How Your Kids Will Pay for Detroit

It comes as no surprise Detroit is bankrupt.

The city, which had the highest per capita income in the United States in 1960, has been on a downward trajectory since… well… 1960.

Stories abound of thousands of abandon homes… fewer police officers (who solve less than 10% of the crimes committed)… and even fewer jobs. Unfortunately, they’re all true.

The long decline in jobs, property values, and businesses has led to a dramatic fall in city revenue. This is particularly difficult because those left behind in Detroit tend to be the ones who rely on social services.

Then there’s the huge class of people to whom Detroit owes money. It’s this group that is particularly grateful for your future support…

The issue here is how Detroit can spend what little money it has and expects to collect in the years ahead. This involves setting priorities, and working with existing creditors to get them onboard for receiving less than they’re owed.

To do this, the state has appointed a special city manager who recently outlined a plan to address these issues. The manager was clear in his approach: Unsecured creditors – those with no claim on a specific stream of revenue, like water and sewer, or on a specific asset, like a building – should receive around 10 cents on the dollar.

That’s a pretty steep haircut.

Interestingly, this haircut applies to both lenders, such as bondholders, and those who accrued a claim against the city, such as retirees. And this, of course, is where the fight starts.

If you’re an investor that holds bonds issued by Detroit, then you have some homework to do.

You need to figure out if your bonds are backed by anything in particular, or simply the “full faith and credit” of Detroit, which is worth about 10 cents on the dollar.

It’s possible that your bonds have further backing from a particular project or perhaps a specific stream of revenue.

Once you know this, you need to figure out if your bonds are insured, because whatever the bond’s backing, the city wants to pay you less, which leaves only a bond insurance company between you and a big fat loss.

However, if you’re a retiree from the city or one of its supported organizations, then you have another safety net… others who buy health insurance.

One of the largest liabilities of Detroit is healthcare for retirees. This number is currently $5.7 billion and growing daily.

There are virtually no funds put away to pay for this.

Now, not all of that money is due today. It’s what the city is expected to be on the hook for over the life expectancy of retirees.

Part of the city manager’s plan is to erase this liability by moving retirees over 65 onto Medicare, and moving current retirees under 65 (remember, many municipal workers retire in their 50s) onto the as-yet created health exchanges that are part of the Affordable Care Act.

Given that these retirees had separate health benefit plans, I don’t know if they paid into Medicare during their working years, so I will leave that aside. It’s the part about moving current retirees onto the health exchanges that catches my attention… and my wallet.

I would guess that most of the current retirees do not work, or if they do, then they’re not drawing a salary greater than several times the poverty level of their area. This means that when they apply for health care under the new laws, they’ll receive subsidies.

These subsidies are paid for by everyone else in general, but in particular by those who are over-paying for health insurance.

I say “over-pay” because I mean it.

The new health laws are specifically designed to shift the burden of the cost of insuring against a bad outcome – sickness, organ failure, etc. – from those most likely to experience such things, like 50-year-old-plus retirees, to those that are less likely to experience such things, like consumers in their late 20s and early 30s. This means that a young, healthy guy or girl, who is now required by law to buy health insurance, will be using part of his or her premium to support current retirees from Detroit.

Hmmm.

At the same time, there’s the transfer of premium from those around the same age as Detroit retirees who happen to earn above the level that would qualify for a subsidy. These folks, who are also the parents of the young workers, will be sending some of their premium payments to cover the youthful retirees of Motor City.

Interestingly, the emergency city manager of Detroit, Kevyn Orr, called together the creditors of Detroit recently to layout his plan and call for their support. What he did not do was call on those who will be required to foot the bill for part of his plan… those who will be covering the health premiums of these retirees.

You’d think if he’s going to take my money, at least he’d be nice enough to tell me. Maybe my invitation got lost in the mail.

The point is that when cities like Detroit – or even private companies – go bankrupt, they’re always looking to shove off as much cost as possible. Now that the Affordable Care Act requires insurance companies to take all applicants, and we as a nation require young people to buy insurance as well as provide subsidies to those with low income, it’s easy to see how some of these large burdens will once again be handed to the rest of us.

This might not have been one of the goals of Obamacare, but it sure is one of the outcomes.

Look for more of this to occur as other entities, like the cities of San Bernardino, CA and Stockton, CA, deal with their own financial issues.

Rodney

 

 

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About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.