By Mohamed A. El-Erian
FORTUNE -- The strong and impressive recovery of the U.S. auto industry has proven insufficient to prevent the proud "Motor City" having to declare bankruptcy. The next steps involve difficult and complex legal and financial issues, some of which conflict with traditional concepts of social justice. There are also questions as to whether this largest-ever city bankruptcy in American history will have negative impacts that extend beyond a community that has already suffered through too many tragedies.
Detroit's bankruptcy has been years in the making. It is the result of repeated political and financial mismanagement, inappropriate financial engineering, and institutional failures. The auto industry's initial inability to withstand international competition eroded jobs, incomes, and tax receipts. As the city suffered, people, companies and jobs migrated to other more buoyant locations. The subsequent erosion of the tax base made it even more difficult to meet expenses associated with public services and pensions, both current and future.
Kevyn Orr, Detroit's emergency financial manager, felt that there was no alternative for the city but to declare bankruptcy. Similar to the 2009 bankruptcy of two of the big three auto makers (Chrysler and General Motors (GM)), the hope is that Detroit will reemerge with financial obligations that correspond more closely to its income and assets.
Already, tough financial and legal issues have come to the surface, including the often-tricky interactions between seemingly-conflicting federal and state laws. And the most complicated aspects relate to burden sharing – or who, among the city's many stakeholders, suppliers and creditors should take a hit, and in which relative and absolute sizes.
This pits pension recipients against creditors, and suppliers against beneficiaries of basic public services.
Should the city pay its senior bond holders while cutting the pension payments that retirees earned and get? Should bondholders who financed investments in municipal services get priority when it comes to allocating payment receipts?
As the seniority of payments implied by legal contracts can often conflict with what many would view as socially just, it has not taken long for some to suggest the need for the federal government to bailout Detroit. In addition to protecting municipal workers' pensions from deep cuts and countering some of the pressure for yet more outmigration, this could also open the door to overriding legal seniority (as occurred a few years ago with the Federal government's auto bailout).
Yet a federal bailout is far from a simple proposition. Even if the political will existed, which is far from obvious, the spillover effects could be considerable:
Whichever way you look at it, Detroit compels the administration to consider yet another difficult choice that is not of its making. But there is also a silver lining to this new cloud.
Detroit's tragedy is an extreme component of an unfortunate reality that still prevails five years after the onset of the global financial crisis: Due overwhelmingly to political polarization and dysfunction, both of which repeatedly undermine proper economic governance, America has yet to deal effectively and comprehensively with its residual problems of insufficient growth and employment engines together with pockets of excessive indebtedness.
Perhaps Detroit's very public financial demise could serve as a catalyst to significantly elevate popular awareness of this sad and unnecessary reality.
Perhaps it could serve as a rallying point and unifying vision that have eluded Congress for too long.
Perhaps it could act as a catalyst for the tough decisions that are needed and which Congress continues to sidestep.
This is certainly the hope of many who worry about America's persistently high unemployment, its stretched social safety nets, and excessive income and wealth inequality.
Maybe, just maybe, Detroit could be a new "Sputnik moment" for American politicians and the electorate. But if this important hope remains just that -- a hope rather than an evolving reality -- Detroit's considerable human tragedy would end up also constituting yet another wasted crisis for America.
Mohamed A. El-Erian is the CEO and co-chief investment officer of PIMCO.
Wall Street is heavily invested in bank debt across the European Union. If banks begin falling as a result of the Cyprus 'bailout,' investors in the U.S. will feel the loss.
By Cyrus Sanati
FORTUNE -- The terms of the Cypriot "bailout" announced late Friday are simply atrocious and should be revised to protect small depositors to avoid potentially crippling bank runs from popping up across Europe. Forcing bank losses on MOREMar 18, 2013 11:07 AM ET
Five years after the U.S. economy teetered on collapse, here are five reasons why we need to stop pointing fingers and fix the problems that nearly sank us.
FORTUNE -- It's hard to believe, but it's been five years and a day since the U.S. financial system's problems surfaced, and we're still not even remotely close to being able to feel good about the economy. My admittedly arbitrary start date is MOREAllan Sloan, senior editor-at-large - Jun 13, 2012 5:00 AM ET
The debt crisis that started in Greece now threatens to topple the whole continent -- and kill the weak recovery in the U.S. Inside the race against the clock to fix the euro economy.
FORTUNE -- At first glance, Yiannis Boutaris would seem to be an unlikely free-market reformer. The 69-year-old mayor of Thessaloniki, Greece's second-largest city, has tattoos decorating his forearms and knuckles, short-cropped white hair, and a face creased MOREShawn Tully, senior editor-at-large - Aug 19, 2011 5:00 AM ET
An outside critique of our analysis: "Surprise! The big bad bailout is paying off"
By Bob Eisenbeis, Cumberland Advisors
A recent column by Allan Sloan and Doris Burke in the Washington Post claims that the distasteful financial bailout not only worked but also generated a profit for the government of at least $40 billion and perhaps as much as $100 billion. Their conclusion is based on their working of the numbers, and the MOREJul 19, 2011 5:00 AM ET
Our recent analysis of the U.S. bailout caused quite a ruckus. Here is our response to the critics who say we omitted some key details.
FORTUNE -- When we wrote our story about the financial-system bailout turning a profit for taxpayers, my Fortune colleague Doris Burke and I (and our editors) decided that less was more. So we showed you our bailout numbers, but didn't give you much detail about how MOREAllan Sloan, senior editor-at-large - Jul 19, 2011 5:00 AM ET
The U.S. government's often maligned $14 trillion intervention not only staved off global collapse - but is making money.
With Doris Burke
FORTUNE -- The bailout of the financial system is roughly as popular as Wall Street bonuses, the federal budget deficit, or LeBron James in a Cleveland sports bar. You hear over and over that the bailout was a disaster, it cost taxpayers a fortune, we didn't really need it, it MOREAllan Sloan, senior editor-at-large - Jul 8, 2011 5:00 AM ET
Could it be time to start kicking the tires on AIG?
It hardly seems like an auspicious moment. Shares have lost half their value this year, including a 3% walloping Wednesday, making the New York-based insurer the worst-performing big stock in the market. The supposedly smart money is having second thoughts, and AIG's (AIG) accounting, never exactly a strong suit, is being questioned again in an unwelcome blast from the past.
Even MOREColin Barr - May 25, 2011 11:55 AM ET
Fannie Mae is nearing another not so magical milestone.
The government-owned mortgage investor posted its latest quarterly loss Friday, blaming the recent house-price double dip for a rise in credit costs. Fannie (FNMA) also said its regulator will ask the government for more money to cover those losses.
The $6.5 billion request from the Federal Housing Finance Agency will bring the company's cumulative draw on Treasury funds since its September 2008 takeover MOREColin Barr - May 6, 2011 5:02 PM ET
Europe may be lurching toward another crisis, but you'd never know to look at the foreign exchange markets.
The euro held firm against the dollar Thursday after an eventful 24 hours on the Continent. Portugal on Wednesday became the third country to ask the European Union for cash to pay its bills, and this morning the European Central Bank raised its benchmark interest rate by a quarter-point for the first time in three MOREColin Barr - Apr 7, 2011 11:47 AM ET
|GM's recalled Cobalt was a failure from the start|
|Michaels hack hit 3 million|
|Walmart offers cheaper money wire service|
|Why you should pay off your car loan ASAP|
|Americans have fallen in love with real estate once again|