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Weekend Edition

Why Detroit's bankruptcy could be great news for you
Saturday, December 14, 2013

 Finally, some good news for Detroit...
As longtime readers know, the city of Detroit is one of our favorite cautionary tales... It's an ongoing example of what happens when the government's efforts to redistribute wealth fail.
Detroit, once one of the most prosperous cities in America, filed for bankruptcy protection on July 18. And in case you've missed it... this bastion of political scandal, socialism, and malinvestment got the OK to walk away from many of the obligations that have been weighing it down.
 We've been following the decline of the city for years – and how its collapse is a microcosm of what is happening to the U.S. It's some of the best, and most controversial, editorial we've produced.
Porter's original essay appeared in the October 28, 2009 Digest. And he wrote another essay following the news of Detroit's bankruptcy in the July 26, 2013 Digest.
As Porter wrote in July...
Detroit should serve as a stark warning to Americans who believe in liberal social policies, like highly progressive taxes and expensive social safety nets.
These socialist programs don't cure income inequality. They merely destroy wealth by reducing incentives for building businesses and encouraging dependency. That's why societies with lots of government spending typically have few civil institutions and a small middle class.
Here's the message our politicians on both sides of the aisle seem to miss: 50 years ago, Detroit was one of the largest and wealthiest cities in the world. Nearly 2 million people lived there, and it enjoyed the highest per-capita income in the United States.

 And then... Porter described how 1960 changed everything for Detroit...
Liberal Democrats came to power (and have held power since). Their ideas about using the government to build a "Great Society" – using the government to provide a cradle-to-grave social safety net – have slowly transformed Detroit from the wealthiest city in America to a hellhole.
Detroit's population has declined by almost 70% since 1960. Roughly half of the people who remain are functionally illiterate. More than 60% live below the poverty line. And roughly half of all adults don't work. Only about one-third of the city's ambulances are in working order. Almost half of the streetlights don't work. It takes the police an average of 58 minutes to respond to emergency calls. The violent crime rate (no surprise) is five times higher than the national average.
It is shocking to realize that only 50 years ago, Detroit was the shining example for the world of capitalism and civil society. It doesn't take long to destroy wealth.

 So what's the good news?
On December 3, Judge Steven Rhodes ruled Detroit could shed billions of dollars of debt by reducing the amount the city owes to unions, pension funds, and retirees.
"This once proud and prosperous city can't pay its debts. It's insolvent. It's eligible for bankruptcy," Rhodes said when announcing his decision. "At the same time, it also has an opportunity for a fresh start."
 Rhodes ruled that pensions can be cut... And he said a provision in the Michigan Constitution protecting pensions may not stand up in bankruptcy. He's upholding the contract.
Detroit is $18 billion in the hole... And its pensions are underfunded by $3.5 billion. The ability to cut pensions is a potential fresh start for the city.
 Of course, the unions are aghast.
Following the ruling, Sharon Levine, an attorney for the city's largest union (representing half the city's workers), said the labor organization would appeal the decision and that city officials got "absolutely everything."
"It's a huge loss for the city of Detroit," Levine said.
 To the contrary...
Creditors were vindicated for the sins of the General Motors bankruptcy. The government bailout of GM didn't bail out the company... It rescued the union – the United Auto Workers.
GM went bankrupt primarily because it couldn't make a profit building cars... And the main reason it couldn't was because its labor costs were too high. The competition, whose labor costs were a fraction of GM's, crushed them.
When GM entered bankruptcy, it owed $20 billion to the trust established to pay health care for its retired workers. And its pension program was underfunded by $30 billion.
 In short, the government gave GM a $50 billion bailout. Bondholders (who sit ahead of pensions in the credit structure) were nearly wiped out. Taxpayers lost $25 billion. Meanwhile, the unions recovered 93% of what was owed to them. It was a boondoggle.
 Judge Rhodes' ruling in the Detroit case could be a major milestone... Imagine, actually upholding a contract and honoring the original deal that was made with creditors in the case of a bankruptcy. We hope the precedent sticks.
 I asked Retirement Millionaire editor Dr. David "Doc" Eifrig, who is bullish on municipal bonds (those issued by state and local governments), what he thought of the ruling... and how it could influence municipal finance.
The ruling for Detroit is a return to capitalism and the rule of law and property. With GM, the government didn't honor the debt structure and seniority. Bondholders were wiped out. The unions got everything... The government spun it to the people as "We're all in this together as a country."
I'm excited the judge upheld the contracts in place. The claims due to someone who has worked as a firefighter in Detroit for 40 years have always been at risk if the state or city went bankrupt.
It's too bad for individuals who counted on that money... But they needed to account for that risk. I have pension money from the University of Wisconsin. But I'm prepared to lose it in the case of bankruptcy.

 Doc said he believes the ruling will restore some confidence in the municipal-bond market... The fact that the judge upheld the seniority of bondholders' claims adds certainty.
Say you're a large investor and you invest $1 billion in muni bonds believing you're the senior claimant on tax revenue from a certain toll bridge. Then after a bankruptcy, the judge says, "you don't have the claim. The state employees who work on the bridge have the claim." But the legal documents say the workers' claims are junior to yours. It doesn't instill confidence.
Contractual obligations should be upheld. And using the example above, if you're a worker on that bridge, that's your choice. But you should know that your pension claim is junior.
I don't want to sound cold, but you have to recognize the risks... This is also about people taking responsibility as individuals.

 Doc currently has three funds that hold municipal bonds in his Retirement Millionaire model portfolio... And they're all rated "strong buys."
Doc recently published an issue reviewing every open position in the Retirement Millionaire portfolio. He currently has more than 20 positions that are rated "strong buys." It's an important issue to read to help you reposition your portfolio going into 2014.
 In addition to his financial advice, Doc packs his issues of Retirement Millionaire with insights into building wealth, saving money, and protecting your health. It's all designed to help subscribers live a "millionaire lifestyle" on much less money than you'd expect.
Doc also recently released a book compiling his extensive research into how to prepare you and your family to survive any kind of crisis – natural, manmade, or economic. His insights include secrets like the best medical supplies and medications to have on hand (and how to get them) to the No. 1 way to prevent almost any home break-in.
You can sign up for Retirement Millionaire right now for only $39 for one year. You'll receive immediate access to all his Retirement Millionaire reports and his "field manual" on emergency preparedness... And you'll receive a new Retirement Millionaire issue every month for one year. If you decide within the first four months that the service isn't for you, you can get a 100% money-back refund. To learn more, click here.
Sean Goldsmith

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Date Range:12/5/2013 to 12/12/2013