Mike’s Financial Pocket – Let The City of Detroit Go Bankrupt

The big news of last week was Detroit’s Chapter 9 bankruptcy filing, which the Pocket Full of Liberty Team touched on a couple of times as the story broke.

There’s an interesting (though unscientific) poll on Yahoo! Finance that, at the time of the writing of this post, shows that people agree by a near 8 to 2  margin that the Federal Government should not bail out Detroit. This is significant, considering that two of the options are “Yes” and “The government has to do something to help.” The poll currently has over 110,000 respondents.

I am sure that my faithful Financial Pocket readers know how I voted in this poll.

Government intervention does not solve the root problems of financial crises. Intervention may delay an inevitable collapse, but unless serious structural reforms are made, the collapse will simply be bigger and bigger.

This is what we saw happen with the financial crisis of 2008. In response to the 2000 recession (that began under Bill Clinton), the Federal Reserve cut interest rates and continued to do so after the terrorist attacks of 9/11. The cheap money flowed into a new bubble: the housing bubble. This bubble was larger than the tech bubble — as we all know now.

As the financial crisis began in 2008, companies (including the auto industry) lined up for bailouts. These bailouts did not save the auto industry, but merely delayed the inevitable bankruptcy of two of the three crown jewels of Detroit.

The automakers suffered from overcapacity, both in cars and labor, as well as crushing pension costs. The initial bailout did not save the automakers and they filed for bankruptcy. Yet they still have massive pension obligations that are growing daily.

History may not repeat itself, but it often rhymes (to paraphrase Mark Twain).

Detroit should not get bailed out by the Federal Government, because such a bailout would not fix the underlying structural issues that Detroit has.

First of all, pensions and benefits of public employees are protected constitutionally in Michigan. This presents an interesting legal quandary, since the whole point of bankruptcy filings are to impair contracts. We may see that provision to be found unconstitutional under the Supremacy Clause of the United States Constitution.

I think that this is really the only way to “fix” Detroit. The public sector pension shortfall makes it clear that without re-structuring the public sector promises, Detroit will continue to be insolvent.

Bankruptcy only works when all unsecured creditors come to the table and offer concessions. This includes retirees, current employees, and lenders. Without a complete restructuring, Detroit will be in a worse position than it was before it filed for bankruptcy.

A follower of mine, @GeekGirl913 smartly pointed out that NYC’s mere threat of bankruptcy forced concessions across the board:

@ThePantau Yup. People forget to look at NYC history in that regard.

— ProcrastinationChamp (@GeekGirl913) July 18, 2013

New York City, despite its problems, is much better off now than it was in the 1970s.

Concessions across the board is the only way to attempt to fix Detroit. Detroit will be better off in the long run. Bankruptcy is a free market solution to fix personal, corporate, or municipal debt when it’s out of control.

As always, free markets are better markets.

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Financial news for this week includes a slew of earnings from Apple, AT&T, McDonald’s, UPS, Halliburton, and many other companies.

Earnings will comprise the bulk of this week’s news, with Apple being the focus. Economically, UPS is more interesting for me, because it’s an indicator of broader economic activity. If more packages and letters are being sent by businesses, that’s a good thing.

June housing sales and weekly jobless claims are other potential market-moving reports as well.