Can Detroit Be Saved?

“It’s not tough at all as long as the fans are yelling, screaming and hollering” – Bill Laimbeer

Ahh Laimbeer – one of the “Bad Boys” of the Detroit Pistons dynasty that preceeded, ever-so-slightly, the Jordan era of the NBA. The motor city could use you now Bill. And by that, I mean they could use the taxes you would undoubtedly pay with an NBA salary to help get them out of the current financial debacle.

We’ve talked about Detroit a few times before (for example “The Government Run System is Failing Badly When …” or “For Three Sins of Progressives, Even for Four“) but the city keeps crossing new thresholds of impending collapse, so it keeps coming back up. As Porter Stansberry notes (article linked in “For Three Sins” above) the city is the poster child for centralization and socialism – and has proven an utter failure. Every left-leaning special interest has a hand out for extra benefits at the expense of the rest, and the weight of it all is just too much to bear. Industry has left, taxpayers have left, other taxpayers have stopped paying (because they get no services for their taxes) – you can’t run a city like this.

The city is broke and the state of Michigan has appointed a financial manager to take over and guide the ship “safely” aground. In the latest development, the manager has decided to default on some debts (see “Detroit Recover Plan Threatens Muni Market Underpinnings“). This has folks all in a dander, but it had to happen. As Mish likes to say, that which cannot be paid back will not – by definition.

A situation like this provides plenty of fodder for snarky commentary …

We Lost the Auto Industry …

I caught an interview with Jessie Jackson earlier today about the Detroit predicament. Jessie looks at Detroit and I believe he honestly hurts for the people (and good for him). He pointed to the loss of the auto industry as having a crippling impact on Detroit – and he’s surely right. He also noted that we need to “reindustrialize” Detroit (and he said it with a great Jessie Jackson intonation) in order to save the city. And, I suppose, he’s probably right about that too. But how? I suggest that the answer (or non-answer) to that question lies in the “why” of the auto industry departure. Why did the automakers leave Detroit?

The answer here is simple – they couldn’t compete anymore. Toyota, Honda, heck even Hyundai were kicking the Ford/GM/Chrysler cabal’s collective tail. The promises that the latter made to their union employees were in no way sustainable or competitive with global market rates for labor. This gave Toyota a huge advantage. They could either produce the same product for cheaper, or a better product for the same price (they generally chose the second). The Big 3 collapsed and we had to bail them out (and violate bankruptcy law for the sake of political expediency in the process – but who’s counting?).

So how do we reindustrialize? How do we get this thing going again? Well, I suppose we could see a resurgence in the American auto industry. Of course, we already build a lot of cars in America – we build them in places like Alabama and Tennessee, where there are solid workers with low(er) wage demands. When Toyota and Hyundai wanted to build cars here, they sure didn’t go to Detroit. The chances that the auto industry, or any industry is just going to up and choose a failing city with massive demands for compensation/pension support are frighteningly miniscule.

(It is apparently well known in the oil industry that New Orleans was a better place to put all the necessary infrastructure to bring in oil from the Gulf of Mexico – not Texas. But nobody wanted to deal with the corruption and graft of New Orleans, so they chose the less-geographically appropriate Texas instead.)

We will not reindustrialize Detroit in its current state. We will either have to revamp the city and make it competitive again (lower taxes, lower wage demands, lower pension demands, less city-handout-overhead to deal with) – OR – we will have to use government funds to place and industry there, even though it will lose money. Darn those corporate elites and their “freedom of association”!

Banks Really Hate to Lose …

The threat of a default really isn’t about the auto industry. That story has long since played out – I just wanted to give a head-nod to Jessie Jackson and agree that the decay of the “motor city” is related to the decay of the American auto industry. Today though, the primary issue is that of the banks and other creditors.

The banks hate to lose. I mean they absolutely hate it (when your god is money that will happen). They are always looking for a way out, a way to shift the losses to someone else.

In the housing mania banks were lending 100%+ loan to value ratios to people with no income, no job or assets (NINJA loans). Housing prices were off the charts and the banks just kept throwing money out there – nobody wanted to miss out on all those loan originations.

When the market collapsed the banks realized they were in trouble. The standard deal in mortgages is “money backed by house”. The bank loans me a ton of money to buy a house, and has a right to the house if I don’t pay the money back. It’s a fair deal. But the bank typically only means the “money backed by house” agreement is a risk to the borrower, not a risk to the bank. When borrowers fail to pay back $300,000 on an asset worth $500,000 banks are happy to take a cut in liquidation. (Of course, that never happens – the house can always be offloaded by the borrower at a bargain price to cover the balance.) But when the borrower fails to pay back $300,000 on an asset worth $180,000 the bank is left holding the bag.

At this they balk and kick and scream and demand that people take up “moral responsibility” for the bad debt. This is absurd though – we made a deal, and a fair deal at that. I borrow money to buy a house, and I can either pay you back in money or in house. That’s the deal. Don’t pitch a fit at me just because you didn’t do due diligence and step back from making loans on houses of questionable valuation. (Side note, I have never defaulted on a mortgage and am not underwater on my current home – not by a long shot – just in case my Mom is reading this and got the wrong impression.)

The banks tried everything to offload the bad debts and eventually had to go to the “lender of last resort” – the Federal Reserve – who has been buying $40,000,000,000 of mortgage-backed-securities (read “bad home loans”) a month to help make the banks whole again.

My point is that the banks envisioned a system where they got paid interest without risk, and were flummoxed by the notion that there would actually be risk.

The same is true in Detroit and municipalities (and states) all over this country. Institutional lenders (often banks) have dreamed that they could make risk-free loans to cities and states and they would always get the money back. The way they figured it, the city or state could always just raise taxes as much as needed to pay the debt. This doesn’t work though, as the taxpayers pick up and leave, as has happened to Detroit (darn you freedom!).

Now they’re scared. They’re dropping hints about “shockwaves” through the bond markets. To this we say the same thing as in the housing bubble. If you can’t figure out that lending $500,000 to a guy with no job and no assets to buy a house for $450,000 is a bad idea, then you deserve to lose your shirt. And if you can’t figure out that lending $17,000,000,000 to a city with no industrial base, a shrinking population, and massive deficits is a bad idea, then you deserve to lose your shirt.

Will a Detroit default (or even bankruptcy) send shockwaves through the system? You bet. But the shockwaves are coming sooner or later. If Detroit is where it starts then fine.

Can Detroit Be Saved?

Believe it or not, I am an optimist (some of the time). Can Detroit be saved? Yes, but it won’t be. Detroit is an American city full (or half full) of American people, and such an enterprise can be “saved” in the sense that it can still be made to work, it can still be effective and productive and even efficient. But it won’t be. The number of people who have been promised something that cannot possibly be paid back is far too high. Free people won’t freely choose to participate in that bailout when they can go to some other city and get a much better deal. The people who are owed vast sums are unlikely to forgo their demands, hoping against hope that someone larger will step in with a bailout (it will be days, weeks, or perhaps months before congressional rancor really kicks in over a federal “aide package” for Detroit).

Detroit will default, perhaps even go into bankruptcy. The city will continue to shrink. The scrappers will continue to come in and make use of whatever copper, aluminum, and other metals they can find. The city will be reclaimed one way or another. But it won’t be saved, it won’t be restored to its former glory … unless … unless … unless …

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