What Wall Street is reading about Detroit today: Four years ago, Dan Gilbert moved his highly successful online mortgage lender, Quicken Loans, from suburban Livonia, Mich., to the new Compuware Building in downtown Detroit. The billionaire, 52, has since invested some $1.5 billion to buy and rehab more than 40 buildings in downtown and nearby Greektown. The buildings, many of which sat half-empty for more than a decade, now house 12,000 of his employees, as well as a growing number of retailers, hip restaurants, and tech outfits, some of which have been incubated by a unit of his holding company, Rock Ventures. In a wide-ranging interview with Barrons, the executive acknowledged that his efforts were guided by more than just altruism or boosterism. I expect to do well by doing good, he said, adding in tech lingo, Detroit has the hardware [infrastructure, landmark buildings, and location] to attract young, entrepreneurial people and thrive if we just get the software [buzz and ambience] right. In a hopeful sign, Gilbert was recently outbid by a Chinese developer for two properties in the area. It at first irritated me, says Gilbert, but after thinking about it, I started giving high-fives around the office. Clearly, a real market had developed in the downtown real estate market, and others were beginning to share his vision. Quicken Loans, which originated $80 billion in mortgage loans last year, is a bright spot in a city plagued by five decades of decline, which culminated in last summers filing for Chapter 9 bankruptcy protection. While its too soon to call a bottom for the worlds former automotive capital, there are other reasons for hope. For example, last November, Warren Buffett attended a press conference to announce the rollout of a Goldman Sachs grant of $20 million to promote entrepreneurship in the Motor City, proclaiming, the resources are here to have a great, great city. But before any real turnaround can begin, Detroit must come to terms with its woeful finances -- terms that will result in severe pains for many of the holders of its crushing $18 billion in debt and future obligations. Some holders of the citys general-obligation bonds could take an unheard of 80% haircut on their principal, while Detroits 22,000 city retirees and 8,500 current employees could see their pensions and health coverage chopped. DETROITS LONG DECLINE is made all the more poignant by its storied past as the one-time epicenter of the world automobile industry. The abandoned Packard Motor Car Plant -- some 40 now-stripped, see-through buildings sprawling over 40 acres -- sits like mute testimony to a once-glorious but now vanished civilization. In all, the city has an estimated 80,000 abandoned buildings. Detroits population, according to decennial census data, has fallen from nearly 1.9 million in 1950 to just above 700,000 in 2010, as the auto jobs in this prototypical one-industry city largely disappeared, the result of plant relocations and automation. Nowadays, Detroit is 83% African-American, the legacy of white flight; over the past 60 years, according to the data, the white population declined by a staggering 96%. Some 40% of Detroiters now live below the poverty line as a result of tragic negative economic selection in the black community. The black middle class also left Detroit in droves over the years, leaving behind an underclass racked with all manner of pathologies. Last year, for example, Detroit and New York both had about 330 homicides. The problem is that Detroit is less than a tenth the size of the Big Apple in population. One can still visit the Motown Records headquarters on Grand Boulevard, now a museum. Its easy to forget that it was about a half-century ago that Smokey Robinson, Marvin Gaye, the Supremes, and the Four Tops recorded their still magical hits in cramped Studio A. Motown founder Berry Gordy, however, pulled up stakes in 1972. Yet, amid Detroits blasted landscape of empty lots and derelict buildings, there are unimpeachable signs of better days to come. The state-appointed Emergency Manager Kevyn Orr, who a year ago was parachuted in by the state of Michigan to take over administration of the city, has fashioned a stabilization plan which, if approved by the U.S. Bankruptcy Court this summer, could materially repair the citys finances. The savings would permit the city to funnel some $1.5 billion over the next 10 years into blight removal, improving Detroits lamentable city services, and refurbishing the citys parks and electrical grid. If nothing else, the threat of an onerous Detroit-type settlement may give other cities laboring under huge retiree pension-fund and health-benefit burdens, such as Chicago, additional bargaining leverage. Moodys recently cut Chicagos credit rating to Baa1, or three levels above junk level. Detroits