We’ve followed the decline and further decline of Detroit as a moral tale on the folly of Democrat politics stretching over decades.
But this writer, a portfolio manager at TIAA-CREF, once looked into the abyss of investing in Detroit, and tells of the Hieronymus Bosh-like terrors he saw:
A couple of years prior to Detroit’s bankruptcy filing, I visited the city for an investors’ conference. The financial situation did not look good, but I was determined to keep an open mind, even vaguely hoping it might be a turnaround opportunity.
No such luck. As a chartered bus took us around the city past block after block of abandoned homes, overgrown lots and empty industrial buildings, we peppered the city’s representatives with an obvious question: Why hadn’t the city acted sooner to remove abandoned homes and buildings?
The short answer was that the city didn’t have the money to bulldoze and remove all the abandoned homes on its list. As for the industrial wreckage, so long as the building owner was current on taxes, there wasn’t much the city could do. Could zoning rules or public safety be invoked to force a clean-up of these eye sores? What about foreclosure? After some reluctance, Detroit’s representatives admitted there wasn’t much political backing for that; the city needed the tax revenue more than an aesthetically pleasing building. And it certainly didn’t need more foreclosed real estate.
We returned in time for lunch with the Assistant Treasurer. As we worked our way through the rubbery chicken, he gave us some upbeat financial projections and then told a couple of stories. One was about a closet full of unopened property tax payments found, of all places, in an office of the fire department.
I suppose he thought this would be entertaining, but to a room of financial professionals, that was far from the case. For a city gasping for revenue, to have uncashed, mislaid checks sitting around in closets was like putting a kink in your own oxygen hose. Moreover, in this age of electronics, why hadn’t payments been automated?
Why would anyone invest a nickel in such an economic and political basket case?
The meeting changed my view of Detroit’s ability to fulfill its pledge to investors, even though the bonds were specifically backed by the unlimited taxation power of the city. The City of Detroit was “required by law to levy and collect ad valorem taxes….without limitation as to rate or amount” in order to pay principal and interest on the bonds. This was stated clearly and unambiguously in the Official Statement. It was the strongest language for general obligation bonds across the country.
Oh, so they promised. Well, that would have been good enough for me.
Moreover, this was America’s 18th largest city, with $388 million of highly secured debt outstanding and a total of $562 million of general obligation debt overall, a candidate for the municipal version of “too big to fail.” No city of this size had ever defaulted. Detroit would either raise taxes voluntarily or be compelled to do so before even considering touching the third rail of bankruptcy and violating the sacrosanct General Obligation Unlimited Tax security pledge.
Or so we thought. Detroit filed for bankruptcy on July 18, 2013. Resolution came five months later as Detroit penned an agreement with bondholders, repaying the debt secured by “unlimited” tax revenue at 74 cents on the dollar. The holders of the limited security general obligation bonds got 34 cents on the dollar.
The lessons here are many, and the longer-term implications mostly negative. To our mind, the primary investment lesson is simple: economics trumps legalisms. Yes, the bond contract said Detroit had to raise taxes “without limitation as to rate or amount.” But as a practical matter, they couldn’t really do that. The budget constraints, tax base and infrastructure to capture taxes had deteriorated so much that they could not adhere to their obligation.
Perhaps this is a hint as to how the other 28 other states that allow municipal bankruptcy or have conditions on filings might respond.
If you are one of those investors running to “revenue” bonds–which have secured liens on specific revenue streams or dedicated taxes–as a way to gather more security, you may be missing the point. There may be some psychological comfort in that language, but as Detroit has shown, words sell at a discount in a bankruptcy.
This may have no direct relevance to you, but it has political relevance to us all. Cities and states issue bonds all the time. But wise investors will remember the lessons of Detroit. You don’t go from the fifth-largest city in the nation to the eighteenth—and still falling—without a lot of rot. Your town may not be as rotten as Detroit—no place is—but ask yourself: how many Democrats have been running it, and for how long?
PS: Hyenas fighting over the skeletal remains:
Wayne County is threatening to unravel a breakthrough deal that settled Detroit’s bankruptcy case unless it receives land or more than $30 million — money the city needs to bankroll Detroit’s revitalization.
In a recent bankruptcy filing, Wayne County said it had a deal with the city to demolish the police headquarters and build a jail. The deal between Detroit and Wayne County dates to 1976, but the city dumped it in bankruptcy court last fall, a move that went unopposed by Wayne County until last month.