Friday, June 21, 2013

Brains: the real vanishing assets in Detroit

In the past week, the emergency manager of Detroit announced a deal that many paves the way to the largest municipal bankruptcy in American history. If you offer ten cents on the dollar, one contact said to me, then creditors might as well take their chances in court. If Mr Orr is trying to engineer a way for the city to relieve itself of debts that will continue to cripple the city and drive away people and jobs.

I had an email conversation with Don Grimes, an economist with the University of Michigan. I unfortunately did not have the space to include his interesting thoughts on Detroit's problems within my piece in the print edition this week. Mr Grimes explained that the city was "upside down in terms of the number of employees and the number of retirees who have been promised a defined benefit pension and employer paid health insurance".

He adds: "This is exactly the same problem the domestic auto industry faced. Also, in both cases their market, vehicle sales and the city's population were shrinking (and is forecast to continue to shrink in the case of the city). The biggest difference and maybe the crucial one is that the federal government gave the auto companies a very significant amount of money. The companies paid a lot of that back, but they would not have been able to avoid liquidation without the government money. Will somebody backstop the city? If not then the haircuts to the pension and health care benefits will have to be much larger than the UAW retirees"

With regards to the future of Detroit, he makes a crucial point. "The main difference between the city of Detroit and economically successful cities including Chicago, Minneapolis, Boston, New York, Seattle, Denver and so forth is that the educational attainment of the residents of the city of Detroit is much much lower. In Detroit about 12% of the population aged 25 and older has a bachelor's or more education. In these successful central cities the proportion of the population with a bachelor's degree or more is much higher, 30%, 40%, and in some cases over 50% of the population."

Mr Grimes sent me a spreadsheet  with data from the American Community Survey, showing the percentage with a bachelor's degree of people between 25 and 64 in US cities. This age range reflects the prime working age population. (He says the data is even worse for young adults between 25 and 34.) If you chart it out it looks like this. The results are pretty grim news for Detroit. Each vertical line from left to right is 10%, so on this chart Detroit is 12.5%, Las Vegas is over 20%, and Sacramento City, California sits on the 30% line (close to the US average).

Here is the chart for cities at the other end of the spectrum, with Seattle and San Francisco sitting at the top of the graduate league. Chicago, at 35.9%, and New York, at 36.3%, just got cropped out of the screenshots of the data. (I couldn't figure out how to import an Excel chart into the blog.) So the problem is not simply that the population in the city has declined in recent times, it is that all the people with degrees seem to have left.

I'll finish with a link to this week's piece in The Economist.

Saving Detroit 

Iron Orr 

The city’s default spells pain for creditors, employees and residents 

Jun 22nd 2013 | CHICAGO |From the print edition
IT IS, says the man who has to deal with it, “the Olympics of restructuring”. After decades of population decline (see chart), political bungling and corruption, Detroit, once America’s third-largest city, now needs an emergency manager to save it. In March the state of Michigan appointed Kevyn Orr, a bankruptcy lawyer (pictured), to the unenviable job. In May, to no one’s surprise, he declared the city insolvent. Its ability to borrow was exhausted after years of issuing long-term debt to pay its bills. The city has liabilities of more than $17 billion, or $25,000 for everyone who lives there. Residents can escape these debts simply by moving away; many have done just that.

On June 14th Mr Orr announced a moratorium on the repayment of all unsecured debt, starting with a $40m payment due that day. To many, this sounded like a default. He offered to pay some creditors a paltry ten cents on the dollar. At the same time, a report to creditors set out the scale of the problem. Property-tax revenues have fallen by almost 20% over the past five years as homes in Detroit have lost value. Unemployment has led to a 30% decline in income-tax revenues since 2002. High tax rates are already speeding the exodus of taxpayers, so there is little scope to raise them further. In any case, many of the taxes to which the city is entitled are not being collected properly. [More...]

Updated: Corrected title of Don Grimes, June 24th.

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