Ernest Hemingway’s 1926 novel The Sun Also Rises contains the following bit of dialog:
“How did you go bankrupt?” Bill asked. “Two ways,” Mike said, “Gradually and then suddenly.”
This quote is the source of the title of the documentary on the 2013 Detroit bankruptcy, perhaps the most notorious municipal bankruptcy in American history. At the time, Detroit had over $18 Billion in debt – an amount estimated to be more than 30 times its readily available assets. That financial condition was not reached quickly as a result of some cataclysmic event, it was something that built slowly over decades as a result of bad luck mixed with bad decision after bad decision.
At one time, Detroit was an American success story. The city grew rapidly in the first half of the twentieth century reaching a population of 1.8 million in 1950. Detroit was the fourth largest city in the country and had one of the highest per capita incomes. But economically, Detroit was a one-horse town whose fate was tied to the auto industry. The struggles of the American auto companies in the 70’s and 80’s popped the Detroit bubble. That bad luck was reinforced by race riots, white flight, and urban renewal failures. Efforts to restore its glory led the city to promise too much, spend too much and borrow too much. The subprime mortgage disaster and the subsequent Great Recession were the final straws.
Fortunately, local government bankruptcies are relatively rare. Only 31 general purpose local governments (out of nearly 39,000 such entities) have filed for bankruptcy since 2001. [1] Many states, in fact, do not allow municipalities to file for bankruptcy or place severe limitations on the process. However, the conditions that lead to bankruptcy – the inability to pay one's bills – are more of a threat than many people realize. Many cities across the country are borderline insolvent and yet their citizens probably don’t know the full scope of the problems that exist or the ramifications that an unexpected economic blow could have for their day to day lives.
The issues are generally obscured by the gradual nature of the problem. Insolvency is almost always a slow, meandering journey to the edge of a financial cliff, and bankruptcy is the abrupt shove that pushes you over the edge. No one intentionally races into insolvency, we get there almost accidentally by not paying attention and by not looking ahead. We get there by slouching step by step down a path we didn’t even know we were on.
A Local Example
My interest in this topic was piqued recently by two different articles that touched on different aspects of this problem. The first was an article in my local paper on the difficulties that Kansas City, Kansas was having with bridge closures. For those not versed in midwestern geography, Kansas City, Kansas (KCK) is the smaller and poorer sibling to the better known Kansas City, Missouri (KCMO). KCK has a population which is about 70 percent smaller and a per capita income which is about a third lower. It is also a city that is bordered by the Missouri River on the north and bisected by the Kansas River and broad rail yards. Thus, bridges are an essential part of KCK’s connectivity to the rest of the metro area and from one part of the city to another.
If the repairs are critical, why not sell bonds to raise the necessary money? The answer is that the city is already awash with debt, over $800 Million according to the recently adopted budget. According to the County Administrator, nearly 44 percent of the property taxes collected by the city are used to finance debt, more than double what he considers to be healthy. [2]
The core issue is that Kansas City, Kansas has more infrastructure than its tax base can sustainably maintain. Virtually all midwestern cities have suffered from low-density sprawl in recent decades, but Kansas City, Kansas is worse than most. The value of its tax base per square mile is 40 percent lower than comparable cities such as Topeka or Wichita – and neither of those cities are in great financial shape themselves. This is particularly problematic for a city reliant on high-dollar infrastructure such as bridges. A cash strapped city can allow a roadway to crumble and it is annoying but not likely to be life threatening. Allowing a bridge to crumble, on the other hand, can be catastrophic.
Houston, We Have a Problem
During a budget meeting several months ago, Houston Mayor John Whitmire made the following statement in an effort to sum up their financial status:
“I think we can all agree on that, we are broke.” [3]
This is likely as much political theater as it is a realistic assessment of Houston’s financial condition, but it is true that Houston has a serious budget gap that needs to be plugged (as with many large cities). In Houston’s case, the shortfall is approximately $160 Million, or nearly 6 percent of the Houston budget. Unfortunately, efforts to solve the problem are likely to be just bandages that cover up the problem temporarily only to have it resurface in a few years.
The immediate problem is a recent agreement with the city’s firefighters that compensates them for being underpaid for the past seven years in which they worked without a contract. The settlement is going to cost Houstonians $650 Million for back pay and an additional $180 Million for wage hikes over the next five years. But the real mistake, in my opinion, is that Houston is proposing to pay these costs by selling a roughly $1 Billion bond that will take 25 to 30 years to pay off. Paying a short-term operating cost with long-term general obligation bonds is almost always a bad idea. As Strong Towns leader Charles Marohn points out, “A child born today in Houston will make final payments on firefighter back pay from 2018 when they turn 30 years old.” [4] And yes, if you do the math, that means that today’s operating cost problem isn’t likely to be paid off until roughly 2054.
