Two tales of a city: How Detroit transcended ideology to reform pensions

July 24, 2014

California Policy Center California Policy Center

The mission of the California Policy Center is to secure a more prosperous future for all Californians by identifying public sector policy barriers to freedom and economic growth. Read more at californiapolicycenter.org

DETROIT – “I see a beautiful city and a brilliant people rising from this abyss.” – Charles Dickens, Tale of Two Cities

Detroit2Traveling through suburban Detroit, a sprawling city of 143 square miles whose population has dropped from nearly two million to less than 700,000, you can often imagine you are in rural Tennessee. Rutted narrow roads bend past groves of cottonwood, oak and silver maple. Deer and jack rabbits forage in tall grass. Until you pass a burned out ruin of a home, not yet removed, obscured by greenery, it is difficult to imagine that these neighborhoods once were filled with homes, set 35 feet apart and carpeting the land for mile after mile.

According to the so-called “right wing propaganda machine,” the tale of Detroit’s demise is attributed to the unchecked power of labor unions. Private sector unions were inflexible in the face of foreign competition, driving Detroit’s auto industry into irreversible decline. Public sector unions gobbled up every dime of taxpayer revenue they could bully and intimidate politicians into granting, further straining the finances of an already imploding city. Financially unsustainable pension benefits, ultimately, drove the city of Detroit into bankruptcy.

A different tale emerges from the left side of the ideological spectrum. Taken from a guest column written for MSNBC.com, here’s a quote from Jordan Marks, executive director of the National Public Pension Coalition, a group largely funded by public sector unions:

While public coffers were running dry, Wall Street banks were out to make millions. Mayor Kwame Kilpatrick, who now sits in jail, worked with Wall Street banks that designed an illegal borrowing scheme that evaded state debt limits and piled on unwise interest rate swaps. When interest rates plummeted, Wall Street demanded more than $300 million from Detroit to terminate these swap deals – making a bad situation even worse. These same Wall Street firms stand to make millions if other cities move to privatize their pension plans.

These two tales of Detroit’s struggles both have elements of truth. With respect to Detroit’s municipal bankruptcy, it is unfair to blame public sector unions as the primary cause. While the city’s unions were unwilling to adjust their pensions and benefits until it was too late, even if they had, the city’s finances would have failed anyway because it lost nearly two thirds of its tax base. And while the automotive industry’s unions were unwilling to adjust their pensions and benefits until it was too late, that industry would have shrunk anyway, because very capable foreign competitors gained strength starting back in the 1960′s. It is unrealistic to expect, under any circumstances, that Detroit’s auto industry could have maintained the overwhelming global market share it had up to and through the 1950′s. Without economic diversification, Detroit was destined to fall hard.

The tale that comes from the left, however, strains credulity even further. First of all, public sector unions don’t represent the “left.” They represent the state. When Jordan Marks writes about banks colluding with corrupt politicians, he is referring to politicians elected and controlled by public sector unions. His assertion that “Wall Street banks” exploited Detroit does not reflect reality. Bankers issue bonds – debt – to cities who willingly borrow the funds because their union agenda forces them to spend more than they collect in taxes and fees. Government pension fund managers pour billions of dollars into Wall Street investment firms every year. Bankers and city governments – controlled by government unions – work together to exploit taxpayers and private businesses. They use the state power of imprisonment to enforce punitive levels of taxation, to pay down debt and unfunded liabilities incurred so they could live beyond their means. Wall Street bankers and municipal government unions work together to build a financial house of cards, and when it collapses they deserve equal blame.

How Detroit has solved its pension crisis will not please the ideologues. For the libertarian right, the failure to throw everyone into 401K plans must rankle. For the left, the new plan’s built in “triggers” that adjust benefits when necessary to compensate for possible future shortfalls in investment returns violates their goal of an immutable defined benefit. But it works. And the libertarian’s ideological enthusiasm for individual 401Ks contradicts their entirely valid criticism of overly optimistic investment return projections on the part of pension funds (Detroit’s was 7.9% a year). When the market tanks, and periodically it does, only a pooled plan with multi-generational, active payees plus retired participants, with adjustable benefits, can maintain solvency through a balance of contributions from active workers and returns from invested assets. A pooled 401K plan is nothing more than an ideologically impure version of individual 401K plans. An adjustable defined benefit plan is nothing more than an ideologically impure version of a fixed defined benefit plan. They can be functionally identical, two tales of the same thing, and they are both practical compromises.

Detroit’s failures, and Detroit’s probable ascendancy from now on, is easy to describe using hyperbole and polemics. But ultimately there is one destiny, one tale in reality, that will define Detroit’s future. Cutting through the rhetoric, cities around the nation may look to Detroit for answers, especially regarding their new pension plan, because Detroit has passed through a clarifying crucible of pain and self-evaluation that cities with better weather and more diversified economies have deferred. One big market correction will erase those advantages. The tale of Detroit makes for compelling analysis, from New York to LA.

Authored by Ed Ring, Executive Director of the California Policy Center

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