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Looking into the abyss

Two gaps threaten Detroit, one of dollars, one of credibility

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Published 3/30/2005

In his State of the City address last week, Detroit Mayor Kwame Kilpatrick laid out many problems that were created before his administration and contributed to the enormous budget deficit that has put the city in crisis today.

But he failed, in any specific way, to describe his own part in the mess and what he’s done and will do to fix it.

And, as if trying to erase hundreds of millions of dollars in budget shortfalls weren’t enough, Kilpatrick has another problem that complicates it further.

It’s a credibility problem. His credibility.

None of Kilpatrick’s budget forecasts in his first three years as mayor have been correct. And one year ago at this time, the city had a $93.5 million deficit that his administration either didn’t know about or covered up.

In its handling of the city’s budget woes since then, the Kilpatrick administration has either withheld or been uncertain even about the extent of Detroit’s red ink through this fiscal year and the next.

At press time, the mayor’s office had failed to return several phone calls or respond to faxed questions trying to clarify the murky budget picture.

Kilpatrick has been clear, however, in heralding visible progress in development, especially downtown.

But in spite of recent 20-year-record numbers of new building permits, a 30-year-record high in new single family units, as well as the downtown additions of Campus Martius, many new restaurants and bars, the revitalization is not intense enough to make up for losses.

So in April — in a year when Kilpatrick and the entire City Council are up for re-election — the mayor will have to cut as much as 15 percent, or $265 million, from the city’s $1.6 billion general fund budget to meet estimated shortfalls. That could mean as many as 2,000 layoffs in addition to the more than 600 announced in January, cuts that will impact services such as mowing grass, trimming trees and maintaining parks, as Kilpatrick reduces Detroit’s bureaucracy to fit a population shrinking by 10,000 people a year.

It’s going to be very difficult, both in terms of what must be done to balance the budget and doing it in an election year. City residents and union workers have fought the mayor on every cut he’s tried so far, from closing the Belle Isle Aquarium to a reduction in bus service, cuts that represent just a fraction of what has to be accomplished.

Since January, the mayor has trimmed at least $45 million from the city’s budget with more cuts in the works, according Council fiscal analysts. But by June 30, when next year’s budget is adopted, the mayor will have to cut nearly five times that much — unless some parts of the deficit are left for future budgets, as has been done in the past.

To cushion the impact, the city will cut in stages, Kilpatrick spokesman Howard Hughey says. But April is expected to bring a big hit.

“This budget is going to be ugly,” Detroit Finance Director Sean Werdlow says. “But we as a city have to do it. I feel comfortable that this administration has done everything humanly possible to avoid layoffs. This is the final frontier for Detroit now.

“We’ve gone and cleaned up our house and now we’re ready to tackle the real issues. We can look the union and everyone straight in the face now and say, ‘This is it. This is the last batch to right-size this workforce.’ I feel comfortable with the future of the city. We are doing the things we are supposed to do.”

But critics are raising concerns about Kilpatrick’s credibility on Detroit’s budget. State law requires cities to erase deficits as they are verified. Last year, the Kilpatrick administration ignored or was unaware of a $93.8 million deficit when it passed this year’s budget. At the time, in April 2004, the administration said the books were balanced. By September, not only had the $93.8 million hole opened up, but this year’s receipts threatened to be more than $60 million out of balance. In other words, the budget adopted on June 30 was more than $150 million off.

When it comes to Detroit’s balance sheet, the administration “is either being disingenuous or they don’t know what they are doing,” Detroit Auditor General Joe Harris says.

In the last three years, Detroit has spent in excess of $225 million more than it brought in — even after borrowing from Wall Street to fill the gap. The administration borrowed about $200 million each year to pay debts, and still ended up in the red, Harris says.

“It’s irresponsible in terms of disclosure, as to where we are in terms of our financial status,” Harris says. “We never should have gone into debt to balance the budget. We should have been able to project the deficit and we should have laid off the people.”

