The Great Unraveling

The Great Unraveling began this week, near Detroit (they moved the meeting to head off protestors), kicked off by Kevyn Orr:

Detroit will immediately stop payments on about $2 billion in debt, the city’s emergency manager announced Friday, an effort to conserve cash. The manager, Kevyn Orr, also said Detroit will need to cut pay and pension and health benefits for city workers.
Debt holders are likely to get only pennies on the dollar.
“Financial mismanagement, a shrinking population, a dwindling tax base and other factors over the past 45 years have brought Detroit to the brink of financial and operational ruin,” said Orr.

This article then goes on to name what happend to Detroit, caused by mismanagement and fleeing of their most productive resources, noted above:

“The city has effectively exhausted its ability to borrow,” he writes in the report, adding that the city “is clearly insolvent.”

INSOLVENT is the key word to understanding what happened in Detroit, and what I believe will soon happen across cities in dire situations across the USA. Insolvent (in practical terms) means that 1) you don’t have enough cash revenue coming in to pay your current bills such as salaries on current staff, pension contributions, payments to vendors, etc… 2) you have already accrued substantial borrowings to date that need to be either paid off (not a chance of that) or re-financed through even more debt (the route that has been taken to date) 3) there is no practical chance that you can find enough revenues to get current on your bills and make a substantial, good-faith “dent” in the backlog of debt that you’ve piled up over the years.

Over many years cities, states, counties and other non-profit entities have piled on debt to avoid raising current taxes and to placate their staff’s demand for higher pay and current benefits. They also promised benefits in the future such as pensions, medical insurance, and the like which don’t exist anymore for many / most citizens employed in the private sector. They failed to pay in advance (pre-fund) those obligations, as well. Meanwhile, many of these cities, plagued by dis-functional government, crime, rising taxes, and a low quality of life, saw an exodus of their most productive citizens, those upon whom the “real” burden of servicing these current obligations and long term debt really lie.

Unlike the United States as a whole, which can capture its citizens’ revenues anywhere within its borders and around the world (there are relatively few that give up US citizenship), cities, states and counties can drive out their productive staff and then the increasing burden of paying for mounting debts will fall on a shrinking (financial) base. Detroit can’t burden those that have escaped; not only has their population fallen, their highest-income citizens fled long ago and have no plans to return (why would they come back to pay the bills of a city that they would no longer recognize?).

Amazingly, the municipal debt market, which has funded these insolvent cities all these years at relatively low interest rates (given the facts that many of these entities are insolvent in practical terms), hasn’t taken an enormous hit yet. While plans are not finalized, Detroit is in essence offering pennies (less than 10 cents) on the dollars for their unsecured bond-holders (they do have some debt tied to utility revenues and other revenue sources which has its own economics). The municipal debt market probably doesn’t really believe, nor do I really truly believe, that the whole worm-infested edifice is about to come down now. In the past there have always been last minute bailouts, subsidies, “insurance” on bonds (with the tiniest of real-world cushions), etc… to prevent the collapse that economic sense says has been coming for years.

Another thing to note in Orr’s statement is that he plans to not only 1) stiff the creditors 2) INVEST in the city to increase the level of policing, infrastructure, etc… Cities and states are run by politicians. The odds that a city would shut schools while paying off creditors should strike anyone with a bit of political sense as incredible. Creditors don’t vote – if it came down to it, why would you put them ahead of your own political survival, especially when your opponent in the next election would just do the same thing, anyways?

The heart of the matter is that all of this Ponzi scheme depends on everyone “pretending” that the problem isn’t there and that somehow, someway, these minor moves of short term cash and budget tricks can put the wolf off forever. But the wolf is here now, and anyone who lends new debt money to these sorts of entities might as well just throw their money into a disposal and expect to get a few pennies out the other side.

Not to sound too “black helicopter” but the super-smart money might be betting that the federal government will bail out the states and cities and make all the creditors whole, to keep the illusion running a bit further. This definitely strikes me as plausible, irrespective of all the supposed Constitutional guards that prevent this from happening. A huge percentage of the funding for states, cities, and counties comes from the US government anyways – perhaps at some point we stop pretending that we will let them fail on their own (and destroy the political “minor leagues” that end up in Washington, in the end) and just backstop everyone’s debts on the US dollar.

Kevyn Orr is calling everyone’s bluff. Maybe this will be the second great accomplishment of our current presidency, stopping the “pretending” that there is any fiscal accountability with real consequences anywhere in the USA. The first accomplishment was the stone acknowledgment that Social Security /Medicare is just a “pay as you go” system of taxes when he cut the tax rate to supposedly spur job creation at a time when the actuarial numbers actually called for higher contributions.

