Detroit the Beginning of a Trend in Municipal Debt?

By George Leong

"Motor City,” USA is in trouble. Detroit, straddled with close to $20.0 billion in debt, simply could not move forward and was forced to declare bankruptcy late last week—the largest bankruptcy in U.S. municipal history.

The news was not unexpected, as the city had already faced a massive migration of people along with industries. The migration’s end result was a significant decline in revenue base—this means unpaid bills, projects put on hold, mounting interest payments, and just general malaise within the community. Mind you, Detroit wasn’t always like this. My wife grew up in middle-class Detroit when it was beginning to show cracks in its foundation, but nothing like its recent cracks.

You hear about the 45,000 street lights that have to be replaced, but there is no money to do so. There are also the tens of thousands of empty and crumbling houses and buildings.

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The bankruptcy move by Detroit was necessary, but this former industrial powerhouse by the lake has many hurdles ahead of it that might make the austerity measures in Greece seem like a walk in the park.

First, the debt holders have to deal with losing the majority of their capital. Next, the city will need to come up with a plan of action that can build a sustainable Detroit, but this will not be easy. Investors in new bonds to rebuild the city will also be needed, but the expected return will likely be insignificant. I just can’t think of many reasons why anyone would take that chance.

The problem with Detroit was created by decades of mismanagement and uncontrolled spending, given the massive migration of tax-paying citizens and companies. This should have been dealt with in a more effective manner in spite of the enormous difficulty of the situation.

But the situation with Detroit may only be the beginning—there will likely be more municipalities that are hurting from debt and seeing bankruptcy as the only way out. The state of California is a prime example of a financial Armageddon waiting to happen—the state is straddled with a mountain of debt, and the real issues will surface when interest rates ratchet higher.

And then there’s the national debt, which is above $16.79 trillion and mounting. Wait until interest rates move higher—the interest payments on the debt could be unbearable.

The reality is that America has become a country of debtors, and even with the recession, we are continuing to see spending rise and savings decline due to the low interest rates. My concern is the mounting debt and that it will need to be paid off—even as rates move higher.

With time, tons of money, a sound strategy, and, of course, some luck, things will get better for Detroit; however, this debt problem isn’t contained within Detroit, as many other municipalities nationwide sit on the edge of bankruptcy.

This article Detroit the Beginning of a Trend in Municipal Debt? was originally published at Investment Contrarians