The Nation's Pulse

Wards of the State

Michigan is seizing control of failed local governments.

By From the September 2011 issue

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How can a state force its cities to stop their fiscal mismanagement? Michigan has an answer: Sweep in and take over municipalities and cut up their costly deals with public-sector unions. Since 2009, Michigan has taken over five city governments and school districts. This includes Detroit's spectacularly inept public school district, which is now under state control for the second time in the last decade, and Pontiac, the former home of the Detroit Lions. This year, thanks to a newly passed law, it may end up taking over as many as 107 more cities unwilling or incapable of getting their financial houses in order. This may include Detroit, whose overwhelming fiscal problems and political corruption continue unabated for a fifth decade.

One city already taken over is Benton Harbor, better known for its scenic lighthouse, low levels of crime (not one homicide between 2007 and 2009), and native son comedian Sinbad than for being a gritty Rust Belt fiscal basket case. In the past decade, the city has all but surpassed Detroit as the symbol of fiscal mismanagement and government incompetence. Between 2006 and 2009, the city's reserves dwindled from $1.7 million to $300,000, while it was paying out at least $80,000 a year in bank overdraft fees. Its defined-benefit pension was underfunded to the tune of $10 million. Last year, a Michigan state investigation determined that Benton Harbor had failed to hand over withheld federal taxes from city workers to the IRS in a timely manner, and that it was siphoning money from some accounts to balance spending in others. The city was so broke it asked state officials for a $325,000 advance to stay afloat.

The state stepped in. It took the city government's finances out of the hands of the grossly inept mayor and city commission and handed them over to emergency financial manager Joseph Harris, a former chief financial officer for Detroit's city government, serving on behalf of the state. Harris proceeded to slash the city's budget to close a $1 million deficit, and began merging its police and fire departments. This year, thanks to a newly enacted state law, Harris has taken over the rest of city government, relegating the mayor and city commission to figureheads.

None of this sits well with either Benton Harbor's officials -- including the old-school black politicians who were responsible for the city's slide into fiscal ruin -- or the public-sector unions that have long profited from its spendthrift ways. And the city's status as a ward of the state has become the latest cause célèbre for race-baiting civil rights activist Jesse Jackson, who is urging the U.S. Department of Justice to stop Harris in his tracks.

Other states are watching what's happening in Benton Harbor and the rest of Michigan -- for good reason. Decades of fiscal profligacy, declines in tax revenues caused by the current economic malaise, and budget-cutting by states struggling with budget deficits have left many cities on the brink of financial failure. Some of them, including dusty Vallejo, California, have already filed bankruptcy; 16 others, including Pennsylvania's own state capital of Harrisburg, may do the same. But cities have found that bankruptcy neither relieves them of their state-mandated obligations to bargain with public-sector unions such as the American Federation of State, County, and Municipal Employees (AFSCME) and the United Auto Workers, nor gives them the ability to cancel decades of costly pension and benefit deals.

Michigan's new city takeover law changes all that. It allows state-appointed finance czars to cancel union contracts or even take control of a local pension fund in order to address a deficit. The finance overlords can also take over underfunded pensions, tossing out the boards that oversaw their financial failure. If the Wolverine State succeeds in turning these cities around, other states may follow with similar measures.

STATE GOVERNMENTS RARELY step in to take control of local governments. When they do, it's usually to run school districts that have fallen into insolvency or become massive dropout factories. (More such takeovers will occur over the next few years thanks to President Barack Obama, whose school reform efforts -- including the Race to the Top initiative and School Improvement Grant program -- are forcing more states to take responsibility for failing schools.)

When it comes to municipalities, states usually limit themselves to management of financial controls. The most famous such instance took place in 1975, when New York State created a financial control board to take charge of New York City's finances and stave off fiscal insolvency. The board's move to end the city's high spending, along with the election of Ed Koch as mayor two years later, helped precipitate the revival of the Big Apple. Earlier this year, the Empire State had to use its takeover powers once again, seizing control of Nassau County, one of the state's wealthiest suburbs, after failing to balance its $2.6 billion budget.

Michigan has had a local government takeover law on its books since 1990, after a state court placed the Detroit suburb of Ecorse into receivership. But in the two decades since, the state rarely used that power. This changed in February 2009, when then governor Jennifer Granholm placed control of Pontiac's budget into the hands of an emergency financial manager after the city ran up more than $60 million in budget shortfalls for five straight years. A month later, Granholm took control of Detroit Public Schools, whose financial misdeeds -- including buying five floors in the landmark Fisher Building for $21 million more than the owner paid for the entire building -- sealed its reputation as the nation's worst urban school district.

