Detroit filed the biggest municipal bankruptcy in U.S. history on Thursday, July 18. Creditors and unions are opposing the bankruptcy and challenging it in a court battle, which ensued on Wednesday, July 24.

The Arab American News sat down with the director of graduate studies in economics at Wayne State University, Allen Goodman, to make sense of the complicated financial situation in Detroit — in English, as opposed to economic hieroglyphics.

“The City of Detroit owes an awful lot of money; $18 billion,” said Goodman. “And bankruptcy means that an entity–a person, a company, a city or a firm–cannot pay its debt, and it wants a relief from having to pay all its debts, along with a plan to settle what it can.”

Goodman explained that the City’s debt is in the form of bonds owned by banks and regular people. He suspects that even if the City wins the legal battle, it cannot totally default on its debt, meaning the bonds will still be worth something, but their value will decrease.

He said that the City has three areas where it spends money. The first is in its day-to-day operations, such as providing services to citizens and paying employees. The second includes a set of self-financed pension obligations. The third is paying the bonds to people from whom it has borrowed money.

“And by declaring bankruptcy, the City– in this case the Emergency Manager Kevin Orr– is saying that, given our revenue stream, from property and income tax, we cannot provide services, and pay the pensions, and pay the bonds, so we want some sort of relief from having to pay everything that we owe,” added Goodman.

Besides requesting relief from its debt, the City will be looking pay less in pensions to its employees after retirement than it had promised them. It was recently discovered that there is a $3 billion gap between the pension funds the City has and what City employees have been promised.

Pensions are retirement plans, where employees give a certain amount of their paychecks to an independent fund, where the money gets invested and grows. After retirement, employees get paid a certain amount of money, periodically, from their already saved pension money. 

The WSU professor explains that pensions should be self-sufficient, but three reasons might have led to the under-funding of Detroit’s pensions.

The first reason is that pension allocations might have not been subtracted adequately from employees’ paychecks.

The second reason is that money, put in by employees, was not growing at the rate that it was expected to grow. Detroit pensions are supposed to have a 7 to 8 percent yearly interest rate, but the money might have been growing at a slower pace. 

“A real conservative rate of interest is more like 2 to 3 percent; 7 percent is a very, very high, and the money might not be growing at that rate.” said Goodman. “As a result of that, the pension becomes under-funded.”

The third reason is “over- promising;” where the City promises more money in pensions than it can actually acquire from employees’ pay.

Goodman says that he has not “dug into all the records,” but all three errors seem to have occurred in Detroit.

He said that the pension gap does not mean that employees will not get anything after retirement, “but, for example, a guy who was supposed to get $20,000 a year will get $18,000.”

The professor said that if the bankruptcy goes through, more City money might be appropriated to City services, such as police and traffic lights, which is what the average Detroiter cares about. 

However, according to Goodman, future City employees will demand a higher pay, because bankruptcy would prove that pensions are not guaranteed, and future debtors will demand a higher interest rate, because bonds are less secure.