water boiled, why'd we'd go out and "ask God" by performing the experiment. And it turns out water boils at 100 centigrade at sea level everywhere. The entire scientific revolution is based on the idea that "math doesn't lie" and that all true answers come from querying the universe.

But somewhere along the line an alternative theory was proposed: all truth comes from the Narrative. Ward Churchill is a native American if we say so. George Zimmerman is white, and Chinese doctors are white, if we say so. And the recession can be ended, says Krugman, if only we imagine that we are printing money to stave off an alien invasion.

The Narrative is the 21st century's equivalent of a stone idol. Unfortunately, SpokenEasily is right. Math doesn't lie. When you're broke, you're broke. Zero means zero. The tale of the next decade will be one of the rediscovery of the scientific principle. You can't beat arithmetic.
38 weeks ago
38 weeks ago Link To Comment
All Comments   (46)
All Comments   (46)
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I was talking to my wife who grew up in Detroit. Her mom was an administrator at the Detroit Institute of Art (among her many other accomplishments) Now the vandals want to sell off the art . And so it goes..
In western New York where I grew up, little did I realize my city would peak when I was 11 and slide into slow death from there.
Industrial America, even Chicago, which used to be Carl Sandberg's "city of big shoulders" not Obama's 'hood, is no more.
Like the poster mourning the Detroit of his youth, I mourn the end of the gritty Rust Belt which gave us a couple generations of middle class comfort.
38 weeks ago
38 weeks ago Link To Comment
Of course Obama will have to ‘do something’. And 100% certainty that what he does will exacerbate the problem. After all, he's only a community organizer turned politician, never an executive/problem solver.

Nobody can claim “we DELIVERED” like the city of Philadelphia, I mean, nobody. And the city of Philadelphia is broke even though it is not wide spread national news (’near broke’ is the euphemism). You don't think these people watch closely how Obama will play Detroit with keen interest?

And I am sure Philadelphia is not alone.
38 weeks ago
38 weeks ago Link To Comment
IIRC the guarantee/obligation to the taxpayer is somewhat north of $57K/year per retiree, so they still make more than the average worker's salary. So, it's not so low. And it's the taxpayer gittin that haircut.
38 weeks ago
38 weeks ago Link To Comment
Transferring the pension obligations to the federal guarantee system might work.

The federal guarantee system doesn't guarantee high payouts, only up to some low limits.

So there's your haircut, hidden in the fine print of a politically possible transfer.
38 weeks ago
38 weeks ago Link To Comment
What a long strange trip it's been.

Detroit founded in 1701 became the third largest city in Quebec by 1778. Detroit did not become an American city until 1794 when it was ceded to the U.S following the Jay treaty. From about 1880 Detroit was a magnet for immigrants from central and Eastern Europe. Two great migrations of blacks from the Southern States increased the black population by 100 times between 1910 and 1980. Since the 1980's most immigrants from overseas have come from Asia and the Middle East. After peaking around 1950, the population of Detroit has fallen to about the same as it was in 1915.

A funny thing happened to Detroit on the way to the hockey game. The auto industry captured Detroit and the Unions captured the auto industry. Both prisoners developed terminal diseases largely caused by financial promises that could not be met because their arithmetic did not add up.

The pie in the sky promises "won" by the Unions from the Auto companies and the pie in the sky pensions promised to Municipal employees by the City turned out to be giant swindles of working men and women.

Detroit is important now because it will set the stage for what happens at the end of long running massive swindles. Because it is a much smaller scale than the great EU swindle, but is a similar scale to hundreds of other cities, the battles over Detroit’s smoking ruins should have far more significance. The focus in Detroit will be on real human things, like evaporating pensions and unpaid suppliers. The focus will not be on pompous abstract word balloons floated by toad like EUrocrats.

Hopefully Detroit will scare people into recognizing that progressive Democratic Socialism at the National or supra National levels is the greatest swindle of ordinary people ever invented. Maybe the way that the Detroit saga plays out will cause a National "holy s**t” moment. Maybe it will mark a turning point.
38 weeks ago
38 weeks ago Link To Comment
Buick's 50 MPH Tank Killer [http://wheels.blogs.nytimes.com/2013/05/13/before-it-built-the-enclave-buick-built-tanks/]

The M18 Hellcat tank destroyer helped Allied forces defeat the Axis powers in both Europe and the Pacific.

