Jul 192013
 

Earlier this week Detroit, Michigan filed for Chapter 9 bankruptcy protection. If the filing is approved then basically it means the city’s assets are protected from debt collectors. If a person buys a home or a car and is delinquent on their mortgage payments then the lender has the right to evict the person and sell the house to get their money back. Most people can afford to make their payments on time as long as they have an income. But Detroit is so deep into debt that its income isn’t able to meet its current obligations anymore.

Going through bankruptcy will give the city the opportunity to restructure its debt meaning it won’t be paying back everyone it owes money to. It’s disheartening to realize that Detroit was once America’s 4th largest city with a population of 1,800,000, but today it’s only home to 713,000. The city was once known to be the automotive hub of the country but in the last 6 decades it lost 90% of its manufacturing jobs from 296,000 in 1950 to fewer than 27,000 in 2011. Today the unemployment rate is 18%, and 60% of children live in poverty 🙁

13_07_detroitcity

But there are a few lessons we can learn from this unfortunate event.

  • Stay liquid and diversify. If one of the largest cities in the US can falter then so can any city in Canada like Vancouver, Toronto, or Montreal. If you want to invest in real estate make sure you don’t buy ALL your properties in one city. There was a time when people thought real estate was a good investment in Detroit. Well now the median house price there is $9,000. That’s nine thousand dollars! Keep your capital diversified and be prepared to move your money if the local economy takes a turn for the worse. It took decades of financial mismanagement for Detroit to be where it is today so the good news is at least these kinds of events won’t catch us off guard if we’re paying attention 😀
  • Don’t rely on a fully funded pension if you are promised one. At least half of Detroit’s debt is owed to the city’s own pension funds, which represent tens out thousands of active city employees and retirees. Imagine a city where the wealthy people are leaving for better jobs elsewhere. At the same time the poverty rate is going up so the city has to spend more money for aid and food stamps. In Detroit the average 911 response time is already 58 minutes. You can see how pension obligations might need to be cut back. It’s all about priorities. If you have a defined benefit pension, good for you 🙂 but if you’re in your twenties like myself, remember that a lot can happen between now and retirement.
  • Live within your means. Detroit actually makes more state-shared revenue than any other city in the state. Last year the city made $2.3 billion in total income. The problem however, is with their over spending which leads to over borrowing. The city has nearly $20 billion in debt and other liabilities. We sometimes hear how Canadians have relatively high debt to income ratios, currently at 162%. Well Detroit is sitting at 870%, ouch. This is a nice wake up call for myself actually as the last time I checked my ratio it was around 500%. Have to be careful. Wouldn’t it be so ironic if on my journey to financial freedom I suddenly went bankrupt >_<

Here are what other random folks on the interwebs had to say about the story.

  • “Exactly what happens when you run out of other peoples money….”
  • “It is no wonder Detroit is in the shape it is. When the laws break down the law abiding citizens move away followed by the legitimate businesses and the source of the tax income is depleted.”
  • “Having your entire economy based on one product sure leaves you open to collapse. Hopefully Alberta finally has a gov’t that gets it”