A federal judge ruled on Tuesday that Detroit could proceed into bankruptcy and cut pensions to address its fiscal woes.
U.S. Bankruptcy Judge Steven Rhodes affirmed that the Motor City was indeed insolvent and certified that it could move forward with plans to eliminate nearly $20 billion in debt. Half of that shortfall comes from the city’s defined benefit pension system, which was designed to guarantee workers a portion of their salary for life.
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Rhodes said Detroit must provide a pension haircut in order to address the budget deficit.
"It has long been understood that bankruptcy law entails the impairment of contracts," Rhodes said, while pledging that he "will not lightly or casually exercise power […] to impair pensions."
Rhodes overruled an earlier state court decision that pensions could not be cut. The ruling is a step forward for the city, which is now under the control of Emergency Manager Kevyn Orr.
Orr and Judge Rhodes will play complementary roles in the recovery. The emergency manager is able to sell assets but unable to make needed cuts to the pension system, while the court will be able to cut pensions but does not have jurisdiction over asset sales.
Mike LaFaive, a fiscal expert at the Mackinac Center for Public Policy, said that the pair’s decisions will affect everyone from retirees to investors and city residents. Rhodes’ balanced approach to cuts could embolden Orr to privatize or contract out city resources—policies that LaFaive has been calling for 13 years.
"The decision might mean bolder strokes by the emergency manager to generate and save resources and lessen the haircuts to pensioners and bondholders," he said. "We hope that the judge and emergency manager avoid giving deep haircuts to pensioners and bondholders by using competitive contracting for services."
LaFaive said that the city could avoid painful pension cuts if it outsourced some police services to neighboring Wayne County or sold the city’s water department, which he said would generate millions in savings.
"Competitive contracting is a superior tactic than deep cuts," he said.
Orr said he was pleased with the decision, pointing out that 40 percent of tax dollars go toward retiree payouts and could rise to 65 percent in the near future.
"I would ask both of our creditors, none of whom filed objection to our eligibility, but equally our labor partners to come forward and take this opportunity, even in the process of litigation and appeals, to try to get at the sorely needed reform that this city has got to achieve so we can move forward into a new day," Orr said at a press conference following the ruling.
Mayor David Bing called the bankruptcy "inevitable" in a press conference following the ruling and acknowledged that the city should have addressed its multi-billion dollar debts earlier.
"We have wasted a lot of time […] there was no way we were going to solve the long-term liabilities and debt on our balance sheet," he said. "There is going to be pain for a lot of different people, but in the long run, I think the future of the city will be bright."
The city’s largest unions have already filed an appeal challenging the decision, according to the Detroit News.
"We think this is a huge loss for the people of Detroit," Sharon Levine, American Federation of State, County and Municipal Employees, told the newspaper.
Bob Williams, president of State Budget Solutions, said that the city’s decision will serve as a warning sign to other governments that are mired in debt and would better serve Detroit residents.
"From pensioners to bond holders, Detroit’s bankruptcy will require sacrifices made by all," he said. "But the alternative – a city so riddled with debt it is unable to meet the basic needs of its citizens – would be far worse."
Vincent Vernuccio, a pension expert with the Mackinac Center, said Rhodes’ ruling could prove a bellwether decision, as cities and states, such as Illinois, work to address multi-trillion dollar pension deficits.
"The judge is sending a message that it’s a myth that defined benefit plans provide guaranteed income with no risk and that nothing can be done to affect them," he said. "This is going to send shockwaves throughout cities teetering on the brink."