Eric Posner on Detroit Bankruptcy

The Best Rescue Plan for Detroit

Detroit’s bankruptcy filing was unavoidable and largely sensible. But it will help that wounded city little. Detroit’s problems are deeper than its inability to pay its debts. And municipal bankruptcy law gives the courts too little power to impose the radical reform the city desperately needs.

Detroit submitted a petition under Chapter 9 of the bankruptcy code, which contains the rarely used provisions for municipal bankruptcy. As a result of the filing, Detroit can block lawsuits by creditors who seek to be paid before they start seizing city property like zoo animals and priceless Renoirs, and the city make all creditors take a haircut on the loan payments they are due. Those creditors include, most prominently, current and former city workers to whom Detroit owes pensions. And they include suppliers and bondholders—people who lent money to Detroit in return for a promise of repayment plus interest.

Municipal bankruptcy bears a superficial resemblance to corporate bankruptcy. The city or company can’t pay its debts, and a court orders the debts reduced, so that revenues (from sales, for corporations; from taxes, for cities) can service the rump portion. As Matthew Yglesias explains in Slate, corporate bankruptcy is a useful legal mechanism, not a plot device in a Dickensian morality play. The same should be true for municipal bankruptcy.