governance, long a cesspool of patronage, incompetence, and self-dealing, appears to be on the mend. Mike Duggan, a bluff Irish-American with an enviable record as a turnaround artist in public and private life, took over as mayor from his honorable but overwhelmed predecessor, NBA Hall of Famer and Detroit Pistons guard Dave Bing. Already, Duggan is making waves by demanding better performance from city workers, even taking a shift on a city salt truck during a January blizzard. His mantra to Detroit citizens has been give me six months to make things better. Duggan is a far cry from Kwame Kilpatrick, who presided over Detroit from 2002 to 2008, when he was forced to resign as a result of a perjury investigation. Kilpatrick, loaded with charisma and charm but with a distinct predilection for larceny, is now serving a 28-year term in federal prison in Oklahoma after being convicted on multiple corruption counts. The Orr restructuring plan is multifaceted. According to the Detroit Free Press, police will be given new police cars, up-to-date Tasers, body cameras, and vests. The Fire Department and Emergency Medical Services, long operating on a shoestring, will get new rigs and ambulances and the ability to use all of its fire stations, many of which are in a state of disrepair. City street and boulevard lighting, about 40% of which is currently inoperative because of bad wiring and copper thefts, will be fully restored by 2016 with modern LED fixtures. Also getting sorely needed attention will be Detroits deteriorated parks and recreation facilities, and threadbare city bus system. Garbage collection will be outsourced at a distinct savings to the city. Unmentioned are city schools, which are run by a separate government entity. This district has been under state supervision in recent years because of poor performance. Academic results havent improved much since, but at least tighter supervision has eliminated much of the ghost payrolling and equipment thefts by district personnel that had occurred previously. THE TREATMENT OF Detroits $18 billion in debt and other obligations under the plan varies all over the lot. The $5.4 billion in water and sewer bonds, backed by customer water-bill payments, will receive 100% of principal in new bonds. Similarly Detroits $479 million in general-obligation bonds, which have a call on the citys annual state aid payments, will be paid off in full. Holders of $530 million of G-O debt without the state intercept wont all be so lucky. Most of the debt is insured, but $68 million of it is not. Those holders will get about 20 cents on the dollar. The plan calls for even harsher treatment for holders of Detroits taxable $1.45 billion pension obligation certificates, issued in 2005 and 2006 to shore up its public-employee pension funds for uniformed and nonuniformed city workers. The city has sued to void the deals entirely (keeping the money, naturally) on the basis that the borrowings were illegal. Even if Detroit loses the case, certificate holders are likely to get less than 10 cents on the dollar. Even worse, where most of Detroits G-O debt is covered by strong bond insurers who are already covering the timely payment of interest and principal on the defaulting issues, the primary insurer of the POCs is Financial Guaranty Insurance Co., an outfit in run-off and constrained by its regulator, New York state, to pay out no more than 25 cents on each dollar of claims. Naturally, the municipal-bond markets are howling over Orrs rough treatment of investors. The very size of the haircuts proposed on G-O debt shocked the muni market, observes Lisa Washburn of analytic firm Municipal Market Advisors. With their priority pledge on revenues, Detroit G-O bondholders figured a higher recovery of 80 cents to 85 cents on the dollar. A lot of investors bought this debt because they assumed that the state of Michigan wouldnt let its largest city default. That didnt turn out to be the case. Muni investors were initially heartened when the federal bankruptcy-court judge, Steven Rhodes, ruled in December that the citys employee pension plan enjoyed no special protection, deeming the pension plans to be just another unsecured creditor. Yet, the Orr plan would only cut pension payouts to Detroits retirees by 4% for police and fire and 26% for general service employees. The pension payment cuts would have been more catastrophic but for $815 million that various foundations, the state of Michigan, and the Detroit Institute of Arts plan on contributing to the pension funds in order to head off city creditor plans to sell off a number of DIA masterpieces to boost bankruptcy recoveries. Unfortunately, the DIA, which holds major works by Bruegel, Degas, Cezanne, and Van Gogh, is owned by the city, though under the new bargain, the museum would achieve independence