It’s already been written that the city of Ypsilanti will not declare bankruptcy, at least not in the foreseeable future. Yet, there are lessons that Ypsilanti could learn from other cities that have been bankrupted.
For many communities all it took to bust their budgets was one mistake, one bad investment. In Harrisburg, Pa., the state appointed a receiver to handle the city’s finances in 2011 after it failed to make payments for a municipal incinerator it constructed in 1972. In Stockton, Calif. which filed for bankruptcy in 2012, the city failed to make contributions to its pension fund and payments for a redevelopment project it started in 2004.
Stockton’s story is most similar to that of Ypsilanti. Yes, Ypsilanti has avoided bankruptcy – its assets exceed its liabilities by $16.7 million – but both have found themselves in financial trouble after redevelopment deals that went awry.
In 1999, the city of Ypsilanti started to purchase real estate on Water Street. The hope was for the city to buy the land and then attract prospective buyers for mixed use development, which would include both residential and commercial properties. These real estate purchases by the city continued until 2006.
Then the real estate market went bust in 2007, and the city was left with land that had diminished in value. A development deal with Freed and Associates also failed to materialize.
The subject of whether or not cities and towns should attempt such development deals or leave it to the free-market is a debate for another time. Surely, a mistake was made with the Water Street project. The city should not have financed the project with the issuance of bonds for multiple reasons, first of which is that this added to the city’s debt burden. Ypsilanti has limited means to raise revenue. The city does not have an income tax or sales tax, and property taxes are already near their constitutional and statutory limits.
Instead the city should have drawn money from tax collections and pooled them into a special fund in order to purchase the real estate. This would have taken more time, but it would have avoided the trouble the city is in now. Because now, not only is the city left with property that it can’t sell – at least not to an attractive buyer – but it also has the debt associated with the real estate purchases.
Private companies make the same decisions in order to finance their operations. The decision is to either finance activities with debt or equity. Equity is the value of the capital (money) involved in an enterprise (assets – liabilities = owner’s equity). Debt isn’t always bad. Borrowing money is a basic function for a corporation whether it is private or public.
Notably, the city made the purchases on Water Street as the bubble in the real estate market continued to inflate. This means the city paid more and more, parcel by parcel, only to be robbed of the capital gains that would have come from resale if the market continued to rise. There was instead a precipitous drop. (The Case-Shiller 20-city home price index fell to 133.97 in 2008 from a peak of 195.35 in 2005).
The debt from the Water Street purchases has more than an explicit cost. This debt load coincided with a deep recession, and a deep drop in property tax collections. So, the city had to cut, and it had to cut more than “fat.” Cuts that would have already been made necessary by the reduction in revenue were further necessitated by the need to service (pay interest) on the debt from the Water Street project.
City officials now have before them multiple proposals to purchase the property. One deal has already been made with Family Dollar. Another proposal includes the development of affordable housing. However, whether or not the city needs more affordable housing is circumspect. Ypsilanti has always been the cheaper option for those who could not afford to live in Ann Arbor. Despite the fact that the city is landlocked, and therefore land to build on is restricted, there has not been the upward pressure on housing prices that you would see in an area like New York City.
Moreover, while economic development may have been the objective rather than profit, the city will lose out on both accounts. Neither Family Dollar nor the affordable housing unit is expected to create much tax revenue according to city estimates. Nor is either enterprise an anchor, or in other words a property which will attract further development. There will be no tax bonanza for Ypsilanti.
When the city will be able to refinance its debt from the Water Street project, or reissue debt under different (hopefully better) terms in 2016, it will have already missed out on the extremely low interest rates held down by the Federal Reserve System as a part of their efforts to boost the economy. The only positive news to report about the Water Street project is that it is unlikely to lead the city to file for Chapter 9 bankruptcy.
City contractor DIA Corporation used its insider position ...