Privatization & Government Reform Newsletter

Detroit Plan of Adjustment Leaves Much to Be Desired on Privatization

Plan offers a mixed bag on outsourcing, asset privatization

Detroit's ongoing bankruptcy saga has now taken another turn with the long-awaited release of Emergency Receiver Kevyn Orr’s plan of adjustment. While considerable attention is understandably being paid to the treatment of creditors and pensioners in the overall plan—as well as pensions and benefits for employees and retirees moving forward—it’s also important to review how the plan addresses future city government operations, specifically with regard to the privatization of services and assets. In short, the more services and assets privatized, the more manageable the emergence from bankruptcy and the smoother the path to long-term fiscal and financial sustainability—which translate into improved quality of life for Detroit’s citizens and businesses.

However, on both fronts—outsourcing and asset privatization—the proposed plan of adjustment is a mixed bag.

Outsourcing of City Services

Detroit has long been a relatively hostile environment for the outsourcing of city services, though things are starting to change with the bankruptcy. For starters, the city council recently gave final approval to the outsourcing of residential solid waste and recycling collection to two private haulers. This move is expected to lower costs by $6 million annually. And in 2012, the city outsourced its payroll administration to national provider ADP.

Further, the plan of adjustment cites some additional current or proposed outsourcing initiatives:

  • Transit operations: The plan states that the city is “investigating certain other restructuring alternatives, including transitioning [the Detroit Department of Transportation (DDOT)] to the new Regional Transit Authority […] and/or outsourcing certain aspects – or all – of DDOT's operations." This follows on the heels of the city’s outsourcing of transit management to a private transportation management firm last year in a one-year contract that ends in September 2014. My Reason colleague Anthony Randazzo and I noted the significant potential for transit savings through competitive contracting—in some cases upwards of 30 percent—in a recent Detroit News op-ed.
  • Airport: The plan notes that officials are considering reducing the costs of operating the Coleman A Young International Airport by outsourcing certain functions.
  • Streetlights: The plan notes that the operations of city-owned streetlights will be outsourced until the city spins them off to the new public lighting authority in a few years.

Beyond these proposals, the plan is very thin on outsourcing. All it says is:

Where cost savings or service improvements can be achieved, the City will explore potential outsourcing of functions. The City will provide unions with advance notice of competitive bids and allow the unions to bid on the work. The City will work with labor representatives to minimize the effects of any headcount reductions resulting from outsourcing initiatives and enter into effects bargaining agreements when appropriate.

Presumably, this same statement could have been made at the very beginning of the bankruptcy process, so it’s surprising to see this sort of placeholder language now when one would expect concrete cost saving proposals. In effect, this statement can be interpreted as saying, “maybe we’ll outsource other things, maybe we won’t,” which does not inspire confidence that significant additional proposals will be forthcoming. Worse, in the section dealing with the 10-year revenue and expenditure projection for the city’s General Services Department, Orr’s plan specifically includes the statement that it "[a]ssumes no additional outsourcing being evaluated for all divisions."

While it’s encouraging to see the solid waste and payroll outsourcings and the plan’s proposals for sensible privatization initiatives in transit, streetlight, and potentially airport operations, they present an underwhelming package in the aggregate. There remains a plethora of cost-savings opportunities through privatization that could yet be mined, particularly in areas like public works, fleet operations and various administrative support functions. If not now, when?

Asset Privatization

One might think that given the severity of its fiscal distress, Detroit would be looking at every opportunity to sell and lease assets and enterprise operations to generate capital that can be applied towards its bankruptcy resolution. A common theme in the contentious discussion of how to handle the city’s art collection—a theme that also applies more broadly across all of the city’s assets—is that if officials don’t make a serious effort to put everything on the table in bankruptcy, that they could undermine the city’s bond rating, set a bad precedent in the financial markets, and ultimately drive up the costs of future city borrowing. This in turn could make it more difficult to recover economically, attract economic growth, restore city services and improve the quality of life for its residents.

