Detroit files for bankruptcy

Detroit thin skyline

By Ryan Blodgett

Detroit didn’t file for bankruptcy years ago? Apparently not.

On Thursday, the city filed for bankruptcy in federal court, making it the largest U.S. city ever to do so, USA Today reports. After losing 28 percent of its population since 2000 it is unsurprising that Detroit lacks the tax revenue to remain afloat.

Bankruptcy law exists as a way of facing the unfortunate reality that sometimes entities are unable to meet their financial obligations. Usually when people talk about declaring bankruptcy, it is in the context of an individual who is buried in credit card debt, or a large corporation whose finances got out of whack. It’s not that often that we see large cities relying on the bankruptcy code.

When an entity declares bankruptcy, complicated and arcane rules immediately come into play. A trustee appointed by the government often takes control of relevant assets and the bankruptcy judge and the trustee work with the bankrupt entity and everyone to whom it owes money to try to work everything out in a way that is least terrible for the parties with the best structured financial contracts. Generally, this means that those who have the strongest claims for repayment get repaid first, and usually only a portion of what they are owed. Those with weaker claims might get paid a small fraction of what they’re owed, or many receive nothing at all.

A lot of this hierarchy of creditors is dependent on whether credit is secured or unsecured. Credit is secured when it is associated with something specific that can be taken if the party fails to meet their repayment obligation. For example, a mortgage is a secured form of credit because if the homeowner fails to repay, the bank, in many cases, can take the house back. Credit cards, on the other hand, are unsecured because there is nothing specific that the credit card company can retake if the cardholder fails to repay.

In this case, what this all means is that anyone who is owed money by the City of Detroit is likely to get only a fraction of what they are owed, and maybe nothing at all. This may sound like it only impacts large corporations, which isn’t great in itself, but it also will affect current and former city workers. These Detroit workers will see their pension funds go under attack by the city’s other creditors. These other creditors are owed money and deserve to be paid as well, but in bankruptcy proceedings, payment to creditors is generally zero-sum, as only a small pot of money exists to be dived up.

When Detroit finishes bankruptcy proceedings, it will receive a more or less clean slate, although one with a lot worse credit score. But what about other cities? This is the kind of thing that scares financial institutions. Detroit filing for bankruptcy may well make it more difficult for other cities facing financial troubles to get credit, which could make their problems worse.

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Posted by on July 18, 2013. Filed under Economy,National Politics,Recent News,Top News. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry

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