Will Chicago suffer the same fate as Detroit?

Jane Ridley is a Senior Director at Standard & Poor’s Rating Services in U.S. Public Finance, and serves as the analytic manager and team leader for the State and Local Government Department’s Great Lakes group. Her 25-member team covers local issuers in 13 states across the Midwest. Since starting at Standard & Poor’s in 2001, Jane has worked with issuers throughout the region and is currently the primary analyst for Detroit and Wayne County, Michigan.

As Standard & Poor’s primary analyst for the city of Detroit, you have noted that Detroit’s fall into bankruptcy did not happen overnight, but was a long time in the making. In your opinion, what were the factors that drove Detroit to bankruptcy?

Detroit’s bankruptcy story starts with the population loss that started in the 60s and that the city never really recovered from. Over time, there have also been changes in the auto industry that impacted Detroit. That doesn’t necessarily mean that the Detroit area isn’t still a mecca for the auto industry, but a lot of activity moved out of Detroit and into the suburbs and surrounding counties. Particularly, a lot of high-paying, R&D-type jobs located outside the city. With the population loss – people moving out to the suburbs and never moving back in – things started to deteriorate in the city.

As a result of the population loss, the city has experienced revenue loss from a loss of income tax, a loss of property taxes from falling property values, and issues with the state of Michigan in general. One of the largest sources of revenue for Detroit had been state revenue sharing, which the state cut when it was having issues.

A lot of things happened. Blight that never got cleaned up. Projects that someone would start, but didn’t come to fruition. A lot of ideas, but not a lot of long-term plans that were followed through on.

Some commentators have drawn parallels between Detroit and the city of Chicago. Yet, Standard & Poor’s considers Chicago’s debt investment grade (with an A+ rating on Chicago’s general obligation[GO] debt), and has argued that the city of Chicago is not likely to suffer Detroit’s fate. What are the common challenges Chicago and Detroit face?

Probably the biggest common challenge are legacy costs: pensions and other post-employment benefits (OPEBs) specifically. These issues, though, came about for different reasons. A lot of Chicago’s legacy costs are the result of the state legislature’s control of pensions and OPEBs, coupled with constitutional provisions that limit the ability to adjust benefits once given. Detroit’s challenges, on the other hand, have to do with it being a strong union town and a lack of changes to the benefit structure over time. So, some of the types of changes other places have been making — like St. Paul getting rid of its defined benefit system a long time ago – Detroit has not been making. Chicago, while it wanted to make some of those changes, was hamstrung in terms of what it could do.

What about the financial management of both cities?

Financial management – things like accounting practices, cash and liquidity administration, debt management, forecasting – they all have an impact on a city’s credit quality. Through our financial management assessment, we look at the policies that govern financial management, and not necessarily the outcomes of those policies. A city can have strong policies and still end up distressed. Detroit, for example, does have some strong policies: they had long-term financial planning, they reported regularly on the budget; it’s just the budget wasn’t created effectively in the first place. While our financial management assessment tells us about how you plan and what your multi-year thoughts are, it doesn’t measure the results. And that’s a place where the two cities clearly had different outcomes.

Speaking of outcomes, in Standard & Poor’s opinion, what differentiates Chicago’s credit quality from that of Detroit?

The economy is clearly one of the differentiating factors. Chicago is clearly the anchor of the Illinois economy and the Midwestern economy. Detroit is an anchor in the greater Detroit area, but there is a greater disparity between Detroit and its suburbs than between Chicago and the collar counties. Even as the Chicago area has continued to expand into the suburbs, it hasn’t diminished from downtown Chicago. We’re sitting in downtown Chicago. I don’t know that we’d be sitting in downtown Detroit if our office was headquartered in southeast Michigan.

What are some of things S&P is looking at in Detroit in terms of its future credit quality?

We have seen some interesting juxtapositions between bond holders and pensioners in Detroit. Unlimited-tax GO bonds getting 74.5 cents on the dollar, limited-tax GOs getting 34 cents on the dollar, maybe some recovery on the pension obligation certificates that the city has repudiated. Compare that to the grand bargain pensioners struck with companies, philanthropy, and the state to make sure the retirees weren’t too badly hit. They did take away OPEBs and cost-of-living adjustments, but a majority of the hit here is to the bond holders. We see that as a sharp distinction with other recent municipal bankruptcies, like Central Falls, Rhode Island, where the state legislature enacted a law that put GO bondholders first in line when a city was insolvent.

Now, what will be the impact on the bond market going forward? We’re not sure. Standard & Poor’s has long said that there are always going to be pockets of stress and of outright distress, and Detroit is one of them. We do not think there are going to be an increased number of bankruptcies, but once you start asking the questions and making these kinds of cuts, it does inform the conversation about whether other troubled entities will make the same types of decisions.

Feature Photo: cc/(Steph Willems)