Just like the outsourcing issue discussed above, the city’s asset privatization and divestiture proposals leave something to be desired. On the positive side:

  • The city is exploring a potential monetization of its parking assets and has retained a consultant to conduct due diligence and produce a report on the long-term value of the parking system. This report, according to the plan, “is expected to serve as a basis for the solicitation of potentially interested bidders for the parking assets, and the City anticipates that the transaction may close during Fiscal Year 2015.” This is a sensible move, as I noted at a recent Reason Foundation panel discussion on Detroit. It presents a potential opportunity to generate upfront cash, modernize the system, shed the operating costs, and increase parking revenues to the city over time. Indianapolis presents the best example here. That city entered a lease of its downtown parking system in 2010, receiving $20 million upfront and an estimated $300 million in shared revenues over the 50-year lease. It also shed its operations and maintenance costs and got a complete technological makeover as part of the deal, on the private sector’s dime. While these are very different cities economically—and Detroit may or may not be able match the terms of that deal—at the very least it’s worth testing the market on parking.
  • In addition to outsourcing the operations of the Coleman Young airport, officials are also looking at other alternatives, “including possible sale or lease transactions [and] modernization initiatives designed to attract core users of the airport.” It’s unclear how attractive the airport would be to private investors today, as it currently lacks the revenue streams from passenger fees and service-related revenues that would entice significant upfront capital from a private investor-operator. However, it’s certainly worth testing the market and looking at alternative private-sector-driven proposals.

Things drop off quickly after that:

  • The plan only proposes to sell one significant asset—the Veterans' Memorial Building, which houses the UAW-Ford National Programs Center operated by UAW-Ford, a 501(c)(4) organization. And the city is not putting it on the market to the highest bidder, but rather is negotiating a sale of the building to UAW-Ford directly, a move likely to leave money on the table.
  • None of the tens of thousands of other lots and buildings owned by the city appear to be on the chopping block. While many have limited value—including thousands of vacant lots and buildings—and others have title and other legal complications, surely there are at least some other city-owned buildings and property assets that could be sold outright.
  • The city’s plans to lease the water and wastewater system to a regional public authority are baked into the plan of adjustment but remain in doubt, given the resistance of surrounding suburban governments to making $47 million in annual lease payments to the city over a 40-year period, totaling over $1.8 billion. That said, the system’s massive debt load and capital investment needs make it a difficult sell with regard to a long-term lease to the private sector, though outsourcing operations and maintenance could be an option to improve its balance sheet.
  • Though beyond the scope of this article to explore in detail, the well-publicized plan to prevent the sale of the city’s art collection by pledging philanthropic and state bailout funds to pensioners, as well as the recent turnover of Belle Isle park’s operation to the state rather than selling it are problematic. They take assets with significant potential economic value and leverage them for significantly less than they’re worth, largely on emotional grounds. This tradeoff might seem logical as a short-term political calculation but ultimately may not be conducive to the long-term fiscal health of the city.

Conclusion

Detroit’s plan of adjustment offers a good start with regard to service and asset privatization, but at this stage of the bankruptcy proceedings, a “good start” is too little too late. The current plan leaves a lot of opportunity on the table in terms of potential revenue generation and cost savings, which does not bode well for the city’s future fiscal and financial recovery moving forward out of bankruptcy. It leaves too many pre-bankruptcy government structures in place.

One of the silver linings of bankruptcy is that it presents a major opportunity for reinvention and restructuring, but the current plan does not seem to fully leverage the transformation moment. Rather, it seems to seek to avoid pain for the city as much as possible, while inflicting more of it on pensioners and creditors to varying degrees. Ironically, internalizing more of that pain now through more aggressive restructuring of city services and assets would best protect the city from having to revisit that pain later in another bankruptcy.

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Leonard Gilroy is director of government reform at Reason Foundation and is the editor of the Privatization & Government Reform Newsletter, available here. This article was featured in the February 2014 edition of the newsletter.

Leonard Gilroy is Director of Government Reform





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