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Thursday, November 17, 2011

When there are no more options

If there was ever hard evidence that people are the drivers of wealth generation, current day Detroit is it. It also provides evidence that manana faith based economics paves a road to financial catastrophe. Detroit is showing where Greece will end up down the road.
http://www.freep.com/article/20111116/COL33/111160318/Stephen-Henderson-Detroit-s-clock-striking-midnight

Stephen Henderson's article in the the Detroit Free Press  "Detroit's clock is striking midnight" is a sobering account of the end game for a city which has failed to come to grips with a culture which made promises it could not keep. Detroit now finds itself incapable to funding the most basic of services and even if they completely stopped delivering services to current residents and succeeded in maintaining their tax base (not a likely proposition), they could not meet their pension and health care obligations to their retirees.

Detroit represents a microcosm of where we are heading nationally. Private entities recognized long ago that their financial survival depended upon moving their employees to defined contribution retirement programs. Those entities that failed to act are not longer around. State entities have been insulated thus far from these pressures but governmental entities that make bad bets can also fail. These failures have been isolated and have been small cities (with the exception of NYC near failure in the 1980's). That is about to change. It would make sense for the state of Michigan to intervene, but the state does not have the resources to step in  and guarantee all the entities that will line up if that window is opened.

The federal government has been trying through a variety of mechanisms to take the pressure of states such as California, Illinois, and New York using underwriting of bonds to forestall the inevitable. If states used this backstopping to to create a window of opportunity to get their respective houses in order, it might have dampened the blow. However, all this has accomplished is to allow states to avoid having to come to grips with their pension and entitlement pathology.

The lesson is clear from Detroit. Promises that you cannot afford + no growth environment + changing demographics smaller workforce = financial calamity.

2 comments:

  1. It's not simply promises that cannot be kept. It's promises that were soundly made when initiated, but that can no longer be kept under changed circumstances. The original intent was pure, but kept promises are dragging cities and states over a cliff. Should these promises be kept regardless of the cost?

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  2. I am sure that the intentions behind the promises were noble. I am not sure what a "soundly made" promise means. Are you suggesting that the actuarial assumptions were sound? While they were thought to be sound, present circumstances have proved that them to have been spectacularly unsound with tragic consequences.

    Detroit is clear not alone in having made actuarialy unsound promises, often to curry political favor. The temptation to use future dollars to buy current votes is the Achilles heel of democratic states. It is a great gig if you can get it. The best is to borrow from the future unborn with payment due after your own death. Who says there is no such thing as a free lunch?

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