Detroit Bankruptcy Provides Global Lessons

Sep 18, 2015 by

Tom Watkins –

These days, China, in its attempt to straddle capitalism and socialism, is experiencing cracks in their economic system. If there is a lesson to be learned from the Detroit bankruptcy, it is sometimes failure and rebirth is an important part of reality.

“It doesn’t matter if a cat is black or white, so long as it catches mice”. “Cross the river by feeling for stones” – these have been standard phrases first uttered by China’s premier leader Deng Xiaoping, who led China on its current path toward rapid economic growth after Mao Zedong’s disastrous era.

China’s economic plans have worked well, until they didn’t. A 30-plus year run of success, following the epic disasters of Mao’s Great Leap Forward and Cultural Revolution were most welcome by the Chinese people.

Gravity And Stein’s Law

If there’s an iron rule in economics, it may well be Stein’s Law (named after Herb Stein, former chairman of the Council of Economic Advisers): “If something cannot go on forever, it will stop.” This economic law is a way of forcing leaders to address reality.

China has been misallocating its resources. If it does not change course, the country will continue to stumble, turning the Chinese Dream into a nightmare. While President Xi Jinping is in our nation’s capital this month for his state dinner with President Obama, he should dispatch a team to study Detroit’s bankruptcy. There are lessons to learn.

Denial has consequences.

Once more than $18 billion in debt, Detroit became the largest U.S. municipality to ever file for Chapter 9 bankruptcy protection. The city stumbled into disrepair over multiple decades, taking unnecessary risks, its leaders making both bad and corrupt decisions.

U.S. Bankruptcy Judge Steven Rhodes, who skillfully guided Detroit’s bankruptcy proceedings, pointed out that the city’s bankruptcy plan allowed the city to shed more than $7 billion of the its $18 billion of debt and obligations, brought its credit rating up from junk status to “investment or nearly investment grade” and treated the city’s creditors as fairly as it could, setting Detroit on course to restore adequate city services.

The city’s troubles not only impacted the image of the city and the people living in it, it also impacted tens of thousands of people’s pensions and benefits, other creditors, and the economy of the entire region and state. We are already seeing the impact that China’s economic troubles brings on world currency markets.

While the Detroit bankruptcy was painful, it created a once-in-a-lifetime opportunity to shed useless assets and reinvent the city. This phoenix-like rise of Detroit began the moment leaders came together and made tough, painful decisions so that valued assets could be re-deployed to produce productive outcomes.

Mayor Duggan and his team are skillfully leading the Detroit’s rise. The excitement and investment is noticeable and palpable.

Only a return to corruption and poor decision-making will drag the city back to the nightmare it exited.

Lessons Learned

These basic lessons learned from Detroit’s situation could be applied to China:

1)  If you have a hole in your roof- fix it! Pretending to patch a hole does not keep the rain out.

2)  Real leadership matters. Michigan’s Governor Rick Snyder took a calculated political risk in deciding to stop kicking the can down the road and make timely, tough, and painful choices to fix a mess that festered for decades by predecessors. Yes, many other players had a role, but a single leader got the ball rolling.

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Governor Rick Snyder

3)  In baseball, one learns very quickly you can’t steal second base with your feet still on first. You also learn that once you make the decision to go, there is seldom time to turn back. By making the turn of bankruptcy, the city let go of the past that was holding it forever on first with no hope of scoring a run.

4)  When swimming, you learn that if you sink to the bottom of the lake, there is nowhere to go but up. A city, state and nation can’t simply lie on the bottom and drown. All efforts must be made to return to the surface to live another day.

5)  Act. Act like President FDR during the Great Depression when he said, “Do something. If that does not work, do something else. But for God sake do SOMETHING.” By acting, Detroit cut loose the anchors of the past and set sail for a new and better tomorrow.

6)  Take the bitter medicine. The first step towards recovery is admitting you have a problem and doing what is necessary, no matter how painful the fix.

7)  Respect the people enough to tell them the painful truth:  Pain will come before recovery and some will not recover from the pain.

8)  Demonstrate there is a light at the end of the tunnel – and it is not a train. Dish out the reality of the situation with doses of tenacity, persistence, hope and eventual recovery.

9)  Prevention is the key. With truthful leadership, thoughtful decisions, mid-course corrections and not denying reality, most financial calamities can be avoided. Making promises that are knowingly impossible is a prescription for disaster.

10)  Budget. Make decisions that are rational and for the long haul, not for short- term political expediency. Remember, there are only 3 true ways to balance a budget:

1) Increase revenue.

2) Decrease expenditures.

3) Some combination of the two.

Tim Worstall, Forbes Magazine contributor and Senior Fellow at the Adam Smith Institute in London puts it this way:

“The underlying point being that making a loss is not just a problem for the organization that is making a loss. At the level of the whole economy it means that everyone is getting poorer. We have some assets here that are worth, say, $100. We use them to produce something that is worth $90: that’s what making a loss means, that the costs of production are higher than the value of what is produced. Society as a whole is now $10 poorer. This obviously isn’t a situation we want to see continuing. We would much rather, at whatever cost in debt and or shareholder losses, see those assets moved off to do something else, where perhaps $100 worth of assets might make something worth $110, making the society $10 richer.” http://www.forbes.com/sites/timworstall/2015/08/30/what-china-needs-to-learn-bankruptcy-is-the-most-important-part-of-capitalism/

China’s leaders must address the fundamental and underlying problems facing their economy. China has companies and municipalities with debt that is not repayable and assets that are being wasted.

Perhaps a look to Detroit might work. See what decades of denial followed by facing reality and making tough choices with solid leadership at the helm can accomplish.

“If something cannot go on forever, it will stop.”

 

No country, state or city can outrun Stein’s Law.

Source: Detroit Bankruptcy Provides Global Lessons

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