Kilpatrick has laid off more than 1,000 employees in his three years in office for an estimated annual savings of $80 million. Harris says more layoffs should have occurred earlier. And there’s growing concern that Kilpatrick doesn’t have a well-studied plan to deal with the deficit that includes input from all parties and explores options to ensure cuts are as smart and painless as possible.

“I wonder just what they [the Kilpatrick administration] are thinking,” Harris says. “What is the methodology? Wouldn’t it be nice if we had a strategic plan on how we are going to do this over the next five years? There is no plan. And there never has been.”

Some say former Mayor Dennis Archer should have done more, when the city was enjoying record incomes, to “right-size” the workforce. Instead, he added 2,000 new employees to the city payroll. Some blame Detroit residents who left for the suburbs and took their tax dollars and spending power with them, while others point to the tax and insurance burden in Detroit, and poorly performing schools, as incentives to leave.

“It’s our fault as a city,” Werdlow says. “These problems have been here for years and years, and we didn’t start making some of these tough decisions until recently. It’s everybody’s fault. The writing’s been on the wall. The world is being expected out of this administration. You can’t create Rome in a day.”

Despite the obstacles, experts say Detroit can do it, as did New York City and Philadelphia over the past 30 years, and now Buffalo, N.Y., Pittsburgh and a host of cities nationwide facing mammoth deficits. Detroit can do it, the experts say, if the unions come to the table and if the mayor takes serious, quick, wise actions to reduce the workforce.

“We have agreements with the unions. Unless they are changed, we’re screwed,” Harris says. “There is no way out of this morass until we change the terms of those agreements.” Specifically, Harris says the city needs to reduce benefits to workers before their costs swallow the city’s annual income.

“If the unions aren’t willing to renegotiate, I think a receiver should step in to take matters into their own hands,” Harris says. “The City of Detroit has to compete with Ferndale and Royal Oak and Harper Woods. We’re not competitive because we are so inefficient. Until our employees can be competitive with the outside community, it’s not going to happen.

“The suburbs get it. Until we get it, we’re going to continue to lose people.”

In a report to City Council earlier this month, the director of its Fiscal Analysis Division, Irvin Corley Jr., agreed that the Kilpatrick administration has been vague and “disingenuous” in its release of plans to address the deficits, but also said the council itself needs to start cooperating and stop resisting necessary cuts.

Willing cooperation by all parties “is critical” to digging Detroit out of its fiscal swamp, Corley wrote. “I believe Council must step up to the challenge and begin making the very hard choices necessary to bring spending into line with revenues.

“Continuing to expend efforts on form rather than substance will only lead to something nobody really wants.” That is, a “situation where others, a state-appointed financial manager, will be making the choices, choices we were not able to make for ourselves.”

So he suggested that, when the mayor and the council are butting heads over budget choices, “ask the following question: What would a financial manager do?”

City Councilwoman Sheila Cockrel says Detroit should have an open debate on re-engineering city government, and include unions, business people, experts and residents in that process. “We can’t do this without a plan,” she says. “What are the core services the city needs to deliver? I think we should have a discussion about that.

“The budget process, in my opinion, is not designed to make decisions that are responsible. The approach to the budget is generations old. There’s no strategic discussion. And there won’t be this year.”

Give us your millions

The mood is tense in a Cobo Center conference room as a couple of hundred city contractors settle into their chairs. Detroit CFO Sean Werdlow tells the crowd that if they don’t agree to a 10 percent cut in what Detroit owes them for work beginning April 1, a) the city might go into receivership, b) the companies might not ever do business with Detroit again and, c) the city doesn’t have the money to pay them anyway.

In other words, things are very bad.

“There’s a misconception out there about the city,” Werdlow tells the business people. “The perception is that we have money. We don’t.”

Several business reps plead with the city CFO, saying a 10 percent cut could put them out of business or cause a year-end loss. Werdlow is unfazed. He says Wall Street bond-rating agencies are clear: They want to see cuts and layoffs and an end to borrowing to balance the budget. Werdlow says he can’t legally promise favoritism for companies that help out, or retribution for those that don’t, but both effects are implied. “If the city goes into receivership, all bets are off,” Werdlow says.

Not everyone will comply.

