Should the Federal Government Bail Out Detroit?

 

The former Obama administration auto czar, Steven Rattner, wrote in yesterday’s New York Times that “We Have to Step in And Save Detroit” from bankruptcy.  Detroit has $18 billion in liabilities, half of which are for municipal employee pension plans and retiree health benefits.  Mr. Rattner says that “It isn’t fair to cut pensions.  The workers didn’t cause this mess.”
Many state and local governments are indeed in terrible financial condition because of the cost of public employee pensions.  There have already been several municipal bankruptcies around the country and there will be many more.  The state of Illinois is in particularly bad financial shape, for the same reasons as Detroit, and will almost certainly have to declare bankruptcy in the near future.
The basic problem is that state and municipal governments often have so-called “defined benefit” pension plans for their employees rather than the “defined contribution”, or 401(k), retirement plans used by private business.  Defined benefit plans guarantee a certain level of pension payment, based on the employee’s salary, regardless of the investment returns of the contributions to the fund.  Defined contribution plans, on the contrary, only pay out in benefits what has actually been accumulated in investment earnings.  For a defined benefit plan the employer (i.e. the government and therefore the taxpayers) is at risk for any shortfall in funding.  For a defined contribution plan, the individual employee is at risk for underperforming investment of the fund.  The only viable solution to this massive problem is for state and local government to shift as rapidly as possible from defined benefit to defined contribution retirement plans.
For the federal government to jump in and bail out one particular struggling municipality would create a moral hazard.  Every other state and local government with the same problem, numbering in the hundreds or thousands, would want equal treatment.  The federal government can’t afford such an expense because of its own perilous financial condition.  Furthermore, federal aid would just delay the fundamental changes in fiscal policy which must be made at the state and local level.
It is a very bad idea for the federal government to bail out Detroit!

4 thoughts on “Should the Federal Government Bail Out Detroit?

  1. No they should not bail out Detroit. What happens when you go from 4 million to less than 800,000 in your city and not change a single thing? What happens when you have over 50 years of Democratic leadership? They need a fresh start which is bankruptcy, NOT a bailout.

  2. You are entirely correct. The only way that Detroit will ever address its fundamental problems is to be able to throw off the financial dead weights under which it presently struggles.

  3. The pensioners and employees bear responsibility too. If represented by unions, they could have negotiated to have moved to defined contribution plans. Or if not they could have made the same case through public-spirited citizens.

    One substantial asset that definitely needs to be available to the creditors is the $2+ billion worth of art in the city museum. Art interests are whining that the city would lose its soul, etc., etc. by selling it. Maybe it should try to raise outside money to pay artists to make copies that would stay behind after the originals are gone.

  4. Thanks for your input, Mr. Drake. Whether or not the pensioners and employees could have done anything to avert the financial crisis in Detroit, trimming their future benefits will have to be part of the solution. Detroit will have to adopt innovative and unprecedented measures in order to be able to operate in a financially sound manner in the future.

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