Detroit Bankruptcy: Why the Emergency Manager Powers Were Insufficient

According to the Manhattan Institute, Michigan has the most comprehensive policy for addressing and alleviating municipal fiscal stress. But it wasn’t enough to prevent Detroit from going bankrupt.

That is because properly understood, the purpose of Michigan's emergency manager law is to enact structural reforms of city operations. Only a federal bankruptcy judge has the power to reduce a city's debt.

In June, Emergency Manager Kevyn Orr laid out his plan to bring fiscal and administrative reform to Detroit. He proposed major improvements to nearly every city operation. But Orr's main focus was on addressing what he termed the city's long-term legacy costs, payments on some of the city's general obligation debt, the funds it borrowed to pay pension contributions, and pensions and retiree health insurance.

According to his projections, without restructuring, those costs are expected to increase from $477 million to $672 million in the next five years, ultimately consuming almost 2/3 of operating revenues.

Orr argued that given the economic situation of the city no amount of reform would enable Detroit to pay this debt back in full. But his request for relief on some of the city's debts was large — nearly 90 percent from some creditors. While there would be an unknown amount that might come in from asset sales, any revenue increases, or positive variances from the plan that could be used to pay those obligations, the situation was bleak.

Had all of Detroit's creditors agreed that Orr's plan was fair and the best chance they had, the city would have had a way out. But this was not so, as illustrated by the lawsuits filed by creditors after his proposal was made, and the bankruptcy filing itself.

Still, even without the consent from all creditors, Orr should be able to reduce some of the city's long-term obligations outside of bankruptcy. The money the city borrowed to make pension contributions contains pretty weak repayment provisions.

And, outside of a settlement made with some retirees in 2006, Orr should be able to reduce retiree health care obligations. But general obligation bonds are protected by the city's "full faith and credit," and pension benefits are guaranteed by the state constitution. Only a federal bankruptcy judge is likely to be able to do much about those payments without agreement from creditors.

Orr already is making headway on the city's operations. But he proved unable, outside of bankruptcy court, to pay down the city's long-term obligations under the agreed upon payment schedules.

The final option in Michigan's emergency manager law is to allow the emergency manager to file for bankruptcy. It's unfortunate that Detroit proved too far gone, fiscally speaking, to avoid bankruptcy, but the law is working as intended.