Detroit filed for bankruptcy Thursday afternoon, becoming the nation’s largest public sector bankruptcy. The move could slash pension benefits to city workers and retirees, and leave bond holders with only pennies on the dollar.
The bankruptcy was filed by Emergency Manager Kevyn Orr and approved by Michigan Gov. Rick Snyder. Snyder said the financial condition of the city left him no choice, and that Detroit could not meet its obligation to either its citizens or its creditors.
“We have a great city, but a city going down hill for the last 60 years,” he said at an evening press conference. He said 38% of the city’s budget is being spent on “legacy costs” such as pensions and debt service, which cuts into spending on city services. He said police take almost an hour to respond to calls, compared to a national average of 11 minutes, and that 40% of street lights in the city are turned off.
“That’s unacceptable,” he said.
But public employee unions are sure to fight the move, charging that the city did not negotiate in good faith and should not be allowed to walk away from obligations made to employees and retirees.
The Detroit Fire Fighters Association said it was “very disappointed” with the bankruptcy filing.
“We are working with other Detroit employees to form a unified coalition to address the financial concerns of Detroit,” the group said. “Detroit’s Fire Fighters will continue to protect and serve during this difficult time, regardless of the economic challenges.”
Orr already halted payments on about $2 billion in debt last month, saying the city needed to preserve its dwindling supply of cash. The city faces total liabilities of about $18 billion. Orr’s reorganization plan calls for cutting $11.5 billion in debt down to $2 billion. That would mean that investors and retirees would receive an average of just 17% of what they are owed. Specific plans for the cuts are unknown at this time.
No major municipal bankruptcy has ever resulted in cuts to retiree benefits, said Michael Sweet, a California bankruptcy attorney.
“It’s relatively easy to blow off a creditor. It’s much harder when it’s people who are the fabric of your community,” he said. “You need a police force, you need a fire department. You’re saying [to them] you’re not worth what you were previously promised.”
Sweet said that case law on whether pensions can be cut this way is very limited, and it could take years for a court fight over such cuts to work its way to the U.S. Supreme Court. Given the poor state of funding for many public sector pension funds nationwide, “it’s a big enough question, that (the Supreme Court) is where it likely will have to go,” he said.
When employees of a bankrupt business lose their promised pensions, the Pension Benefit Guarantee Corp. steps in and provides a minimal level of benefits. But that federal agency doesn’t back pensions in the public sector.
Retirees and city employees say they can’t accept cuts in their pension benefits.