Why the federal government should help bail out Detroit

By Allison Schrager
June 2, 2014

detroit101

Starting last month, and continuing through July, Detroit’s 170,000 creditors will vote on the terms of the “Grand Bargain” that will end the city’s bankruptcy.

Different groups are contributing to the deal: the state of Michigan, the city of Detroit, as well as philanthropic organizations including the Knight and Ford foundations. They’ll either contribute money or reduce salaries of city employees, in order to restore Detroit’s solvency and ability to pay its retirees.

So far, absent in the bargain is support from the federal government. On April 24 Treasury Secretary Jack Lew visited Detroit, raising hopes that a $100 million bailout from the government would materialize. The money would come under the category of “blight eradication,” a pre-existing federal program designated for urban renewal. The federal government is careful to avoid setting a precedent of bailing out state or municipal pensions because it doesn’t want to take on a massive liability and, in doing so, encourage local governments to make more unsustainable promises.

This is a mistake. The federal government should use Detroit as an opportunity to take a more active role in state and municipal pensions. Unless the American economy experiences unprecedented growth, future federal bailouts of state and municipal retirement benefits are inevitable. The more likely scenario of low or normal growth will make these retirement benefits a burden to all taxpayers, regardless of where they live. At some point the federal government will inevitably be stuck with the tab, either from increased political pressure or from states gaming existing federal programs.

detroit555The sooner the federal government acts, the lower the cost to taxpayers because the financial hole will only get bigger. In both the mortgage and European debt crises, the world saw how much damage an unacknowledged, but expected government guarantee can cause. Debts became unmanageable and creditors looked to the central government for bailouts. The lack of clarity caused uncertainty and wreaked havoc on financial markets. Rather than staying on the sidelines or engaging in backdoor bailouts, this time the federal government should take a more active role in shoring up state pension finances.

The problem is dire. Retiree benefits — both pensions and healthcare — will become increasingly expensive to provide, and strain state and local governments nationwide. According to a task force chaired by Richard Ravitch and Paul Volcker, in the future many states and municipalities will probably have to choose between services for other taxpayers (like schools, roads and safety), paying benefits, or significantly raising taxes. Even if pension assets earn their expected 8 percent return each year, says economist Josh Rauh, by 2025 20 states will run out of money, and there will be even more financial strain at the local level.

The federal government may claim, as it is in Detroit, that it is not on the hook for local retirement benefits. But it is, for both political and financial reasons.

When more state and local governments run into trouble, the federal government will feel political pressure to step in with financial support. Large benefit cuts expose state employees to hardship when they are most vulnerable and no longer able to work. The prospect of unionized state workers impoverished in retirement is politically untenable.

Existing federal programs, like Social Security and Medicare, already use federal tax dollars to support eligible state workers. The city of Chicago is phasing out its healthcare coverage by moving its non-Medicare retirees on to the new healthcare exchanges, created as part of the Affordable Care Act. Depending on the size of their pension benefit, many retirees will qualify for federal subsidies to buy insurance. By moving retirees on to the exchanges, Chicago expects to save $18 million this year, including the savings of discontinuing Medicare subsidies. The move shifts much of the city’s healthcare costs to the federal government.

The federal government can avoid this type of large, unexpected cost by getting more involved in state pensions now. In the private sector, the Pension Benefit Guaranty Corporation — a quasi-U.S. government agency that is technically independent — insures corporate pensions, paying employers a large fraction of their promised benefit if their company goes bankrupt. In exchange for that guarantee, corporations are subject to more stringent accounting standards and insurance premiums. There is no such insurance for state and local pensions, but there should be, because it would force states and municipalities to pay for that implicit federal guarantee.

A less radical alternative involves tax subsidies. The government could start to enforce more sensible accounting standards and offer states and municipalities the option of issuing tax-advantaged bonds, where the proceeds would fully finance pension and healthcare liabilities.

With either of these options, the federal government would fulfill its obligation to state and local workers — and give Detroit and other struggling American cities the help they deserve.

PHOTOS: Detroit city worker Geraldine Gilmore rallies against cuts in their city pensions and health care benefits during a protest against the city’s municipal bankruptcy filing, outside the Federal courthouse in Detroit, October 23, 2013. REUTERS/Rebecca Cook

A message is displayed on a fence in Detroit, October 25, 2013. REUTERS/Joshua Lott

36 comments

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I, as a taxpayer, do not want to bailout the attempts of corrupt politicians to buy votes with unsustainable, asinine pension plans.

Posted by cpa17 | Report as abusive

Please. “Large benefit cuts expose state employees to hardship when they are most vulnerable and no longer able to work. The prospect of unionized state workers impoverished in retirement is politically untenable.” Says WHO?

Union privilege and greed combined with municipal incompetence to create this perfect storm. Welcome to the real world. We, the people, by and large AREN’T UNION! We do what we can for what we can get. Don’t turn to us to protect your fat lazy butts! Suck up the swill you created.