Some observers have criticized the city for having too many employees (including firefighters) and paying them too well. I’m going to stay out of the pay issue, but it is valid to ask why the city needs so many employees. The answer is the same reason Houston has too many streets, too many water lines, too many fire hydrants, and on and on. Houston is a prime example of uncontrolled, low-density sprawl. The infrastructure and city personnel to support that development pattern is why Houston (and many other cities) are slouching toward insolvency.
Marohn refers to this as the “growth Ponzi scheme.” It appears to make financial sense in the short run – new growth delivers new tax revenue with relatively low initial maintenance cost (after all, everything is new). But with each new subdivision, shopping center, and suburban office building comes a commitment made by the city to maintain that infrastructure forever. In the long run, the tax revenue from the low density development cannot sustain the cost of infrastructure maintenance (and firefighters, police officers, maintenance workers, etc.). To remedy the problem, cities chase more growth to gain more revenue which again seems to be helpful in the short term but simply makes long term problems worse because that growth comes with more infrastructure obligations – hence the Ponzi scheme analogy.
The Allure of Low Density Growth
The term “suburban sprawl” is almost always used in a derogatory manner, but there are a few advantages to that form of development. To begin with, Americans are used to living in a big country with lots of land relative to the population, and our nation has deep, agrarian roots that make us think of owning our own chunk of land as an essential part of the American dream. For many of us, there is something psychologically fulfilling about owning a single-family home on a tract of land that is ours and ours alone.
Beyond that, however, low-density development is relatively inexpensive to build – assuming, of course, that transportation costs are low. Hundreds of years ago when the structure of many European cities were being formed, transportation costs were high and most people never traveled more than a few miles from where they were born. Consequently, the development pattern was relatively dense since most people walked from place to place making distance a major “cost.” In the U.S., transportation costs started high, but innovation after innovation has gradually changed the equation. Particularly after World War II, personal transportation via the automobile made distance almost irrelevant.
There are costs, of course – someone has to build the roads, install utility lines, buy the cars, etc. – but those up-front costs seem manageable to most people. The problem is that there are a number of “hidden” costs that people don’t realize exist or have chosen to ignore. The most substantial of these costs is long-term maintenance of physical assets such as roads, bridges and utility lines, and the ever expanding personnel costs associated with operating cities that are expanding geographically. Calling these “hidden” costs is misleading, of course, because all of them can be estimated with relative precision if you are willing to do the work. Unfortunately, these long-term costs can easily be dismissed as someone else’s problem which won’t need to be solved for decades. From the point of view of a politician, is it better to set aside funds for future maintenance and personnel costs or to build something new and shiny for the voters to enjoy? The answer is obvious and so are the eventual ramifications.
The other hidden cost is that if everyone is driving, then the initial street capacity built by the developer is never enough. New development inevitably attracts traffic demand from outside the immediate area. After all, everything is new – new roads, new shops, new restaurants, etc. – who wouldn’t want to break away from the old parts of town to experience the latest and greatest? At the same time, the focus on driving makes alternative transportation modes (walking, biking or transit) so inconvenient that there are no options left other than street expansion. So money that could have been used to maintain infrastructure gets diverted to street widening projects which deliver only temporary relief because they just reinforce the belief that driving is the only way to move from place to place. It becomes a feedback loop that is almost impossible to exit.
A Different Kind of Asset
If cities were run like private corporations, they would account for every asset (every road, bridge, fire hydrant, etc.) with maintenance schedules, depreciation tables, and replacement costs using what is known as the accrual method of accounting. Cities, on the other hand, use what is known as modified accrual accounting which combines aspects of traditional accrual accounting with the simpler cash-basis accounting. In general, the modified accrual method allows short term events (e.g. account receivables and account payables) to follow cash-basis rules while long term events (e.g. fixed assets and long-term debt) follow the accrual accounting rules.
There are, however, a couple of important differences that apply to the accounting of long-term debt and infrastructure assets. First, in full accrual accounting, long-term debt is recognized in the financial period in which it is incurred. The modified accrual method recognizes the current portion of long-term debt as it matures, which means the impact is spread out over time. Second, most public infrastructure is allowed to be treated as an “inexhaustible capital asset,” thereby eliminating the need for depreciation accounting. [6] To take advantage of this modified approach, governments must demonstrate that they are maintaining the infrastructure to a selected condition level. The problem is that defining the appropriate level of maintenance and assessing the degree to which that maintenance is being accomplished is largely left to the government itself which means there is a lot of room for fudging the true state of maintenance efforts and appropriate expenditure levels.
Many cities attempt to track all of their infrastructure assets and maintenance costs but the process is extremely labor intensive. There is the potential payoff of better allocation of municipal resources but that goal is often undermined by political expediency which shifts money away from maintenance in order to solve a short term budget issue or build something with more political appeal.