“This is sad,” says Tanya Maslak, of Detroit Rolling Door and Gate, a 76-year-old company that repairs commercial doors. “The city is one of our biggest contracts. But I’m not going to do something that’s going to bankrupt our company. We just can’t.”

Busted budget

Convincing businesses to give Detroit a break is intended to save $10 million for the city this fiscal year, ending June 30. Yet, even if they agree, it’s only a small fraction of what’s needed to eradicate the city’s deficits. Those include last year’s $93.8 million and this year’s projected $64 million deficit.

“What appears to have everyone so frustrated is the inability of the administration to attack this fiscal problem before it got so unmanageable,” Corley wrote in his report to City Council. “Without … drastic cuts in expenditures, which are not being implemented, I don’t understand how cash flow will not become a real issue very soon.

“Just as you cannot continue to write checks from your personal checking account above what you deposit, the City is no better able to do this.”

Detroit auditor Harris agrees, but says the city should be OK on cash flow for the next two years. And whatever cuts are coming in April are anyone’s guess.

The only deficit reduction plan committed to paper and made public so far is a vague, one-page memo delivered to City Council in January that includes several uncertain savings efforts, such as a request for voluntary cuts from vendors and a $20 million savings described as “other cost-cutting options.” On Valentine’s Day, the unions delivered a letter to the city declining cuts hoped to save Detroit $10 million this fiscal year.

City Council has pounded the table for a detailed deficit reduction plan since last summer. Council members Maryann Mahaffey and Sheila Cockrel — who sit on opposite ends of a two-sided council battle and who each supports an opponent of Kilpatrick for mayor (Mahaffey supports Councilwoman Sharon McPhail; Cockrel is backing former Archer deputy Freeman Hendrix) — say their concerns were heightened when the mayor announced cuts to the Detroit Department of Transportation in January without a study of riders and routes. After heavy protest, the mayor backed off the DDOT cuts. With the studies completed, new cuts were announced last week.

Council was angered last month when the mayor announced the closing of the Belle Isle Aquarium for a savings of $500,000, because it wasn’t discussed or included in earlier deficit reduction talks, and aquarium supporters were unsure whether the administration had petitioned private interests to take over the historic site. “You can’t do this without a plan,” Mahaffey says.

In a possible sign of things to come, the administration and the council can’t even agree on what constitutes “a plan.”

Kilpatrick spokesman Hughey says the mayor has been delivering plans and information to the public for months. After inviting national experts to an economic forum to discuss what’s happened in other cities with financial crises, the mayor put out a thick document discussing options, and several consultants have put together proposals for action. Also, Hughey says, the mayor held public budget forums throughout the community to discuss his plans.

“Not to sound flip or crass,” Hughey says, “but I guess it depends on your definition of ‘a plan.’”

Hughey says council plays an active role in what will end up in the city’s budget.

“Ninety-nine-point-nine percent of what’s in the budget we bring to council before it hits the table,” Hughey says. “They have a very strong arm, a very strong influence, and they play a big role in developing the budget. They have the power to veto the mayor’s budget, and that’s all the power you need.”

Ignore the holes

Michigan law requires cities to balance deficits as soon as they’re known. If a shortfall occurs in a budget year, the city must balance it or pay off the debt in the next year’s budget.

But in April 2004, when Kilpatrick presented his most recent budget to City Council, an outstanding $93.8 million deficit from the prior year was ignored, or unknown. At that time, last April, the mayor and his budget director, Roger Short, reported to City Council and to the state that 2003-04 was set to balance.

But it didn’t. Now estimates show a $93.8 million deficit for that year. The city went through three quarterly reports showing a balanced budget before the $93.8 million hole was discovered or disclosed.

Harris says it is incompetence in accounting — not deceit — that led to the unknown deficits: “They do not know what they are doing,” he says.

Failing to account for an outstanding deficit is “bad accounting practice,” says Jeffrey Pardee, a board member and national liaison for the Michigan Government Finance Officers Association. The former Oakland County finance director now serves in that role in Adrian, Mich.