Posted by OneOfTheSheep | Report as abusive

Ms. Schrager,
I struggle to follow your logic. You seem to start from the premise that the Federal government will be forced to bail out Detroit. If this was correct, I agree that immediate actions usually cost much less when solving catastrophic systemic failures like this one.
But the premise is false in my opinion.
To support your logic you offer two potential outcomes. One is that political pressure will be greater than the risk of moral hazard; which everyone knows it’s only a hazard so long as there is a Federation in the US. If there was no separation between national and local governments, then all debts would be on the shoulders of the Federal government. But while many wish to see the Federal government grow its influence until there are no more state or local powers, such is not how our present system works and will probably take much more than a Detroit to change. So, local governments will have to continue to be accountable to their local constituency and, when they fail, the Federal government will have to respect its legal place as mostly an observer and sit on its hands.
The second outcome you offer is that, since local governments will divert existing funds away from their present use and towards their pension needs, we should just give them the rest. This one idea is perhaps the weakest argument within your thesis. I see no reason why all local governments would not already game the system. I therefore see no more than a fractional increment as potentially available. I just don’t see why a bank should call bank robbers back to give them the money they didn’t take.

Posted by JustProduce | Report as abusive

I vehemently disagree with this article. Eternal vigilance is the price of freedom. Those who flagrantly abuse their freedom should pay the price. The voters of Detroit put in office people who did not deserve their support and who bankrupted the city. Let these same voters–and the courts–sort out the mess they created. Detroit’s bankruptcy will sharpen up analysis in the municipal bond market and scorch some banksters and union leaders. Bernanke is gone, and it will be difficult to characterize Detroit’s IOUs as “Troubled Assets”.

Posted by sixfathom | Report as abusive

The author strongly supports a federal bailout of Detroit’s pensions. Careful reading of the author’s article shows that he is unable give a single reason to do so.

Posted by QuietThinker | Report as abusive

“the sooner the federal government acts, the lower the cost to the tax payer…”
I have a different opinion on that statement that won’t cost us a dime.

Why is it always someone’s idea that when they find a “turd in the punch bowl”, the solution is always “We need more punch”??

Posted by Deternam | Report as abusive

Great article

Posted by Reb_at_Acumen | Report as abusive

Detroit should get the same aid that NYC got from President Ford, the 2 words: “Drop dead”.
NYC managed to get back from the brink, even though it really began happening only after election of a Republican Giuliani in a Dem stronghold NYC is.
If Detroit manages to dig itself out of the hole – good for them. If it drops dead – at least Hollywood will get a backdrop for shooting post-apocalyptic flicks. But throwing good money after bad is not a solution. The taxpayers are NOT and should NOT be held responsible for years of mismanagement, corruption, and pondering to electoral base by generations of Detroit politicians.

Posted by Nagant | Report as abusive

@Taggert,
I know that you are not saying that Federal taxes are higher for blue states than for red states. Last I checked, they were all the same. What does change is local and state taxes. Those are both, (1) much higher in blue states and (2) are certainly not donated to neighboring states.
That’s it. It takes just one paragraph to see that blue states do not subsidize other states but do spend more on their own problems.

Posted by JustProduce | Report as abusive

So,politicians get elected by promising people unsustainable benefits in return for generous campaign contributions, THEN, when the system falls apart, you want MORE money from me. So, the politician is rich and retired, the government worker is rich and retired, and I’m stuck paying for it all? No thank you.

Posted by DaGov | Report as abusive

If you passed a law that said that states could only recieve in federal benefits what their citizenry pays in in federal taxes there would be a huge influx of federal dollars to northern states and cities. This would likely be enough to help Detroit somewhat, although I think Michigan is already a federal welfare state because of the massive support for the car industry. The point here is that the south is primarily the welfare states on a per capita basis and it is the taxes of northerners that subsidize the right wing nut jobs of the facist party of the confederacy. You can find spots like detroit that are exceptions, but generally it is the redneck gun toting bible thumpers of the GOP (meaning facist supporters) that recieve the most welfare. Simply check to see who recieves the most federal aide on a per capita basis. It’s a fact, not an opinion. Oh yes, a fact is a thingy that is true whether you want to believe differently or not, an example is “gravity exists” or “the earth is made mostly of iron”. Things like that.

Posted by brotherkenny4 | Report as abusive

JustProduce: The point being made is that Blue states recieve less in federal benefits than their citizens pay in in federal taxes, while red states recieve more in federal benefits than their citizens pay in in federal taxes. Thus the federal benefits recieved by reds states are subsidized by blue states. This is a fact. See the comment above that includes a discussion of facts.

Posted by brotherkenny4 | Report as abusive

If the creativity and credibility of red state leadership is more successful in interpreting applicable rules in their pursuit of available federal funds, that would also explain in full much of the “why” as to the difference in federal funding received. This consideration is one more than a few would much rather ignore.

Posted by OneOfTheSheep | Report as abusive

@brotherkenny4,
Thanks for your reply. Despite faithfully following most US macro data, I must admit my ignorance as I have never come across government data on federal fund flow in and out of states. Do you have a good source for it? Should I look at the Treasury?
I am interested in the standard deviation as well as per-capita data (which is an average). As you know, Six Sigma people often say not to cross a river that is 6″ in average depth.
Thanks again!

Posted by JustProduce | Report as abusive

So what I’m understanding is the writer is saying that the Feds should control healthcare and pensions fully? The Feds should take them all over to balance things out and keep the bills paid? Sounds like state governments are useless and the Feds should control everything important as long as its connected to our money right?

This all sounds a bit UnAmerican to me. But what would I know, I’m just a disabled Veteran who tried to do the right thing for my country. I’m no snake politican or scumbag writer claiming to be some sort of journalist.

Posted by Syanis | Report as abusive

Detroit is an example of a failed corrupt democracy. They should suffer through it on their own so we have a clear example of what not to do!!!

At least they put their crook in jail!!! I am sure others need to go to jail as well/

Posted by michaelryan | Report as abusive