Joe Scarborough doesn't get it: How GOP and big banks sabotaged Detroit

No, unions didn't kill the Motor City. "In one sense the banks caused it," ex-banker Wallace Turbeville explains

Published December 6, 2013 1:30PM (EST)

Joe Scarborough                (NBC/Today)
Joe Scarborough (NBC/Today)

The same day that Illinois’ Legislature approved a $160 billion “restructuring” of public workers’ pensions, a federal judge ruled that pension protections in Michigan’s state constitution could be overridden as part of Detroit’s historic bankruptcy. Along with fury from unions, that double blow inspired a new round of “I-told-you-so's" from pundits -- like "Morning Joe's" Joe Scarborough -- who frame Detroit as a morality play about politicians who lack the backbone to force cuts on public employees.

To consider what really ails Detroit, Salon called up former Goldman Sachs investment banker Wallace Turbeville, whose recent report for the progressive think tank Demos suggests the pundits have got it all wrong. A condensed version of our conversation follows.

After this decision came out, Joe Scarborough said to his panel on MSNBC, “The problem came from, you know, unions that, you know, push politicians to overpromise benefits that they couldn’t pay for in exchange for votes and money.” What do you make of that kind of analysis?

Well, it’s just based on preconceived notions and not careful analysis of the circumstances. That isn’t what has transpired over the last five years. Because the data don’t reflect that.

And what do they show?

The data show that the current level of salaries paid out by the city, and benefits that are to be paid out are very moderate … The city over the last five years has tremendously cut its operating expenses, close to 40 percent  -- which is mostly salaries -- and is now operating at levels of employee per capita that are imprudent. And the benefits, if you look into them carefully, are quite modest …

The time scales that we’re operating in now suggest strongly that this is largely an issue of a devastated tax base and a reduction in state revenue-sharing, exacerbated by some really potentially concerning cash requirements associated with derivatives deals and overly complex and imprudent financial transactions.

Who’s to blame for the devastated tax basis?

There’s a lot of things. One is the policies encouraged flight from the city … There are several other issues … 70 percent of the mortgages were subprime in the city of Detroit -- so in one sense the banks caused it, right? So there’s lots of different causes that put them in a position where in 2007, 2008, they were absolutely keyed up to be devastated by the financial crisis and the Great Recession.

When you say “the policies encouraged flight from the city,” policies at which level?

State and city … everything from transportation to taxing to regulatory policies … that structural element has been around for a long, long time …

1990 I did a transaction that was designed to produce value so the city wouldn’t be downgraded below investment grade … So that whole issue has lingered and should have been cleaned up, should’ve been addressed aggressively. But it was not …

The way they got crushed is reflected in the tremendous drop in revenues – 20 percent drop in revenues since 2008. They couldn’t bring cash in fast enough.

On the revenue sharing, you wrote following the decision that “the bankruptcy was ‘fixed.’” In what sense?

There was evidence produced before the judge that the bankruptcy was fixed, but he concluded that the evidence was insufficient to say that it was …

I’m not a court and I don’t have rules of evidence, so I can draw conclusions based on looking at something that quacks and walks like a duck, and conclude it’s a duck.

There were tremendous incentives … benefits that the state the political forces that control the state derive from this whole thing ... The city is largely African-American, largely has a certain political philosophy, and [for] a lot of reasons unions are relatively strong forces in the city and can pursue their political agendas. The state is far more characterized by the kind of philosophies that the Tea Party espouses, right? And it’s a state that’s split fairly evenly. That means it's a swing state and is in play in federal elections. It also means it can go back and forth in statewide elections.