According to a recent Buick release, the M18 was a product of Harley Earl’s design studio (Mr. Earl was General Motors’ legendary design chief). And while the Hellcat was no lightweight at 20 tons, it was faster and more nimble than comparable German tanks. Capable of going 60 miles an hour over battlefield terrain, it was powered by a 450-horsepower 9-cylinder Wright R-975 radial aircraft engine, backed by G.M.’s stout Hydramatic transmission. Its suspension system was a torsion bar design developed by Buick engineers.

According to Bill Gross, a historian and M18 restorer, that suspension remains a common inspiration for today’s military vehicles. He said the Buick-built tank’s performance capabilities were laudable.

“The Hellcat was considered the hot rod of World War II,” said Mr. Gross. “To give some perspective, most German tanks of the day were capable of just 20 m.p.h.”

According to Wikipedia [http://en.wikipedia.org/wiki/M18_Hellcat], the M18 Hellcat’s unit cost was $57,500 – a little over $900,000 in today’s dollars.

It carried three fewer passengers than a modern-day eight-passenger Buick Enclave, and its interior lacked a modern Buick’s sophisticated climate-control system. The combination of the radial engine’s air-cooling system and the tank’s open-cockpit design ensured frigid cabin temperatures during Germany’s harsh winters.

A total of 2,507 M18 Hellcats were built on the Buick production line in Flint, Mich.
38 weeks ago
38 weeks ago Link To Comment
THIN ICE

The unholy alliance between the Democrats and the unions has resulted in the collapse of the first major city in the United States, but it will not be the last. Money in the future for votes in the present looked like an easy way to permanent office, and it was, but the cost was permanent poverty. The Democrats and the United Auto Workers have reduced a city of two million employed and financially secure middle class people to seven hundred thousand mostly black uneducated, unemployed and unemployable citizens living in a crime ridden falling down ghetto. But of course it wasn’t the fault of the politicians or the UAW. Everything would have been fine had it not been for the George Bush recession of 2008. So once again the system and the uncaring Republicans have failed all the dreams of the young and talented.

Yes once again fate steals the dreams
Of those the gods have given much
From Walter Reuther to the Dems
Who had for years the golden touch
The cars rolled off assembly lines
And wages, pensions rose to heights
Unseen in modern working times
All unaware the future bites
When promises are not sustained
By growth and honest City Hall
Until the factories grew dark
Shut down with none to heed the call
Studebaker, Packard, Nash
They shut their doors and closed their books
Dismaying not the union boss
Deterring not the many crooks
The Pistons, Lions, Tigers play
On shirts the word Detroit looks nice
But it’s a sham, the city knows
It’s not just Red Wings on thin ice
38 weeks ago
38 weeks ago Link To Comment
The fantasy culture in Michigan is a three legged stool. First is the Islamic community, that embedded within a preexisting Christian Arab community, that has effectively occupied Flint and much of Detroit and views infidel America through a lens of a extractive raider narrative. Second is the UAW which effectively stole GM and Chrysler from the bond and equity holders. Third is the looting of Detroit through a racist alliance of magic check beneficiaries and politicians. University liberals form a brace more than a leg. They provide cover for the serious enemies of sound government.

"revenues that are owed to the city"
There is an undefined phrase that needs scrutiny. Exactly who owes what? Are there any sums owed because corrupt politicians accepted bribes to undervalue properties or grant waivers? Do the politicians now crying they are owed really want us to track those links down? A dime will get you a donut that it will turn out they are the same politicians.

Solvent wealth producing residents should be able to form a new municipality within the shell of Detroit.They should take no responsibility for the schools or public housing or any district or agency that does not pull its weight. It would be nice if they take on the DIA though.
38 weeks ago
38 weeks ago Link To Comment
Okay, one more epitaph! the Ford River Rouge plant, the biggest in the World. My dad saw it in the 1930s and was stunned by its vastness.

http://www.youtube.com/watch?v=Xa0PAg7FfMk
38 weeks ago
38 weeks ago Link To Comment
I visited the River Rouge plant when I was a teenage many years ago. It was pretty incredible. It's gone now, of course. There's nothing there now on that sight. It's being "remediated".
38 weeks ago
38 weeks ago Link To Comment
The mystery guests in this classic misadventure in the world of finance are all the savvy investors stupid enough to buy Detroit's junk-rated bonds. Once purchased, there was really no market to bailout ofl the bonds, so now a distinct possibility exists that the return of face value will not happen. Surprise!
38 weeks ago
38 weeks ago Link To Comment
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