When Detroit declared bankruptcy last week, the financial
markets took the news more or less in stride. However, this could
become yet another factor affecting interest rates on savings
accounts, mortgages and other bank products.
Detroit is the largest American city to file for municipal
bankruptcy. It has just over 700,000 residents, and its financial
liabilities could reach $20 billion. At a staggering $28,500 in
liabilities per resident, that presents a compelling reason why the
city declared bankruptcy.
Indeed, Detroit's condition has been so bad for so long that
perhaps the muted response from the financial markets can be
chalked up to a sense of inevitability. Still, while this
bankruptcy may not have been a huge surprise, it does raise a
number of questions whose answers are as yet unknown:
Detroit is far from the only U.S. local government in deep
financial trouble -- even some states face unmanageable pension
obligations. Mayors, governors and other officials around the
country are going to be watching the Detroit bankruptcy
carefully, and if it turns out to be a fairly painless way of
hitting the reset button, expect a series of other governments to
start showing up in bankruptcy court.
How far does Detroit want to go?
Bankruptcy does not have to be drastic. Sometimes, a slight
reorganization of obligations can structure them in a more
manageable way. If, on the other hand, Detroit looks at this as
an opportunity to wipe much of the slate clean, expect it to have
a much more disruptive impact on the pension system and on
lenders -- if, of course, the bankruptcy judge goes along.
How do Detroit's creditors make up their losses?
The lenders and bond holders to whom Detroit owes money have
their own obligations to meet. If they are caught seriously short
by Detroit's bankruptcy, then there could be a ripple effect of
What are pensioners going to do?
While private employees have largely been set adrift on the
uncertain waters of defined contribution plans over the past
three decades, public employees have enjoyed the certainty of
defined benefit plans. Detroit's bankruptcy could undermine that
certainty, and add to
America's already troubling retirement crisis
Will lenders become more reluctant?
As it stands now, banks already have very low ratios of loans to
deposits, meaning they have little incentive to attract more
deposits. If high-profile loan defaults make banks even more
skittish about lending, it could result in a worst-of-both-worlds
scenario for consumers, where loan rates go up while rates on
accounts and stay near zero.
From Wall Street to the European Union, the domino effect when
one of a series of interdependent entities gets in financial
trouble has been painfully evident in recent years. With its
bankruptcy announcement, Detroit becomes the latest domino to
wobble. How far it tips over and how many other dominoes it takes
with it will be an important story in the second half of 2013.