from the city. But for all the posturing and threatened legal action by bondholders and their insurers, it remains likely that Rhodes will approve something close to the current Orr plan and cram it down creditors throats. Surely, the citys employees and retirees deserve some favoritism in light of the wage concessions theyve endured in addition to drastic cuts under the Orr plan to their health-care benefits. Retirees, for example, will be pushed onto Medicare or, in the case of police and fire, onto the Affordable Care Act exchanges, with only modest monthly stipends from the city to partially finance their coverage. The citys current employees will also accrue future pension benefits under a far less generous formula. The bond insurers and other Wall Streeters on the creditors committee seem to have scant sympathy for the employees, or anybody else in Detroit. Back in June, some 30 of them agreed to take a bus tour with Orr of the citys mean streets. That was until they were asked to sign routine waivers absolving the city of any liability should the visitors suffer any bodily harm during the tour. The trip was canceled when the Wall Streeters backed out en masse. DETROITS NEW MAYOR, Duggan, has an excellent résumé to lead the comeback effort. In the 1990s, he turned around the citys suburban bus operation, improving service and returning it to profitability. He then held various key administrative positions in Wayne County (which includes the city of Detroit), and was ultimately elected the countys chief prosecutor, in 2001. In that capacity, he won many plaudits for his hard-nosed pursuit of building owners, fast-tracking the seizure of properties that failed to meet building codes. But perhaps his most signal achievement came in 2004-12, when as CEO of the Detroit Medical Center, a group of not-for-profit city hospitals, he was able to return it to profitability while also improving services. Emergency-room waiting times in several of the hospitals dropped from interminable to a half-hour. The hospitals in 2010 were sold to the then-publicly traded Vanguard Health Systems. Duggan is a General Patton type, but with a softer side, who both demands performance and listens attentively to people, observes John Gallagher, a Detroit Free Press financial reporter who has written several books on Detroits problems. During his first three months in office, Duggan hasnt disappointed. In January, he appointed a new overseer of Detroits transportation system, after noting during his morning commute to City Hall that a number of bus passengers were freezing in the gelid temperatures along Woodward Avenue, due to late buses. He also has moved to lower property-tax assessments by up to 20%, reasoning that the sky-high property-tax burden on many homes is leading to their abandonment and crippling of revenues. Duggan canceled an interview with Barrons scheduled for a day when a large water main burst in the cold, and power outages closed down 30 Detroit schools. He doesnt want to talk to the national press until he has major, tangible improvements to report, his press aide explained. Duggan and Orr have worked closely with Quicken Loans Gilbert, whose ties to Detroit go back two generations -- his father ran a nightclub in the city and his grandfather, a car wash. A virtual political embed in the citys revival efforts, Gilbert is a co-chairman of the Detroit Blight Removal Task Force, and is personally providing much of the financing for a recent survey to physically inspect all 280,000 of the citys lots, supplemented by tax records, utility bills, and the like to determine ownership and physical status. Blight removal is absolutely a crucial first step before you can tackle crime reductions, jobs, or education to reverse Detroits fortunes, he insists. Abandoned buildings attract arsonists, crack dealers, and other criminals. They also demoralize entire neighborhoods. Gilbert and trucking giant Roger Penske are among the major private donors to a $140 million, three-mile light-rail system up Woodward Avenue that will stitch downtown and midtown together. Midtown has been enjoying a surge in gentrification, with a burgeoning arts and restaurant scene anchored by the presence of Wayne State University and several major hospital centers. Adding to the urban formula of eds and meds is the midtown presence of the DIA, Detroit Historical Museum, and the citys neoclassical gem, the Central Public Library. Of course, there is still some skepticism. Tom Sugrue, a University of Pennsylvania historian who grew up in Detroit and has written extensively on urban America, observes pointedly, I question how the influx of 10,000 or 20,000 hipsters, artists, techies, and young professionals into downtown and midtown can provide enough trickle-down for blacks, who make up 83% of the citys population