A resource guide for students, educators, researchers, Michiganders, and everyone else
by James L. Tatum III
What does it mean for a city to be bankrupt?
On July 18th, 2013, the City of Detroit went bankrupt. For most, to say a person, business, or city is bankrupt is to say that they’re broke. Detroit was broke, but bankruptcy meant that the City subjected itself to a process outlined in Chapter 9 of the U.S. Bankruptcy Code. Researchers interested in the Detroit’s bankruptcy would do well to read “Municipal Insolvency: The New Chapter IX of the Bankruptcy Act” by Lawrence P. King before they delve into the case (1977). In the article, Mr. King answers the above question, “what does it mean for a city to be bankrupt?” His article is divided into six parts: The Requirements for Relief, Procedure Under Chapter IX, The Effect of Filing a Petition, The Filing Process, Approval of the Plan, and Dismissal of Case. The reason that Mr. King’s article is important is that while the Detroit News and Detroit Free Press covered the case, and provided readers with much detail, to better understand case documents researchers have to understand the law.
For those inexperienced in public finance, a Congressional Budget Office report titled, “Fiscal Stress Faced by Local Governments,” is a starting point (2010). The report includes information about the basic duties of municipalities, how their operations are funded, and how the Great Recession has strained state and local finances. Also, there is additional information on municipal bankruptcy. The report is short, and is perfect for the layman, while still useful for those more familiar with public finance.
Understanding how governments are financed is necessary to understanding the City’s case. Detroit used a number of debt instruments – municipal bonds, financial derivatives, certificates of participation – in order to fund its operations, and obscure deficits prior to bankruptcy. These debt instruments are contracts, and in bankruptcy contracts are broken. Out of the City’s thousands of creditors, the matter of who would be paid, how much they would be paid, and who wouldn’t be paid at all was decided. To understand why this or that contract was subverted, while others were honored, researchers must understand at least the base elements of public finance. For more information on the different kinds of debt instruments used by municipalities, and how those debts and liabilities are treated in default, researchers are directed to read “The Insolvency of Public Entities in the United States” by Fred L. Morrison (2002).
To understand how Detroit went broke, researchers should read the aptly titled “How Detroit went broke” by Nathan Bomey and John Gallagher of the Detroit Free Press (2013). The article is in effect a briefer version of “The Origins of the Urban Crisis” by Thomas Sugrue, which is also a worthwhile read, and is perhaps the most important work on urban decline written in the last decade (2005). The two newspapermen provide context, and illuminate which may not be discernible from numbers alone. Of course, researchers can look at City audits for numbers, and in fact that is what Mr. Bomey and Mr. Gallagher did, but their article synthesizes and creates a story out of those numbers.
There are a number of primary documents, documents directly from the case that can be accessed online that are especially useful. These documents are as follows, the first is a letter written by Kevyn Orr, the Emergency Manager of Detroit, to Gov. Rick Snyder in which he request that the City be allowed to file for bankruptcy. Second, is the eligibility ruling by Judge Steven Rhodes, who presided over the case. The eligibility ruling determined the City’s ability to adjust its debt under Chapter 9; further legal arguments are made clear here about a number of topics, such as pension obligations and the constitutionality of Chapter 9. Third, is a document known as a disclosure statement. The purpose of a disclosure statement in bankruptcy is to allow the debtor to communicate to its creditors how it became insolvent, the measures it took to prevent its insolvency, the failure of those measures, and details of its current financial condition. This document from the case is especially important and contains a tremendous amount of data.
The City’s disclosure statement is an extensive document, and the sections which should be read in detail are: The Plan, Means of Implementation of the Plan, Events Preceding the City’s Chapter 9 Case, The Chapter 9 Case, Reinvestment Initiatives. Because of the disclosure requirements incumbent upon the filer in a bankruptcy case, Detroit was forced to provide information that previously was either unobtainable or obscure to outsiders. Also, there are so many issues involved in the City’s case that without the disclosure statement researchers will be lost.
Fourth, is the confirmation ruling by Judge Rhodes, which confirmed the Detroit’s plan to exit bankruptcy. These documents can be found online with relative ease, either on the City’s website, the website for the U.S. Bankruptcy Court for the Eastern District of Michigan, or through the federal registry or Public Access to Court Electronic Records (PACER) system which allows access to documents from federal cases for a fee.
The two issues which attracted the most attention were the ability of pension obligations to be impaired in the bankruptcy, and the monetization of the DIA’s art collection. Pension obligations aren’t debt instruments, but they are contracts that, evinced by the City’s case, can be broken under Chapter 9. Prior to the case, it was assumed that pension obligations were sacrosanct due to language in the state Constitution. “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby,” says Article IX, Section 24 of the Michigan Constitution. The treatment of pension obligations and other labor contracts can be better understood with “Who Does Bankruptcy? Mapping Pension Impairment in Chapter 9” by Vincent S. Buccola (2014).
Researchers particularly interested in the minutia of the “Grand Bargain,” beyond the fact that the art collection was saved, and that the city’s pension funds received a cash infusion should read “From Chrysler and General Motors to Detroit” a working paper by David A. Skeel. Mr. Skeel is a professor of law at the University of Pennsylvania, and an expert in bankruptcy law. His article discusses how the Detroit was able to shield the DIA’s collection from a fire sale, how the sale was orchestrated to only include one bidder – the bidder the City wanted, and how the proceeds of the asset sale were kept away from other creditors and diverted to city retirees.
Only recently, did the City’s case come to conclusion. Therefore, there are a limited number of expositions on the topic. Researchers haven’t had the time to look at all of the data and analyze the effects of the case on the City’s balance sheet – or the effects beyond the balance sheet. It is up to intrepid researchers such as those who have visited this site to slowly fill in the sketch. This is to be done not only for the pure pursuit of knowledge, but so that such a disaster can be prevented in the future.
Bomey, N., & Gallagher, J. (2014, September 15). How Detroit went broke: The answers may surprise you – and don’t blame Coleman Young. Retrieved from Detroit Free Press: http://archive.freep.com/interactive/article/20130915/NEWS01/130801004/Detroit-Bankruptcy-history-1950-debt-pension-revenue
Buccola, V. S. (2014). Who Does Bankruptcy? Mapping Pension Impairment in Chapter 9. Review of Banking & Financial Law, 585-608.
City of Detroit, Michigan, Debtor, 13-53846 (U.S. Bankruptcy Court, Eastern District of Michigan December 11, 2014).
Congressional Budget Office. (2010, December). Fiscal Stress Faced by Local Governments. Retrieved from cbo.gov: http://www.cbo.gov/sites/default/files/12-09-municipalities_brief.pdf
King, L. P. (1976). Municipal Insolvency: The New Chapter IX of the Bankruptcy Act. Duke Law Journal, 1157-1175.
Morrison, F. L. (2002). The Insolvency of Public Entities in the United States. American Society of Comparative Law, 567-579.
Office of Emergency Manager. (2013, July 16). Recommendation Pursuant to Section 18(1) of PA 436. Retrieved December 6, 2013, from michigan.gov: http://www.michigan.gov/documents/snyder/Detroit_EM_Kevyn_Orr_Chapter_9_Recommendation_427831_7.pdf
Skeel, D. (2014). From Chrysler and General Motors to Detroit. University of Pennsylvania, Working paper.
Sugrue, T. J. (2005). The Origins of the Urban Crisis: Race and Inequality in Postwar Detroit. Princeton: Princeton University Press.
James L. Tatum III is a native of metropolitan Detroit, and an alumnus of Eastern Michigan University where he studied state and local finance.