Can Detroit Come Back Again?

US News

Detroit has weathered so many storms over the past five decades, it seemed the city had nowhere to go but up - and in many ways, that was where it was moving.

But while Detroit's Big Three automakers have been steering their way to a strong recovery, and a revived downtown has been drawing crowds to glittery new shopping malls and sold-out Tigers games, the Motor City itself has run out of options. The city's staggering poverty and shrinking tax base have finally overwhelmed its finances after decades of struggle, culminating in its bankruptcy announcement this week. Because Detroit and its carmakers have made so many comebacks over the years, some expect a revival. But nobody expects a miracle anytime soon.

"It can be a phoenix rising from the ashes now," says Dan Heckman, fixed-income strategist for U.S. Bank Wealth Management. "But it needs to get its fiscal house in order, and it needs to diversify its economy [beyond autos.] It's going to take a long time."

Detroit's bankruptcy comes as no surprise to its business community, which is "hopeful that the city's revival can continue," says George Hill, chief executive of Diversified Chemical Technologies Inc. His company, with four plants inside the city, has remained in Detroit for the past four decades while other employers and hundreds of thousands of jobs have left.

"We are clearly on the cutting edge of something new and different now, and I'm not entirely certain I like what we are going through," Hill says. "But this city has great resources to draw on. Large ones like [General Motors] and small ones, thousands of entrepreneurs and working people committed to the city's success."

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The city needs to draw on the large resources of the state and region, as well as Wall Street and Washington, to move forward, Hill says. "We all share a realization now. Perhaps we all did not do what we could have done. We really need to invest in the people who will stay in the city to make it work like it has in its jeweled history," says Hill, who lives in downtown Detroit and is actively involved as a leader in the city's African American business community.

Detroit's fiscal collapse comes as most of the rest of the country's cities and states rebound from the worst effects of 2008's financial crisis, Heckman says. While urban affairs experts see Detroit as a special case, they think its recent woes have big implications for municipalities throughout the country that are struggling to manage with $3 trillion in municipal bond debt as well as a U.S. pension shortage that Moody's figures to be $4.65 trillion. Indeed, some worry that Detroit could inspire other cities to use the bankruptcy threat or force concessions from unions and in dealing with investor demands.

Following the announcement of what is the largest municipal failure in U.S. history, Republican Gov. Rick Snyder, in a message on the official Michigan website, said, "Let me be blunt: Detroit is broke."

What comes next will be watched closely by city managers, labor unions and bond investors throughout the United States to see who wins and loses as the city tries to repay an estimated $18 billion in debt. Pensions are a relatively small part of the total, but a growing concern for its aging workforce.

More broadly, much of that debt will be expunged as surely as unpaid Siberian bonds in the era of the Russian czars. But the city has already signaled that it will place a high priority on repaying bondholders. Market analysts expected little impact from Detroit's well-previewed fiscal failure on the municipal market. Indeed, the bankruptcy filing may be welcome news to investors of Detroit debt who had been offered as little as 10 cents for each dollar invested in the negotiations leading up to the filing.

[Read: What to Expect From Bond Mutual Funds in 2013.]

"Historically, municipal bondholders have held a very senior position in bankruptcies," Heckman says. "The city has to makes sure now that bondholders are treated fairly because when it comes out of bankruptcy, it will want to access capital markets. It can't be overly punishing to them if it wants to be in good standing."

The likely losers are the city's workers, firemen, police and teachers who have counted on pensions and health care coverage. The city has borrowed heavily to pay the billions in costs and it is seeking large concessions in both present and future obligations. Their interests will be pitted against debt owners and other creditors.

Detroit began piling on debt and pension obligations in the 1950s, when it was the prosperous No. 4 city in America. The city's peak population of 1.8 million, reached during the Truman administration, has fallen to just 700,000, barely remaining in the top 20 after it plunged into a cycle of poverty, job losses, crime and fiscal decline. The fall in real estate prices that hit the entire country accelerated Detroit's decline. "This is a situation that's been 60 years in the making," Gov. Snyder said on Michigan's website.

That's not to say there is no weakness among other American cities. Nearby Chicago and the state of Illinois face problems similar to, if less severe than, Detroit's, and have seen deep cuts in debt ratings. In Michigan, as in other places, the battle has political overtones with its statehouse run by Republicans who now manage an overwhelmingly Democratic city, which has already been placed under emergency fiscal management and federal bankruptcy court supervision.

The largest state, California, narrowly averted a fiscal failure and relied on IOUs to pay bills last year while it sought a permanent fix. It seems to have staved off disaster. In the more distant past, Cleveland, Ohio, flirted with bankruptcy, and America's largest and wealthiest city, New York, required federal help to avoid the same fate in 1975.

The municipal bond market went into one of its biggest declines ever in 2011 after the widely followed Wall Street analyst Meredith Whitney said she saw hundreds of possible bankruptcies. That never happened. The market recovered to all-time highs last year, and Whitney has backed off her bearish stance.

[Read: What's Making Famous Bear Meredith Whitney so Bullish?]

Detroit's ebullient spirit, which survives even as one-fifth of its real estate lies vacant, stems from its long history as the world's car-making capital, despite years of dramatic ups and downs. It rebounded once again after Chrysler and GM both declared bankruptcy in the depths of the last recession. GM's headquarters still towers over the city.

"GM has a big leadership role to play, and they have been working hard on the city's problems," Hill says. But everyone agrees the city's future will need to rely on a more diversified base as the auto industry goes global. Chrysler is now a division of Italy's Fiat, and GM is China's leading carmaker. There is little hope for a huge rebound in auto manufacturing jobs, a hard reality in a city where average home prices dropped below the price of an average car in the depths of the recession.

While the city tries to improve its quality of life and attract new business for the long term, it will be under the supervision of federal bankruptcy court for a period of months and perhaps years as the court reviews the extent of the problem and decides which creditors will be paid and how much. The first step alone could be difficult. "It's difficult to say how deeply in debt the city really is," Heckman says.

Detroit's emergency fiscal manager, Kevyn Orr, who has been working in the city since March, has pushed for more clarity and blames past mismanagement of city's finances for making matters worse. "Everyone knows the problems really well," Hill says. "We don't know the solution yet, but we know what we need to work on. I'm hopeful that we are in the middle of a phoenix rising."



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