Term Sheet

The latest on private equity, M&A, deals and movements — from Wall Street to Silicon Valley

What Detroit can learn from cities that fell (and survived)

August 20, 2013: 11:09 AM ET

Detroit may be the biggest municipal disaster, but it's not the first.

By Preston Cooper

detroit-20130819-620xaFORTUNE -- How do you get the Motor City revving again? Since Detroit filed for bankruptcy last month, many have wondered if and how it could make a comeback. Recovery is never easy; bankruptcy or default can wreck a city's economy and kill its credit rating.

Municipal bankruptcies are rare. Several cities have come close, and only 61 cities and counties have filed in the last six decades. They all have a different story from Detroit's, but some faced similar hurdles and could certainly teach the Michigan city a thing or two about how to follow a similar path to recovery.

Here are three lessons for Detroit from cities that fell before it and survived:

Pittsburgh: Grow up

While Pittsburgh never went bankrupt, its decline played out similarly to Detroit's: Both saw acute population loss during the second half of the 20th century. Both also witnessed the demise of their city's major industries -- for Pittsburgh, it was steel in the 1980s; Detroit has never recovered from losing its once thriving auto industry.

"[Detroit must] figure out what it's going to be when it grows up," says Tom Murphy, who was mayor of Pittsburgh from 1994 to 2006 and oversaw a resurgence in construction.

MORE: How business just won in Detroit

Like Pittsburgh, Detroit could reinvent itself. After the collapse of the steel industry, Pittsburgh suffered an employment mismatch, where workers who specialized in manufacturing weren't qualified for other jobs. Over the years, however, the city shifted into a services economy with growth in the health care and education industries. Eventually, Pittsburghers adapted to jobs in the new sectors.

"Pittsburgh is rebuilding again," declared a Pittsburgh Post-Gazette editorial in 1998. Murphy oversaw an infusion of tax dollars, in partnership with major businesses, to construct two stadiums and a new convention center. The paper cited new construction of offices and shopping centers as a reason for the city's "Renaissance III" that brought commerce back to the downtown.

In Detroit, officials have expressed optimism that the city's downtown could see revitalization.

Prior to the bankruptcy filing, Emergency Manager Kevyn Orr announced plans to invest $1.25 billion in Detroit's failing infrastructure with the hopes of spurring economic growth. He often cites the movement of young businesses, such as Quicken Loans, to the city's downtown as evidence that Detroit has a renaissance of its own underway.

Orange County: Boost incomes and raise property values 

In 1994, Orange County, Calif., went bankrupt, but the wealth of its citizens cushioned the blow to its overall economy. Despite a staggering $1.5 billion bankruptcy and a 41% cut in municipal services, the county's overall economy grew steadily through the late 1990's. Total personal income rose by 42.8% between 1994 and 1999, compared with 34.7% nationwide. A diverse economy -- with major sectors ranging from high-tech to retail to tourism (it's the home to Disneyland, after all) -- propelled the boom.

It's hard to imagine how Detroit could replicate this, given an unemployment rate that stands uncomfortably high at 16% (more than twice the national average) and a median household income that barely clears $25,000. But policies designed to accommodate the growth of business in the downtown, such as infrastructure development, would bring higher-wage jobs to the city.

MORE: Luxury automakers' 12 most deluxe cars

Economic growth is an intrinsic part of any recovery, as seen in Orange County. Here growth alone -- voters refused to approve any tax hikes -- generated the tax revenues necessary to restore services cut in bankruptcy.

Strong growth in home prices also raised tax dollars for the county. In the five years after bankruptcy, from 1994 to 1999, the median price of a single-family detached home in Orange County increased 75%, according to the California Association of Realtors.

The prevalence of blighted and abandoned buildings in Detroit's downtown is a drag on property tax revenue, and so recovery policies should focus on filling these buildings. Driving down the numbers of abandoned buildings is a double boon for property tax revenue. Not only do the new owners pay taxes, but their occupancy of the buildings also increases the value of surrounding properties. After all, no one wants to live next to an empty house.

Cleveland: Restore credibility

The last solution is a political one. When looking for short-term help, a change of face can often persuade current and potential creditors with the reassurance they need to extend a lifeline to the beleaguered city. After its 1978 default, Cleveland's change of mayor showed how this could work.

Like Detroit, Cleveland suffered heavy population losses in the lead-up to its bankruptcy, seeing a 24% population decline during the 1970s. That, coupled with a recession, led the city to default on debt repayments of $15.5 million.

Six local banks held the majority of the debt. Mayor Dennis Kucinich, whom a 1993 survey later named the seventh worst mayor in American history, tried unsuccessfully to refinance the debt. It wasn't until George Voinovich replaced Kucinich as mayor that the banks agreed to refinance $10.5 million in defaulted bonds and lend the city an additional $25.7 million. Cleveland eventually produced a surplus and was able to pay its obligations.

The entry of Voinovich brought some much-needed credibility to Cleveland and was largely the reason the city got the help it did from the private sector.

Detroit's mayoralty suffers from its own credibility problems -- former Mayor Kwame Kilpatrick has a laundry list of scandals and felony charges attached to his name. Current Mayor Dave Bing will not run for another term.

Businessman Mike Duggan looks likely to win the upcoming mayoral election. His history as a reformer who led the Detroit Medical Center back from the brink of bankruptcy could play well with creditors skeptical of Detroit's ability to manage its finances. Emergency manager Orr's status as a budget-savvy outsider may not hurt, either.

Many other cities, even major ones like New York, have ventured to the brink and returned. Detroit can do the same, but its economic recovery will require an acknowledgement that the city must evolve. Reinvention and learning from history are the makings of revival.

Join the Conversation
Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.