By J. PATRICK PEPPER
The precarious financial situation of the city of Detroit has led to increasing speculation about the possibility of bankruptcy — a situation in which experts believe the fallout would extend well beyond the limits of the once-prosperous automotive capital.
Government bankruptcies are a relative rarity. Only about 600 have occurred since a Depression-era law made it possible. Detroit city officials have continued to mention it as a possibility, however, as they try to unscramble a $300 million budget deficit.
But even as surrounding municipalities deal with their own hardships in an economy where tax revenues have plummeted, public officials across metropolitan Detroit remain keenly aware of the implications a hub city bankruptcy could hold for their own communities.
“If it appears to people in the finance community that (local) cities as a whole simply aren’t going to be able to guarantee their bonds, then that could dry up capital investment for almost everything,” Dearborn Mayor John O’Reilly Jr. said.
Bonds are used to finance most construction endeavors undertaken by municipalities, including things like the park upgrades, facilities improvements and road repairs. Although each city’s situation is analyzed separately for investment purposes, if the greater investment community becomes skeptical of the financial capacity of one city in a region, the perception of instability can dog surrounding municipalities.
“Hopefully the (credit) rating agencies will be lenient with this,” Dearborn Heights Treasurer John Riley said.
Both O’Reilly and Riley said their communities remain in a stable position fiscally. Still, their proximity to Detroit could end up imposing a sort of guilt-by-association penalty that would show up in the form of higher yields on city bonds.
How big that difference would be is hard to tell, said Robert MacIntosh, chief economist at Boston-based Eaton Vance Investment Managers, because the end number is determined by the perception of investors.
But by way of comparison MacIntosh, who also directs Easton Vance municipal bond operations, said Michigan communities as a whole already are experiencing higher finance charges than communities across the country simply due to the area’s well-chronicled economic hardships.
“If you took a Michigan municipal bond and you pit it with a bond from North Carolina, for instance, and all the terms and conditions were equal, the Michigan bond would have a higher yield on it,” MacIntosh said “even if it’s a Livonia or some other community that’s perceived to be a wealthy suburb, just because it’s in Michigan.
“That’s just the way the market works. It tends to associate credits in a certain vicinity with other credits in the same area.”
Compared to other communities nationwide, MacIntosh estimates Michigan communities already pay a 0.05 percent to 0.1 percent premium on debt, primarily, he said, because the regional economic difficulties have created a dour perception of Michigan among other Americans.
And even at just a fraction of a percent, that small premium can add up quickly on long-term, multimillion-dollar debts.
One of the best known examples of one government entity’s financial problems affecting seemingly unrelated governments’ financial capacity is the Washington Public Power Supply fiasco of the early 1980s. Known as “Whoops” for short, the poorly executed power plant building project continually exceeded budgets and eventually defaulted on its bond payments.
The results were devastating: thousands of investors lost billions of dollars, the conventional wisdom that municipal bonds were a sure bet was shattered and governments throughout Washington had a difficult time finding financing for years to come.
One Washington state official said at the time, “The whole thing is a nightmare. If traders on Wall Street have the choice between something that says Washington on it or Indiana on it, they are going for Indiana. We have a cloud hanging over us.”
The situation locally is not completely similar to Whoops, but MacIntosh said clouds still loom.
“The conclusion the market has reached on Detroit and the surrounding area, including Dearborn, as unstable are not unwarranted. There will be better days ahead, but they are a (ways) off,” MacIntosh said.