Part of the problem is that an infrastructure asset is different from a normal business asset (like a factory) or personal asset (like jewelry). To begin with, infrastructure assets are almost always acquired by the city for free. The developer “gifts” the streets, water lines and storm sewers to the city as part of the development process. The only “cost” is the implied promise to maintain those assets forever. Second, the value of the infrastructure asset is very difficult to pin down. No one wants to buy the sidewalk in front of my house so exactly what “value” does that asset have? It does have some value to kids walking to school or people walking their dogs, but pinning that value down – and deciding how much money should be spent to maintain it – is very difficult.
Perhaps the best approach to the concept of value is to think of public infrastructure as an asset that enables the abutting private property owners to create value with their property. After all, a shopping center wouldn’t have much value if it weren’t for the streets and bridges that allow goods to be sent to the shopping center and customers to reach the shopping center to make purchases. The catch, however, is that two virtually identical assets (e.g. streets) can produce wildly different pools of value depending upon the success of the partnership between the city and the private property owners. In some locations, the street may produce a great deal of value that lasts for a long time. But in other locations, private development might not produce much lasting value at all due perhaps to poor planning, shoddy construction, or just bad luck.
This approach refocuses the issue to be “how can cities encourage private property owners to create as much value as possible with the city’s infrastructure assets?” There is no easy answer to that question because cities have other goals (such as maintaining a certain community character) that can conflict with the goal of maximizing property value. Finding the right balance is never easy but to me it suggests a development approach which emphasizes design, durability and adaptability rather than simple development volume.
The Bottom Line
It probably shouldn’t be a surprise that few cities actually follow a detailed maintenance plan for their infrastructure. Cities have a detailed plan, of course, they just find excuse after excuse for not following it. For most cities, the infrastructure maintenance budget is a relatively random number that grows or shrinks depending upon other budget priorities. Municipal decision-makers know they should spend more on maintenance but the allure of growth and the political appeal of something new and improved overwhelm their better judgment.
What is really unfortunate is that every level of government, from the federal bureaucracy to the smallest village board, is structured to focus on building new infrastructure to support new growth despite the fact that the vast majority of cities and counties are actually static or shrinking. It is almost always easier to get a grant to build something new than to get a grant to fix something that is old.
Houston provides an interesting example of this phenomenon. The City of Houston has approximately 16,000 lane-miles of streets that it is responsible to maintain. Given the average life of a street, it means that they should be resurfacing roughly 400 lane-miles of street each year. According to data from the City (via the Bill King Blog), the last time the city resurfaced that many lane-miles was 2004. The average for the past five years has been 146 lane-miles. Clearly, Houston needs help with street maintenance. You might think the State of Texas would assist, but instead the State is pushing the North Houston Highway Improvement Project – estimated to cost between $7 Billion and $10 Billion – to improve Interstate I-45N from downtown Houston to Beltway 8. Repairing stuff is boring, building something new and “improved” is always better!
Our country is growing and community needs change over time so new development is a necessity. There is, however, a right and a wrong way to grow and more often than not American cities are opting for what is familiar and easy instead of doing the harder, more innovative work of building cities that are focused on the needs of the next 50 years rather than the past 50. The Ponzi scheme is going to break down eventually, as all Ponzi schemes do. The question is how much damage is going to be done to your city before you have slouched your way to insolvency?
Notes:
1 Jeff Chapman, Adrienne Lu and Logan Timmerhoff; “By the Numbers: A Look at Municipal Bankruptcies Over the Past 20 Years;” The Pew Charitable Trusts; July 2020; https://www.pewtrusts.org/en/research-and-analysis/articles/2020/07/07/by-the-numbers-a-look-at-municipal-bankruptcies-over-the-past-20-years
2 Bill Lukitsch; “Leaders, residents alarmed by number of bridges on repair list;” The Kansas City Star; September 12, 2024.
3 Greg Groogan; “Mayor John Whitmire says the City of Houston is ‘Broke’ ”; March 2024; Fox 26 Houston; https://www.fox26houston.com/news/mayor-john-whitmire-says-the-city-of-houston-is-broke
4 Charles Marohn; “Here’s the Real Reason Houston Is Going Broke”; April 2024; Strong Towns; https://www.strongtowns.org/journal/2024/4/1/heres-the-real-reason-houston-is-going-broke
5 The Corporate Finance Institute; “Modified Accrual Accounting;” https://corporatefinanceinstitute.com/resources/accounting/modified-accrual-accounting/
6 Government Finance Officers Association; “Modified Approach for Infrastructure Reporting;” January 2019; https://www.gfoa.org/materials/modified-approach-for-infrastructure-reporting
