Bailing Out Detroit?

07/29/2013 10:02 am ET | Updated Sep 28, 2013

I didn't hear Treasury Secretary Jack Lew on TV yesterday, but I read this morning that he was asked "how come the Obama administration bailed out the banks but isn't talking about doing so for Detroit?"

Fair question. The answer is, I think: the correct motivation for federal bailouts -- meaning some combination of managing a bankruptcy, paying off creditors (though often with a haircut), or providing liquidity in cases where that's the issue as opposed to insolvency -- is systemic risk. The failure of large, major banks, two out the big three auto companies, the secondary market for housing finance-all of these pose unacceptably large risks to global financial markets, and thus the global economy, to a major industry, including its upstream and downstream suppliers, and to the national housing sector.

Because a) there's not much of a case that Detroit is systemically connected in those ways, and b) Chapter 9 of the bankruptcy code appears to provide an adequate way for it to deal with its insolvency, I don't think anything like a large scale bailout is forthcoming.

But that doesn't by any means suggest there's no role for the federal gov't in helping Detroit recover (it's already supporting the city it various ways, which clearly need rethinking). I agree with Katz and Bradley that there's a lot the feds could and should do to help get (a smaller) Detroit back to a place where business want to locate and citizens want to stay.

Retooling Detroit's old industries and advancing its new ones will take public money, and the feds are the only ones with money to give these days. But Washington already spends heavily on Detroit-$18.4 billion went to the city and the surrounding county in 2008. This money, however, isn't invested with any broader purpose, a sense of how all this spending can add up to something grander. A better return on federal investments will take a functioning local government as well as leadership in suburban counties that is willing to collaborate closely with the city. And, with so much sclerosis, change will only emerge with a strong hand from above. State and federal governments should place the city's most dysfunctional agencies in receivership as a quid pro quo for federal investment-a milder version of the federal takeover of Washington, D.C., in the 1990s.

That's a smart, longer term approach. But it's also the case that the citizens there are victims of an economy that's failed to offer them anything close to gainful opportunities for years. So it's worth thinking about the quick implementation of a federally supported temporary public works program that accelerates the part of the Katz/Bradley plan that rebuilds the city's parks and infrastructure. If the local government isn't up to efficiently pulling that off, they'll need outside help.

Pretend Detroit just got invaded, not by slowly creeping globalization, de-industrialization, and bad governance, but by Canada. If that happened, we wouldn't bail out their creditors, we'd help them defend themselves.

This post originally appeared at Jared Bernstein's On The Economy blog.

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