So it would be in the political interests of the governor and the prevailing forces in the state Legislature to restructure the city of Detroit and reduce the political virility of Detroit and its environs by politic[s], right? So one sort of looks at the series of events, the whole notion of the emergency manager is for the state to take over the political power of municipalities, and in particular Detroit, which is of course the largest city by far in Michigan, and use the occasion of a financial crisis to give effect to their philosophies. So that, as Rahm Emanuel once famously said, no good crisis should go to waste. There was a disincentive to do reasonable prudent things to avoid the worst, if you will … When it came time to deal with state revenue-sharing effective 2012, '13, the state Legislature elected to reduce state revenue-sharing, particularly as it related to Detroit …

If you look at [the emergency manager’s] recommendations, they’re clearly designed to be based on a philosophy that workers', public employees’ salaries and benefits should be reduced. And that is not so much based on an analysis of whether they’re too high right now. It is based on a belief that that is directly connected to the power of unions …

The outcome was what they wanted.

You wrote that it appears the judge “does not understand the financings yet” including “massive derivatives transactions.” What should the judge and people who are understanding the issue understand about those financings?

It’s not that the city took a bet in 2005 and lost on interest rates. What it was, was … the swap was too susceptible to some of the special things about swaps -- one of which is this termination value concept. And the termination was triggered originally by a downgrade of the city by one grade …

That was what was imprudent about it … The problem is that it gave the banks the right to terminate and call for what is, in effect, all of the future interest that was in the deal … Putting the city in a position that was so precarious, given the benefits of doing the transaction, was extraordinarily imprudent -- to the level that even if the city wanted to do it, the banks shouldn’t have done it. It’s a little bit like subprime mortgages …

It’s not that the documents aren’t being followed. It was an inappropriate product for that customer -- being the city.  And so that’s important to get into to really understand why the termination payment [to banks] needs to be either eliminated or severely, severely haircut, because the financial sector side of the deal didn’t have clean hands.

So is it your suspicion that the banks foresaw this turning out this way?

Suspicion? Oh, of course. There’s no doubt in my mind that either that, or they’re morons. And I don’t think they’re morons …

Given the long-term structural issues with the city of Detroit in 2005 and 2006 … who could conclude that the possibility of a termination from a downgrade wasn’t just remarkably high?

… I can’t see into their heads. I don’t have access to the emails to find out what was really going on. But is it really credible that that wasn’t a severe concern? It was passed over because, I’m sure, it was quite profitable.

What will this decision mean for the future of defined-benefit pensions in the U.S.?

Well, it’s not good ….

Now what the court said is that those obligations are not outside [the judge’s] jurisdiction … The judge, either for reasons of providing cover for himself or actual substantive statement of what his intent is, he did say that it was not a foregone conclusion whether and how much pension and health benefits would be cut. He said that that’s all to be determined … [But] the implication that bankruptcy courts have some power to adjust those obligations is not good …

Mayor Bing, in responding to this decision, said “we can’t continue to kick the can down the road,” and it’s necessary to “make tough decisions.” What do you think the tough decisions -- or easy decisions -- are that the city should make?

There are decisions that have to be made that ultimately enhance the tax base and revenue base of the city … One thing that’s pretty clear from the judge’s statement is he understands the point that … you can’t reduce the cash out … They’ve taken a 40 percent reduction in five years ...

Can you cut the future benefits? You can legally, but can you as a practical matter do that in a way that is both fair to individuals and also sets the city up for success as it tries to do the structural reworking of itself? My conclusion is that there’s little or nothing to be gained from that …

The way to increase revenue is to increase the tax base -- in other words, make the city more productive economically, increase property values. That’s a little bit of a longer-term thing, of course. What I keep coming back to is: The state has the capacity to tide them over. They just do. And since they were part of what precipitated the thing, and since it’s actually in the interest of the state to make this work, and turn Detroit back into ultimately a working, functioning, vibrant place ... they need to kick in some revenues.

That’s the sensible thing to do. And unfortunately the bankruptcy court can’t order the state to do it ... It just doesn’t hold up that the benefits paid out to everybody, or to be paid out to everybody, are just so egregious. They’re just not, and that just isn’t true. But that’s what they want to concentrate on, because it has secondary benefits to them.

By Josh Eidelson

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Bankruptcy Demos Detroit Joe Scarborough Law Michigan Msnbc Pensions Unions Wallace Turbeville