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 🙁
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”
I used to live really close to Detroit (on the Canadian side), so it’s really sad to see this happening. We used to go to Detroit all the time for concerts and Mexican-food (seriously – they took Canadian money at par on Monday’s back when that made a big difference).
I feel for the people of Detroit because my hometown is struggling a lot too (although on a much smaller scale). Like Detroit, it was a one-industry town. At one point my town had nearly 10,000 people, and now it’s less than 2,000… People have had their house up for sale for years, with zero interest. It’s very unfortunate.
That’s really nice of them to accept Canadian money. I hope Windsor, ON can hold its own against a struggling neighbor. Sorry to hear about your home town too. Lots of people want to live the big cities now and the smaller communities that are already short on talent skilled workers have even less.
Wow! That really is sad. Makes me grateful to live in a city with diversity. However, I’d like to find a municipality that isn’t living off loans, taxes and craziness.
Here, I live in the Maryland Capital. We have 8 zip codes. One is for the Navel Academy another is for the Comptroller of the Treasury and the rest is residential and business. Very diverse and lots of people. About 92 thousand people.
Our waterfront downtown area was hit pretty hard with the recession and we lost a lot of business’s but at the same time, new business went in.
However, when we drive further away from home, some of the suburbs have really been decimated and remind me of Detroit.
It really IS an uneven recovery in the US unfortunately. Half of the parks in Detroit have been closed since 2008. The hard truth is that the less money a city has the less desirable it becomes, the less likely for people who have money to move there.
I still don’t quite understand how a city can declare bankruptcy, but its definitely a good reason to make sure you look after your own assets and don’t expect anyone else to help!
Yup, the only way to survive in the long run is to be self dependent 🙂 Works for personal finance, business finance, and government finance. No one has ever been able to borrow their way out of financial difficulty, unless they control monetary policy.
I grew up in Detroit and it’s just so sad to see that the city that was bad when I was growing up actually got WORSE! It’s amazing though the pride that people have for the area. My friends who still live there are saddened, but still hope and believe the city will rebound. I hope it does too!
Me three. I think it probably will recover but will be a very slow and painful process. The business sector of the city is doing quite well. People are making decent wages and investments are constantly going into the city core. It will be difficult to allocate the wealth around to the entire city as a whole though. According to the huffington post, nearly half of Detroit’s adults are functionally illiterate, so that really limits the economic potential for people to get high quality, skilled jobs. But if we give it enough time I hope things will work out.
Useful lesson for you on debt ratio I hope. When you have high debt you have considerable risk should something “unexpected” happen… It is one thing to leverage in good times, but one must always be ready for the inevitable rebalance. Nothing is really guaranteed, but when you own your own stuff, it is much harder fro someone to affect your life. For the record our debt ratio is ridiculously low at 2.5%. Hum maybe I should leverage a little more? – Cheers.
2.5% practically means you have no debt lol. The unexpected could happen at any time. The S&P500 is at an all time high so there’s a concern that it could correct at any time. I think starting next year I will de-leverage my portfolio a bit as I’m getting another year closer to retirement.
Yep, little to no debt my friend (^U^), and trust me in times like these past few years, it sure has made our lives easier and much less stressful than others are feeling even today. as to Mr.Market, my personal thoughts are that we will have a decent run at least into 2014… Markets kind of corrected “went nowhere” late April through end of June, and typically when this has happened, according to my records, the Fall run is good. The wild card will be the tax loss selling of energy and commodity companies in late fall since many are WAY down again this year, so here’s hoping we can at least stay on the main wave for a few more months – Cheers.
That is scary! I wonder what may happen to Detroit in the future, many old industrial towns have seen a new boom as they learned to attract other kinds of businesses, it may not be the best place to live but if a good university or company takes a gamble on the cheap real estate it may be a good time to buy as well. Or “only” a $9,000 loss haha.
That would make for quite an interesting business news to follow if a large company starts buying houses there. Large real estate companies have already picked up hundreds of homes in other cities just in the last year so maybe there’s a chance they’ll go after Detroit in the future 🙂
Geez, I just read your post in my reader. On the same wavelength recently 🙂
Detroit is in a serious mess of trouble. Might become the biggest ghost town on the planet.
Good reminders Liquid.
Yeah, great minds think on the same wavelength :0) I hope other US cities with large amounts of debts can learn from Detroit and avoid bankruptcy.