September 27, 2013

A Bailout for Detroit's Bad Fiscal Practices

Eileen Norcross

Senior Research Fellow
Summary

Administration officials recently announced that Detroit will receive $320 million in federal and private aid to help in the recovery of the bankrupt city. Mercatus Center scholar Eileen Norcross writes that the move is both unsurprising and perhaps precedent setting for other cities struggling to solve their budget problems.

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Administration officials recently announced that Detroit will receive $320 million in federal and private aid to help in the recovery of the bankrupt city. Mercatus Center scholar Eileen Norcross writes that the move is both unsurprising and perhaps precedent setting for other cities struggling to solve their budget problems.

"I am not entirely surprised by the bailout, which sounds like a mini-stimulus via federal municipal grant programs. And I openly wonder what it portends for other cities that find themselves looking at similarly dire economic and financial situations."

In particular, Norcross has warned that a big part of the problem is that Detroit and many other municipalities are underestimating their pension liabilities.

"That illusion of 'overfunding in boom years' flows from the practice of discounting liabilities based on expected asset returns.

How much damage has this accounting assumption and all the behaviors that flow from it caused? For Detroit – a significant amount. The city reports its pensions are underfunded by $634 million. It’s actually underfunded by $9 billion on a market basis."