As of 2011, Michigan had taken financial control of five local governments. But the emergency financial managers didn't have a whole lot of tools to overhaul finances. State law required municipalities to bargain collectively with AFSCME, UAW, and other union locals regardless of financial condition; the unions therefore had little reason to make more than perfunctory wage and benefit concessions. City officials, particularly miffed that they finally had to answer for their fiscal misbehavior, were still technically in charge of operations; this meant they could sabotage overhaul efforts. When Detroit's then financial czar, Robert Bobb, decided in March to push ahead with a plan to overhaul the district's curriculum, the school board successfully sued to stop the effort.

Granholm's successor, Rick Snyder, decided the financial czars needed more power. In March, he persuaded the state legislature to pass a new emergency financial control law that allowed the czars to cancel or amend union contracts and gave them full power over city operations. With that law in place, the finance czars moved swiftly to repair the damage. In Detroit, Bobb's successor, Roy Roberts, announced a deal under which the state will take control of 45 of its schools, a move similar to what Louisiana did in New Orleans after Hurricane Katrina. Meanwhile, his counterpart in Pontiac, Michael Stampfler, canceled the city's contract with the union representing police dispatchers.

In Benton Harbor, Harris ousted members of the city's commissions and increased city water fees by as much as $46. By June, those moves, along with the merging of the city's police and fire departments, allowed Harris to declare to Benton Harbor's residents that "we do have a positive cash flow."

Of course, neither the law nor the moves by the finance czars sat well with either the state's city officials or its union leaders. Soon after the law was passed, Detroit's pension funds sued to invalidate it; Benton Harbor's officials have also filed their own tort. They, along with left-leaners across the nation, are borrowing from the conservative playbook, declaring that Michigan is engaged in big government overreach. They also accuse Snyder of trying to subvert democracy and push blacks out of political power, conveniently ignoring that all the takeovers so far took place under his Democratic predecessor.

But some officials have found the threat of state takeover a nice weapon in their cost-cutting efforts. Detroit mayor Dave Bing, for example, is using the threat to get the AFSCME local and other unions to agree on cutting $121 million in annual health care costs. Declared Bing in an interview with the Detroit Free Press: "Our unions are kidding themselves if they think refusing to negotiate is going to make this problem go away."

AT THE VERY LEAST, Michigan's takeovers have staved off the possibility of state bailouts, forcing city officials to make tough choices. Whether the turnarounds will work is another matter.

In corporate America, turnarounds rarely work out. In education, they fare even worse. Just 11 percent of California elementary schools forced by state officials to undergo turnarounds were successful three years later, according to former Thomas B. Fordham scholar Andy Smarick. Save for the turnaround of New York City, few state takeovers of local governments have been successful. The birthplace of basketball, Springfield, Massachusetts, has had its finances under control of a state board for eight straight years now. Michigan knows this all too well: Michael Moore's hometown of Flint, which spent two years under state control in the last decade, may end up under state control again by year's end. Its sister city, Ecorse (whose insolvency led to the passage of the state's first takeover law), is back under state control.

One reason why the efforts don't work? The financial czars still have to struggle with the long-term consequences of overspending and public--sector union influence. In Michigan, the governments are constitutionally on the hook for pensions even if the obli-gations are too burdensome to bear. The fact that the unions still wield tremendous political clout through rank-and-file workers and campaign giving to state and local officials -- along with the clout they retain to force a city back to the bargaining table once the finance czars finish their work -- means that the conditions that led to a city's insolvency remain in place. Given that city residents have been far too willing to accept fiscal mismanagement in the first place, the success of the overhauls will always remain an open question.

Snyder and his fellow state officials are themselves struggling to get the state's finances in balance. Two previous years of budget tricks -- including $1 billion in one-shot revenues for the 2010–2011 -fiscal year alone -- forced state officials to cut spending and tax giveaways in order to make up a $1.2 billion shortfall in the state's 2011-2012 budget. To keep the budget in balance, Snyder must either force the state's own public-sector unions to agree to $145 million in concessions, or lay off some of the 47,000 employees on its payroll. Meanwhile Michigan faces a longer-term crisis in the form of at least $70 billion in public pension deficits; based on estimates by Northwestern's Joshua D. Rauh and the University of Rochester's Robert Novy-Marx, the busted pensions could be tapped out within the next 12 years.

Abolishing collective bargaining laws, a step taken by Michigan's fellow Rust Belt state Wisconsin earlier this year, is one way local governments in Michigan and elsewhere could rid themselves of costly union contracts and return to a strong financial footing; so would getting rid of laws requiring local workers to contribute to unions whether they want to or not. States will also have to step in and address local pension issues as part of their efforts to deal with their own obligations. Ultimately, voters must finally subject their elected officials to scrutiny, and vote them out when they are overspending. If folks in Benton Harbor and other Michigan cities had done so years ago, their pols wouldn't have run up such huge tabs in the first place. 

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About the Author

RiShawn Biddle the editor of Dropout Nation , is co-author of A Byte at the Apple: Rethinking Education Data for the Post-NCLB EraHe can be followed at Twitter.com/dropoutnation.