I don't think it shocked anyone that Detroit filed for bankruptcy yesterday, but it set off a mad scramble by the creditors….most interestingly perhaps(but not surprising)…by the city's pension funds.
First…lets take a look at the numbers. I found a copy of the city's last full fiscal report on their website….covering the period ending 06/30/2012. I'm guessing the 6/30/2013 may be delayed by just a bit.
Ballpark….per page 21, total revenues were $2.3B, vs. total expenses of $2.6B, for a total deficit of $300M. That's a 13% annual deficit…which honestly doesn't sound that huge. The US deficit…over the last 12 months ending 6/30/2013 was $800B….$3T of revenues and $3.8T of outlays….good for an annual deficit of 27%….more than double of Detroit's.
Debt, according to the headlines at the time of the bankruptcy filing was $18B…about 8X 2012′s revenues. The US is in a little bit better shape….with $16.7T of debt on $3T of revenues, good for a 5.5X ratio. So, we still have a ways to go before we get to Detroit's level, but it is definitely on the horizon.
Now…I don't have the 2013 numbers, but this clearly illustrates how a relatively small annual deficit can topple a huge mountain of debt. The bottom line is…as long as people are willing to lend me money….I can keep a scheme like this going indefinitely. I can borrow to pay my bills, I can borrow to pay pensions, I can borrow to build a football stadium, and I can borrow even more to pay the interest on all the debt I already have. But…once the lenders start to think maybe you can't pay it all back….it is almost instant death. All of a sudden…you can't make payroll, you can't provide police protection, and when your debt comes due….either the rates to refi are suddenly astronomical, or you just can't refinance at all. So while maybe you could afford to pay $30M or so of interest a year on that $1B bond coming due….but you certainly can't afford to refinance at 10%, and the odds of you coming up with $1B to…god forbid…actually pay down debt are zero.
So who gets paid? There is $18B of debt, yet the city is running a deficit of $300M per year (again…year old data). And by all accounts…they are not even able to provide basic services to the city…like even fixing broken street lamps. The bondholders…well, they were foolish enough to keep lending, even though it has been obvious for a while what was going to happen. I think they should get nothing.
Now the pensioners….this is a bit more complicated. There is no money to pay…it's a tragic situation no doubt. Some will argue that the unions negotiated outrageous pensions with their cronies in government…that's probably true to some degree. I don't know the answer, but if nothing else, this illustrates the enourmous unrecognized risk of defined benefit plans, whether it is from the city of Detroit, a fortune 500 company, or…the granddaddy of them all…Social Security. In all of these scenarios…you pay in or defer income for decades…perhaps half a century…for the promise that someday….decades later a) the organization will still exist period and b) the organization will still have the ability and willingness to make good on that promise.
This in itself is something I find so hard to understand about defined benefit plans. How many people in this world would you personally trust to take care of hundreds of thousands, or millions of dollars of future benefits for you? Maybe your parents, siblings, or children….maybe… Uncle Sam? No!! Congress... with an approval rating of what…15%? No!! The mayor of Detroit? No!! Any CEO of any company? Hell No!! Wake up America. The entire premise of all defined benefit programs is blatant fraud. Rather than pay you now…in cash….companies and governments offer to pay you later…in another quarter, when it will be another CEO's problem…another Congress's problem…another Mayor's problem…another President's problem. Shall I say it again…wake the hell up!! You will not be paid. You were conned…you were scammed….you bought the lies hook line and sinker, and ultimately…you must own the consequences of your poor decisions. Yes you are a victim here…yes it sucks….unfortunately…nothing can be done about it. The money is gone….spent decades ago by politicians you elected.
Ok…stepping off that soap box….We are all Detroiters (is that even the right word??) now. What happened to Detroit is what will ultimately happen to the United States Of America, and it may be sooner than any of us realize. Already….under the guise of helping a struggling economy, the Federal Reserve has resorted to manipulating interest rates to near zero and has resorted to essentially printing money and lending to itself using QE…to the tune of nearly $2T. These are already desperate measures….how long can Bernanke and Lew keep this charade going? My guess is less than 10 years….perhaps much less. As with Detroit…once we lose the ability to issue new debt and roll what you currently have…It will be nearly instant death. It would seem we have nearly run out of people to loan us money, so we have resorted to printing money and loaning it to ourselves with the Fed as a middleman. Were this game to end, and interest rates return to a normal rate…say 5% or so….I think we'd be done within a year or two.
But…as many have noted….it is nearly impossible for a sovereign nation with it's own currency and a printing press to technically default. They are probably correct as this seems like the path of least resistance. So…in 2043 when you take that 30 bond in for redemption….you may well get your $1000….but you'll be lucky if it buys you a bag of potato chips. Same for today's 38 year olds….hoping to retire in 30 years. You very well may get a social security payment deposited into your account each month, but it won't even be enough to buy a bag of dog food…for your pet of course.