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Detroit's Promising Lesson for America's Failing Cities

Bill Pugliano / Getty Images

Detroit, once known as the home of the Model T, might soon be known as the home of the Model Bankruptcy. Over the course of the past 14 months, philanthropists, private corporations, the city and the state have hammered out a grand bargain to serve as the centerpiece of a plan that will eliminate $7 billion of the city’s $18 billion in debt. Now, the only hurdle left for Detroit to begin exiting bankruptcy is to prove the legality of its complex arrangement to one man, Judge Steven Rhodes. The trial, which begins Tuesday, will set the script for municipal bankruptcies across the country. If Detroit gets its way, the precedent will be a promising one.

The grand bargain began with a chance conversation in a downtown deli between Detroit federal judge Gerald Rosen and Mariam Noland, the president of the Community Foundation for Southeast Michigan. What followed was the creation of a coalition of philanthropic leaders from the Kellogg Foundation, Ford Foundation, and others. Together, the non-profits—many of them based outside of Detroit—pledged more than $300 million, and the Detroit Institue of Art and State of Michigan pledged $100 and $195 million, respectively. The total pile of $816 million over twenty years would reduce much of the cuts aimed at municipal retirees’ checks. Meanwhile, the Detroit Institute of Art, which had been in jeopardy as bondholders pushed for its art to be appraised for possible auction, would be spun off into a charitable trust, safe from bankruptcy cuts. The deal’s most vocal opponents are bond insurers like Syncora that are slated to receive as little as six cents on the dollar back.

But critics of the grand bargain should take a look at the fate of formerly bankrupt cities like Vallejo, California. The San Francisco Bay area city, which exited bankruptcy almost three years ago, left its pension obligations untouched because taking on the California retirement system, CalPERS, in court would have been too expensive and time-consuming. Now, Vallejo continues to face a budget crisis as its pension obligations grow ever larger each year. This year, retirement obligations could eat up as much as 26 percent of the struggling city’s budget.

Vallejo isn’t the only city: Most cities that are facing financial crises, like Providence, R.I., are watching huge portions of their budgets evaporate on account of unrestrained pensions. Famously, one retired Providence chief firefighter rakes in almost $200,000 in a year. Without reasonable cuts to retirement obligations that grow with quality-of-life increases each year, a city would be hard-pressed to exit bankruptcy in a better financial place.

Pensions have long been protected by federal and often state law, and Detroit’s plan to dip into promised retirement funds could change the way cities muddle through bankruptcies. In December, Judge Rhodes ruled that pensions would be treated just like any other contract in a Chapter 9 municipal bankruptcy, despite the protections written into Michigan’s Constitution. The Detroit pension funds immediately filed an appeal in federal court, but after the grand bargain was approved by its members, it asked the court to indefinitely hold off on the trial. It’s a decision that undoubtedly made the California pension behemoth CalPERS boil.

Bankruptcy is never pleasant. It’s a messy game of deciding who will earn pennies on their dollars, and who will earn nickels or dimes. City services must be trimmed back, taxes must rise, Wall Street must see a diminished return (on what was clearly a bad investment), and pensioners must see their monthly checks take a hit. But as cities across America watch pensions skyrocket and threaten to push them into bankruptcy, the Detroit bankruptcy trial may herald a positive change. The pension groups’ willingness to place their benefits on the butcher’s table means that future trials will likely follow suit, creating bankruptcy exit plans that will help cities balance their budgets in the long-term. In a city that is so famous for failure, this bargain may be Detroit's greatest success since the GM bailout.