Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / What Happens When a City Really Defaults
Transcript
- Lucas: When a city runs out of money, what actually happens? Most people assume the state or the federal government steps in. But the answer is often: nothing, for a very long time — until a judge takes control. Luna: You're talking about municipal bankruptcy — Chapter 9. It's rare, but when it happens, it's brutal. Lucas: Right. And the textbook example is Detroit in 2013. The city filed for Chapter 9 with eighteen billion dollars in debt. At the time, it was the largest municipal bankruptcy in US history. And the way it played out tells you everything about how fiscal failure works at the local level. Luna: Before we get into the weeds — I want to mention something. This podcast is ad-free by design. We don't run commercials, we don't have sponsors. And that's a choice. If you find this kind of deep-dive useful, the way to support it is simple: buy me a coffee dot com slash fexingo. It keeps the show independent and lets us keep digging into stories like this one. Lucas: Yeah. No ads, no interruptions. Just the fiscal facts. So — Detroit. How did a major American city end up in bankruptcy court? Luna: It was a slow-motion collapse. Population decline, deindustrialization, and decades of borrowing to cover operating costs. Lucas: Exactly. Detroit's population peaked at about 1.8 million in 1950. By 2013, it was below 700,000. That means the tax base shrank by more than half, but the city still had to maintain the same physical infrastructure — water pipes, roads, streetlights — for a much smaller number of people. So they borrowed. And borrowed. Luna: And the debt wasn't just bonds. A huge chunk was pension obligations and retiree health care. Promises made to city workers when the city was flush. Lucas: Right. By 2013, Detroit had about 3.5 billion dollars in unfunded pension liabilities and 5.7 billion in retiree health care. Plus about 6.4 billion in secured debt and other obligations. When the city couldn't make the payments, the state of Michigan stepped in — not to bail them out, but to appoint an emergency manager. Luna: That's the key difference between a city and a corporation. A company can file for Chapter 11 voluntarily. A city in Michigan can't even file for Chapter 9 without the state's permission. The emergency manager law gave one person — Kevyn Orr — near-total control over Detroit's finances. Lucas: And Orr used it. He filed for bankruptcy in July 2013. Then the real fight began: who gets paid first? In a corporate bankruptcy, secured creditors are at the top. But in a municipal bankruptcy, there's a political dimension. You can't just liquidate a city's assets and walk away. Luna: So what did the actual restructuring look like? Who took the biggest haircut? Lucas: That's the fascinating part. General obligation bondholders — the ones who lent the city money for basic operations — ended up recovering about 74 cents on the dollar. But the pension funds — retirees — they were initially told they'd see cuts of up to 30 percent. That caused a huge uproar. Luna: And that's where the famous 'grand bargain' comes in. The state of Michigan, private foundations, and the Detroit Institute of Arts basically pooled money to protect the pensions and keep the art museum's collection intact. Lucas: Right. The grand bargain was about 820 million dollars. The state contributed 350 million, the DIA raised about 100 million by selling some art and fundraising, and foundations like the Kresge Foundation and Ford Foundation chipped in. In exchange, the pension cuts were reduced significantly — most retirees took a reduction of about 4.5 percent on their pensions, not 30. Luna: And the art collection stayed in Detroit. That was a huge deal culturally, but also economically — the museum is a major tourism draw. Lucas: So the outcome was messy but functional. Detroit exited bankruptcy in December 2014, after about 18 months. The city shed about 7 billion dollars in debt. But the cost was real: retirees took a hit, bondholders took a hit, and the city sold off assets like the parking system and the water department. Luna: And the water department sale — that's controversial. The Great Lakes Water Authority was created, and the city leased its water system for 40 years. That brought in immediate cash, but critics say it gave up long-term revenue. Lucas: Exactly. And that's the tension in any municipal bankruptcy: you need cash fast, but the things you sell are often the city's most valuable long-term assets. Detroit also sold its city-owned parking garages and lots to a private operator — another source of one-time revenue, but lost recurring income. Luna: So what does Detroit look like now, more than a decade later? Has the city recovered? Lucas: It's a mixed picture. The downtown and Midtown areas have seen a real renaissance — new businesses, new residents, rising property values. The city's budget is balanced, and the bond rating has improved from junk status to investment grade — slowly. In 2024, Moody's upgraded Detroit to Baa3, which is the lowest investment grade tier, but still a huge step up from the Caa3 rating during bankruptcy. Luna: But the neighborhoods that were already struggling before 2013 — they haven't seen that same rebound. Population is still declining overall, and poverty rates remain high. The fiscal crisis may be over, but the economic crisis isn't. Lucas: Right. And that brings us to the big question: could this happen to another major city today? There are a few that are under serious fiscal stress. Chicago has about 40 billion dollars in unfunded pension liabilities. San Francisco is facing a budget deficit of roughly 800 million this year. But filing Chapter 9 is extremely difficult politically and legally. Luna: And most states have laws that make it hard for cities to file. Some states require the governor's approval. Others require the city to go through a state oversight board first. Only about half of US states even allow municipal bankruptcy. Lucas: So the threat of default is often a negotiating tool. Cities use the possibility of Chapter 9 to extract concessions from unions and bondholders — even if they never actually file. Detroit was the exception, not the rule. Most distressed cities find a way to kick the can down the road. Luna: And that's the uncomfortable truth. The system is designed to avoid defaults, not to make them clean when they happen. Detroit's bankruptcy was a one-off event that took years of preparation and a lot of political will. It's not a template — it's a cautionary tale. Lucas: Right. And the lesson for anyone watching municipal bonds or public pension funds is: don't assume a city is too big to fail. Detroit was the 18th largest city in the country when it filed. If it can happen there, it can happen elsewhere. Luna: So what's the one thing a listener should take away from this episode? Lucas: That municipal bankruptcy is not a clean exit. It's a painful, politically charged process that leaves scars for decades. And the best way for a city to avoid it is to not dig the hole in the first place — which means honest budgeting, realistic pension assumptions, and a tax base that doesn't shrink year after year. Easier said than done. Luna: Yeah. And if you want to see how your own city's finances stack up, look for its annual comprehensive financial report — usually posted online. The pension funding ratio and the debt per capita are the two numbers to watch. Lucas: Great advice. That's it for this episode of The Fiscal Policy Podcast with Fexingo. We'll be back next time with another deep dive into how public money actually works.