Cross posted at LITGM

9 thoughts on “The Great Unraveling”

  1. A few thoughts:

    – Anyone who loaned money (via bond purchases) to Detroit in the past, say, 30 years deserves exactly what they get.

    – I’m not sure if muni bond investors will get bailed out. The primary holders of muni debt are high net worth individuals and insurers – not the most sympathetic claimants in the court of public opinion.

    – Did anyone see the Twitter brouhaha a few days back after Virginia Postrel (formerly of Reason magazine) wrote a piece suggesting the Detroit Institute of Art sell some of its pieces to shore up its balance sheet (and also to place the art in growing, rather than dying, cities)? Multiple accusations of racism on Ms. Postrel’s part; ALL of which were from white people.

  2. True but Detroit is merely the canary in the coal mine, kind of the “poster child” for urban dilapidation and mismanagement.

    There are many many other cases that are circling the drain including entire states potentially like Illinois.

    The issue isn’t so much “screwing” today’s muni bond sellers (the people that loaned money to Detroit over the last 30 years) is that once we “screw” them, no one in the FUTURE will loan money to these cities.

    If the cities had to attempt to even meet today’s cash obligations (no to mention any sort of contributions towards future obligations like pensions) without assistance from muni bond sellers many, many would be insolvent in minutes.

    This is the “real” great unraveling.

    Detroit is just a pioneering case.

  3. Detroit is a particularly ugly example, but there are a lot right behind it in line.

    This: “Not to sound too “black helicopter” but the super-smart money might be betting that the federal government will bail out the states and cities and make all the creditors whole, to keep the illusion running a bit further.” It would be hard to do this. Would the congress do this, where most of the legislators are from states that are not in need of a bailout? How could they justify it to their voters?

  4. We moved as the Spirit* listed. They* never altered their pace.
    Being neither cloud nor wind-borne like the Gods of th Market-Place.
    But they always caught up with our progress, and presently word would come
    That a tribe had been wiped off its icefield, or the lights gone out in Rome.

    * “Spirit” ….think fashionable, worldly schemeing. “They” think “10 commandments”.

    From Rudyard Kipling’s “The Gods of the Copybook Headings”, the third stanza.

  5. An excellent question – how would the government do this?

    I have no idea. I also had no idea that the government could take over GM and Chrysler and give a lot of the remaining equity to the united auto workers. I didn’t know that they could force banks to take billions that some of them didn’t want.

    The government today comprises a lot of the budgets of various entities. Maybe they set up a special funding mechanism for distressed debt? I don’t know.

    As far as why – that’s easy. The President is a democrat. All these cities and states that are in danger of going under are (almost all) in blue states, right in the heart of his power base.

    Can congress stop them? Maybe. Don’t know. The house could be split by state – for instance if Illinois starts to go down you’d have all the dems and even some of the republicans trying to keep it afloat.

    States rights are way in the toilet nowadays anyways. Look at the health exchanges. If the federal government is providing a lot of your revenues it is suicidal to fight them, although some will.

    But this is pure speculation. Likely it will take more than just Detroit. But who the heck really knows.

  6. Sounds easy to me. I think the US will backstop the states. And, I think that they would backstop the cities as well, if they were begged. Even Ford, with his famous “Drop Dead” headline in the NY Post, signed the legislation to give NYC federal loans.

    A difference in kind, not even in degree.. we can have zombie cities along with zombie banks and zombie corporations and zombie government departments. Cleveland.. “We’re not Detroit!”

  7. carl from chicago Says:
    June 15th, 2013 at 7:10 pm

    An excellent question – how would the government do this?

    If the regime goes the total bailout track [not sure if they will, but it seems likely] it will be absolutely bi-partisan. The most reasonable explanation for the collaborationist conduct of the Institutional Republican party, and of the Chief Justice of the United States Supreme Court is probably to be found in the revelations over the last couple of weeks of massive and all-encompassing government spying on the American people. Those politicians who cannot be bought [a miniscule fraction mentioned just for the sake of completeness] can be blackmailed. Or a combination.

    The question is, if the Federales bail out the Leftist cities and states who are in reality down the drain, it will have to be with literally trillions of fictional dollars created by the Federal Reserve fairly instantaneously. Which even the Fed and St. Buraq Hussein [PBUH] cannot prevent from being noticed by the rest of the world. And the sudden resulting worthlessness of the dollar kind of negates the whole exercise, along with the country. So how do they plan to try to finesse that!?

    I’m pretty sure that the end of the Republic is nigh anyway. At least this way it will be quick.

    Subotai Bahadur

  8. You may recall there was already a bailout of Washington, DC. They did have to forfeit control of finances though. A Financial Control Board was put in charge by Congress and Anthony Williams did a reasonably good job of getting things more in control. But Marion Barry is back in District Government and the rest of them are just as bad so they will probably be back in the same pickle shortly.

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