and are desperately poor. No Rust Belt city -- not Cleveland, not Pittsburgh -- has a black underclass nearly as large or a history of racial conflict as fraught as Detroits. THE CITYS NEW POLITICAL LEADERSHIP and financial rescue, at least, gives Detroit a shot at escaping the lethal negative feedback loop of deteriorating city services leading to depopulation that, in turn, spawns even worse city services. Downtown and midtown may constitute only a tenth of Detroits total dimensions, but the neighborhoods boast more than half of the citys jobs. And theres an undeniable multiplier effect at work with good-paying yuppie jobs giving rise to additional service jobs, from table bussing and private-security work to financial advice and tax planning. Also, Michigan Gov. Rick Snyder recently proposed assigning 50,000 EB-2 visas -- employee-based green cards -- to highly skilled immigrants who agree to live and work in Detroit. Nobody expects Detroit to return to its former size or even, perhaps, eminence. But just holding to its current size of about 700,000 souls on a financially self-sustaining basis would still leave it the largest city in Michigan and linchpin to a southeast region of Michigan that remains a global leader in automobile-industry research, design, and intellectual property. Clearly, the citys footprint will have to shrink, since it cant afford to provide city services to the citys entire 139 square miles. Various plans for the new Detroit have been advanced, including an academically oriented study released last year called Detroit Future City. The study envisions a Detroit with a vibrant central core surrounded by an archipelago of new communities with more density and greater variety of housing options than currently exists. In the interstices of the citys sprawl, the plan recommends reforestation, agriculture, greenways, and blueways of ponds and streams to beautify the area. Utopian in concept? Sure. But on the tabula rasa that is now Detroit, some of this kind of development is already occurring spontaneously. With plenty of surplus land to spare, Detroit already has about 1,000 community gardens. Financial-services entrepreneur John Hantz has bought 1,500 blighted parcels from the city in the Eastside near his home in upscale Indian Village, and cleared the land of derelict structures, tires, and other refuse piled in vacant lots. Among other things, hes in the process of planting rows of hardwood trees like oak, sugar maple, and poplar to make neighborhoods more livable for poor residents. OBVIOUSLY, SUCH NEIGHBORHOOD relocations to right-size or, in the words of some opponents, white size Detroit will encounter some resistance, as has a similar plan in New Orleans. But if truth be told, the working-class neighborhoods of Detroit have never engendered much homeowner identification or multigenerational occupancy. The housing stock in Detroits sprawling blue-collar neighborhoods is mostly single-family, but of second-rate, frame construction, unlike the brick bungalows and six-flats found in similar neighborhoods in, say, Chicago. Thats because Detroit, as one academic notes, was really like a Western mining boomtown where little attention was paid to urban planning or aesthetics when it came to worker homes. Neighborhoods were deemed as disposable as the cars auto makers churned out following the dictates of planned obsolescence. Dan Gilbert envisions a future where poorer residents with sufficient incentives can be relocated to better housing with commercial districts offering real amenities beyond the party stores that currently predominate, offering just booze, smokes, lottery tickets, and cheap snacks. Well be able to auction off to developers cleared space where 500 houses once stood, with all the infrastructure -- streets, sidewalks, gas, electric, and telephone -- already in place, he says. Federal Housing Administration financing is in place. Then, offering a free-market spin, he envisions the developers being required to include charter schools and a police substation in the mix. THE TRANSFIGURATION OF Detroit will take years to accomplish, to be sure. But the city has elements that similar urban basket cases like Gary, Ind., and Newark, N.J., lack. Namely, a storied history typified by magnificent Art Deco buildings downtown and a rich cultural history. Whos to say that Detroit cant be an American version of Manchester in England or Leipzig in Germany, where a combination of government assistance and private initiative brought those overseas cities back from industrial wastelands? Such miracles arent impossible. Corrections: Barrons incorrectly stated that Dan Gilbert moved Quicken Loans to Detroit from Troy, Mich. Quicken Loans was previously located in Livonia, Mich. E-mail: editors@barrons
Posted on: Tue, 18 Mar 2014 13:12:30 +0000