“This seems like the local officials aren’t stepping up to their fiscal responsibilities,” Pardee says. “There’s a law against having an unbalanced budget. You cannot operate legally in a deficit situation. There are several things that can happen if you do. You have to have a plan to get out of your deficit. The plan has to be the first thing in your budget for the new year. If you don’t do that, the state will withhold money until you do.”

Deficits must be balanced when cities complete audited annual reports. Michigan cities must turn in audited reports to the state by Dec. 31. Detroit’s audited report for last year is now three months overdue.

“We are waiting for Detroit’s audited report,” says Terry Stanton, Michigan Department of Treasury spokesman. “If the report shows a deficit, the city will have to provide a deficit-reduction plan.”

Detroit’s books are audited by KPMG, an international auditing firm. In its most recent audit, KPMG noted in a letter to the mayor, City Council and Harris that Detroit should improve its finance operations to assure timely financial statements.

“We believe significant improvement in financial management, reporting and internal controls can be achieved in a centralized finance function,” the letter says. Werdlow says he’s fixing those problems, and the process should be completed by the end of this year.

But Harris is far from convinced.

“This is the worst accounting I have seen in nine years,” Harris says. “We don’t know what we’re doing. I don’t think they know what the deficit is. It’s March, and we still can’t close our books.”

If books can’t be closed and deficits can’t be erased, the state might be forced to get involved even if Lansing politicians don’t want to touch the city’s bleeding books. Under Michigan law, 14 things can trigger a state review of a city’s finances (see sidebar), such as vendors going unpaid. Once an investigation is triggered, state finance officers recommend whether the governor should appoint a fiscal manager to get the city’s books in balance, as Gov. John Engler did with Flint, Hamtramck and Highland Park. So far Detroit hasn’t set off any of the triggers.

Fuzzy glasses?

When the current budget was adopted in June, not only was the previous year’s deficit unknown or undisclosed, but projections for this year were off by an estimated $64 million. Some question whether the administration’s current budget is realistic. For instance, while the city saw a $20 million shortfall in income taxes last year, it budgeted $319 million — $8 million more — in income tax revenue for this year. But by September, income tax receipts already threatened to fall $45 million short of that prediction.

Also last year, the city did not account for a $30 million payment for a new emergency communications system that had already been purchased. Failing to account for expenses at the beginning of the year allows the government to spend money it doesn’t have, creating shortfalls. Reducing projected incomes requires governments to enact cuts — because you can’t spend more than you expect to get in.

“We don’t pad our numbers,” Werdlow says. “Are those numbers somewhat optimistic? Maybe. But if we knock off $20 million, we have to find $20 million somewhere else. At the end of the day, what we’re fighting is population loss. Could things have been done differently? Absolutely. But in reality, not everything occurs perfectly. If that was the case, we’d be in a better situation.

“We did the best we could on the information we had, and we felt the numbers were conservative. It’s a situation where you think you are going to get it, and the market changes. We’d hate to cut services or employees and then have the money come in.”

Normally, income taxes should increase about 3 percent a year due to inflation. But Detroit continues to lose wage-earners, throwing projections off. Werdlow says the city uses local experts from such businesses as Comerica Bank to help make predictions. The administration was taking measures to avoid layoffs, finding savings wherever possible, Werdlow says; overtime was slashed and unnecessary services were ended.

“Some would argue, for a mayor just coming into office, layoffs aren’t the thing to do,” Werdlow says. “You have to get your arms around the situation first. How can you justify cutting people when you’re sitting on money?”

Werdlow gave City Council a lengthy presentation on Detroit’s financial situation in 2002.

“We knew the future was going to be difficult. We knew we’d have to make revolutionary changes,” Werdlow says, adding that everything is on the table. Managers might soon be on the chopping block, he says, because Detroit’s ratio of managers to workers — sometimes one to two — is far too high. “You will see that change over the next couple of weeks.”

Also, new hires will likely be offered reduced benefit plans.

“We’re trying to get unions to agree to some tough concessions,” Werdlow says.

The city’s pro-union bent is part of the problem, Werdlow says. “We’re not here to provide jobs. We’re here to provide services to our residents. We’re not in the business of employment. That’s not our primary business. Our first priority is to our residents.”

