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What are the costs of Detroit’s rise from bankruptcy?

Detroit has emerged from bankruptcy, but the process has been sharply criticized, which could impair its success. Reuters

Earlier this month, we learned that the biggest municipal bankruptcy in history would also be among the swiftest.

The emergency manager for Detroit filed for bankruptcy in the summer of 2013 without a friend in the world. The city’s restructuring plan had no creditor support. The filing was met with hostility from elected city officials and residents. The Michigan and federal governments both ruled out any possibility of financial help.

Fast forward to today: the federal bankruptcy court recently entered an order officially confirming Detroit’s adjustment plan. Poised to reduce its debt by more than US$7 billion, Detroit’s final plan was supported by nearly all its creditors, including bondholders and retired workers. The state of Michigan ultimately put in money (with significant strings attached), as did an array of third-party sources, such as the Ford Foundation. Participants and observers have used revelatory words to characterize this outcome: Remarkable! Miraculous! Unprecedented! Creative!

Will the ends justify the means used to get there? History will be the judge, of both ends and means, but here’s a snapshot of how it looks right now.

The means: short but not sweet

Detroit’s swift trip through bankruptcy was made possible by the confluence of two factors. First, Michigan’s governor, Rick Snyder, installed an emergency manager under a controversial, and possibly unconstitutional, state takeover statute that affects a large percentage of African Americans who live in Michigan. The emergency manager’s limited term created an incentive for a shorter stay in bankruptcy. By its structure, too, the takeover law allows the emergency manager to make more streamlined decisions, operate more quickly than ordinary operations of city government would likely permit.

Detroit Mayor Mike Duggan believes the bankruptcy will help his city return to fiscal health. Reuters

These factors could not have produced a confirmed timetable without the federal judges overseeing Detroit’s bankruptcy exercising a level and type of control unprecedented in the history of municipal bankruptcy, potentially beyond the constitutional boundaries of federal courts. Much of the court’s activity happened behind closed doors, increasing the potency of any anti-democratic critique of Detroit’s overhaul.

Critics usually decry decisions of so-called activist judges made after hard-fought adversarial processes. Less discussed are situations in which the power of the court is enhanced by avoiding litigation and reaching deals, as in this case. As one might expect, the settlement required parties to waive their rights to appeal key issues, such as the treatment of public pensions in bankruptcy. Detroit’s bankruptcy produced a precedent of a different sort: the implementation of judicial oversight that, in ways large and small, affects the timeline for Detroit’s bankruptcy exit and the blueprint for its future.

The ends: not yet time for a victory lap

Will people think the result is worth these sacrifices? Detroit’s restructuring helped make Governor Snyder one of Governing Magazine’s public officials of the year. But what lies ahead is hard to say.

In the corporate context, at least, faster restructuring is associated with a greater likelihood of a return to financial distress. A financial expert appointed by the bankruptcy court, Martha Kopacz, found Detroit’s plan feasible, albeit barely so. She suggested that the speed of the case may have undercut feasibility to some extent.

The negotiated cuts are certainly more modest than the emergency manager’s original proposal circulated before the bankruptcy. Are the savings enough to give the city a fighting chance? Richard Ravitch, a New York politician and businessman tapped first to serve as a behind-the-scenes consultant to the bankruptcy court and then to be a senior advisor to the panel that will oversee Detroit’s fiscal decisions, says that its difficulties are much, much worse than New York City’s in the 1970s. Detroit Mayor Mike Duggan’s task, says Ravitch, is Sisyphean, like rolling a rock up a hill just to have it roll down again.

Emergence from bankruptcy is a breakthrough but just the beginning of a journey to try to conquer problems decades in the making. In addition, the emergency manager and his team put the restructuring plan in place, but elected officials will have to implement it, subject to some oversight by a new financial review commission. Although those officials told the court during the confirmation process that they support the plan, it took barely a business day for fractures to emerge publicly.

Mayor Duggan and Detroit’s Corporation Counsel have been arguing in court and the media that the city cannot afford the professional fees incurred during the bankruptcy if it is to improve services for residents. That argument generates more than a little awkwardness when, just days earlier, the bankruptcy court ruled the city’s plan was feasible.

As for creditor outcomes, no one was immune from sacrifice. Retirees are taking sizable hits, especially to health care. Financial creditors have accepted far less than the face amount of their debt. The creditors getting the lowest return – civil rights claimants, personal injury claimants, lessors and counterparties to contracts the city is breaking – didn’t settle, lacking an organized way to negotiate collectively with the city (an official committee that would have represented their interests was disbanded by the judge in early 2014). These claims are a small fraction of Detroit’s overall debt, but quite substantial from the perspective of the people seeking payment.

It may be years before we know whether Detroit has truly turned the corner. But we can say right now that the methods used to get this far, this fast, were costly in more than money.

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