Save Detroit the New York Way

A great American city -- once an engine of the nation's manufacturing-oriented economy -- struggles under massive debt, credit rating downgrades, an investor exodus, a flight of white-collar workers, and finally the threat of an outside takeover or, worse, bankruptcy.

The year was 1975.  The city was New York.   But you could be excused for believing this to be a description of Detroit in December 2012.  The details match perfectly.

While we all know the story of New York's breathtaking turnaround in the decades that followed, Detroit's story has yet to be written. As Motown inches ever closer toward an emergency manager takeover or chapter 9 bankruptcy, city, state, and federal leaders would be wise to remember a key lesson of the New York's post-1970s economic miracle: that well-designed federal assistance can be both fiscally responsible and potentially transformative for a city in need.

There's no doubt: Detroit today is in a difficult situation.  With $2.5 billion in general fund-backed debt, $11 billion in retirement obligations, a chronically-underfunded school system, rising crime, and falling population, many are questioning whether the city can remain solvent.  This uncertainty has shot borrowing rates sky high.  While Mayor David Bing's administration says the city will be able to make payroll at least through the end of the year, analysts show the city with a significant shortfall by summer. 

In the likely scenario, a federal bankruptcy judge or a state emergency manager would break labor contracts, eliminate services, and liquidate assets.   In a city where declining public safety and poor public schools are deterring businesses from investing and forcing residents to relocate, these cuts to vital services and personnel would almost certainly make the situation worse.   Yet many consider them inevitable.

Rewind 37 years, and you'll find that Detroit is hardly in uncharted waters for a great American city.  New York -- with skyrocketing crime rates and notoriously dirty streets -- cut its workforce by 65,000, froze wages, eliminated 3,000 public hospital beds, and shut numerous police posts, fire stations, libraries and schools in the face of bond market fears of immanent default.  Mayor Abe Beame notoriously prepared a statement in 1975 that the city would run out of money if the teachers' union did not invest $150 million from its pension funds into city bonds. 

From a fiscal standpoint, New York then looked remarkably like Detroit now. 

But there's a key difference.  While the federal government stepped in with a series of interventions including the Seasonal Financing Act of 1975 and the Loan Guarantee Act of 1978 to lower New York's interest rates and help restore solvency, Detroit -- at the moment -- appears unlikely to receive any such assistance.    This is understandable given current politics and the nation's fiscal situation.

But a closer look reveals that the right kind of federal assistance could be more fiscally responsible than a failure to act. 

Part of what made New York's financial recovery arrangement so successful was that New York Gov. Hugh L. Carey and the State Legislature set up innovative ways to monitor city finances and borrow funds on the city's behalf to promote reinvestment and recovery.  Such an approach could be applied today.  And, unlike a loan guarantee program, the approach could be designed to minimize interference with the functioning of the free market. 

Congress should modify and extend a popular Recovery Act program that reimburses distressed cities for a portion of their interest payments in order to help Detroit regain short-term solvency without directly manipulating interest rates.  Such funding, which could flow through an entity managed jointly by local, state, and federal authorities, could additionally be used to make strategic investments in the city's economic competitiveness: factors like education, public safety, and workforce development.  Combined with other incentives like reduced capital gains rates for long-term equity investments in Detroit, these policies could represent a more market-oriented approach to the successful interventions that saved New York City.  They would also be far less costly to state and federal taxpayers than the fallout from what would be the largest municipal bankruptcy in history. 

To some, the comparison between Detroit and New York may seem like an exaggeration.  While Detroit has been a victim of outsourcing for ages now, New York in the 1970s was, as it has always been, the financial and cultural capital of the nation.  But Detroit is known as the nation's manufacturing capital for good reason: it still has the facilities, the firms, the research institutions, the workforce, and -- of course -- the grit to justify the title.  The right kind of assistance could get Motor City rolling again.