How did we get here?

On Jan. 1, 2002, departing Mayor Dennis Archer left Kilpatrick with a nearly $100 million budget hole to fill during his first six months in office. Archer recommended cutting government spending by 5 percent. Instead of doing that, Kilpatrick found one-time fixes to balance the books — mainly, a $100 million payment from the city’s casinos spread over two budget years.

But the deficits have been on the horizon for years. Back in 1997, Detroit auditor Harris began to sound the alarm. In his annual budget address, Harris informed City Council and then-Mayor Archer that Detroit needed to re-engineer its bureaucracy because revenue wasn’t keeping up with spending, and the matter was only getting worse.

Harris is the loudest and most independent voice in City Hall when it comes to matters of financial management; he isn’t up for election nor can he be fired. In 1995, City Council appointed him to a 10-year term, and he’s expected to use the bullhorn even more during this, his last year in office.

Harris explains the city’s money conundrum like this: Since 1957, Detroit has lost an average 19,000 residents a year (that number is closer to 10,000 a year since 2000). Thousands of businesses and plants left the city, bleeding away yet more tax revenue. Most of the people remaining in Detroit are low- to moderate-income earners or seniors who don’t pay much in taxes.

In 2000, the stock market slowed drastically, increasing what the city must pay on its debts. At the same time, the city faced a reduction in its income tax rate, from 3 percent to 2 percent, because Engler Republicans felt the tax was detrimental to the city. In addition, the state continued to cut the amount of money it doled out to Detroit. Meanwhile, annual pension and health-care costs skyrocketed, with pension payments alone increasing more than $100 million a year since 2000.

So, Harris told the city, there must be layoffs. But nobody listened.

“Archer did nothing of consequence to reduce spending or increase revenue,” Harris says, adding that Kilpatrick isn’t better. “It is true that much of this is beyond their control,” Harris says. “You can’t blame Kilpatrick for the 10,000 people a year leaving the city.”

When Archer took office in 1994, the city was coming off five years of deficits, during which time Mayor Coleman A. Young often borrowed to balance the budget. Under Archer, the city enjoyed six years of surpluses, buoyed by the 1990s economic boom. Spending rose along with revenues, and Archer increased the city workforce. Later compounding problems, in 2003, Kilpatrick gave employees a 2- to 5-percent raise. “Why would you give a raise to employees we can’t afford in the first place?” Harris asks.

With surpluses averaging $16 million a year for four years, Archer created a $38 million “rainy day” fund — a budget reserve account encouraged by Wall Street rating agencies. Cities rated highly for investments are expected to keep 10 percent of their budget in such a fund; in Detroit, the ideal amount is $160 million. Kilpatrick’s administration has emptied the fund to fill budget holes.

In 2000, Harris’ predictions came true. Archer’s last year in office saw a $26 million deficit. When he left office in December 2001, the city was facing an additional $75 million shortfall. When Kilpatrick took office, he found money to take care of the shortfall and ended his first budget year with a $2 million surplus. The good times ended there.

Since then, the city has had three straight years of deficits as the local economy soured. City unemployment has reached 14 percent, and the exodus of residents continues from neighborhoods that shoulder the bulk of the tax burden.

Archer says it all started in 2000, when DaimlerChrysler announced it was trying to cut its workforce by 26,000. “That began a very sobering issue for the entire country, but clearly [for] the state of Michigan and, for our purposes, Detroit,” Archer says. Income taxes began to drop. The terrorist attacks of Sept. 11 caused another economic hit.

Archer says he hired more people to take care of the parks and do important work. He looked at privatizing garbage pickup, but a study he commissioned found Detroit already had the most efficient garbage pickup in the country, he says.

“We gave it our best run. We balanced the budget. We got upgrades in how Wall Street looked at us, from junk status to just below ‘A’ grade. I don’t think there’s any question if you could do a better job, but until you sit in that seat you don’t have an appreciation for what the issues are.”

 

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Lisa M. Collins is a freelance writer. Send comments to letters@metrotimes.com.

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