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3 personal finance lessons learned from Detroit’s bankruptcy

I’m not sure if you caught this news, but Detroit, Michigan is now officially bankrupt.  After decades of overspending, Detroit has now become the largest U.S. municipality ever to file for bankruptcy.  The city faces $18-billion in debt and that number climbs higher every day.  Sadly, for the residents of The Motor City, Motown, and for sports fans, Hockeytown USA, everything has officially collapsed.

How did this happen?  How could what was once the country’s 4th largest city go flat broke?

Well, from what I’ve read, extreme city government money mismanagement occurred and kept occurring, for years.  Combine this prolonged attitude of borrowing at all costs with a slow steady decline of Detroit’s manufacturing industry and you’ve got another significant strike with many people out of work.  The third and final blows came from macroeconomic conditions far beyond the city’s control, a dot-com bubble that burst over a decade ago and more recently The Great Recession that many Detroit residents never recovered from.  Three big strikes and you’re out.

Want some proof of how bad the situation in Detroit really is?  Take a look at these real estate prices on Zillow here.  There are, on this site alone, almost 5,000 houses ready for foreclosure auction.  Let me give you some examples of how low things can and will likely go…

  • I recently heard about a house selling for about $500.
  • Some 2-bedroom, 2-bathroom homes are being sold for less than $10,000.
  • You can buy an entire 20-room apartment building for less than $60,000.
  • You can call an 8-bedroom and 8-bathroom mansion in the city home for just $75,000.

Detroit’s situation, while scary, can provide lessons learned for many of us if we haven’t already faced some financial crossroads in our lives.  I know for me, here’s what I’m taking away from this ugly financial disaster.

Lesson #1 – Leverage and lack of diversification can be disastrous

Borrowed money to invest can be a smart move, but only if you have the financial security and income to pay it back.  Leverage, especially in real estate, can be great when prices are rising but it can be a disastrous move when the economy is shrinking around you.  My home is first and foremost a place for me to live.  If my home appreciates greatly in value over time, that’s a bonus.  Come to think of it, people depending solely on their home for their retirement nest egg are playing a dangerous game.  While leverage can provide great rewards it also comes with great risks.  So, instead of leverage, I diversify my investments and I’m working on this all the time.  I try to never bet the farm on any one thing.

Lesson #2 – Conquer debt before it conquers you

I wrote in a recent blogpost that overextending yourself can put you into a mess of constraints. Financial independence comes with growing assets not growing liabilities.   While some debt is “normal”, like borrowing money for your first home, I think it must be done in a measured way.  By this I mean you should probably only borrow so much money as to absorb mortgage payments that are double or even triple your current payments since you nor I, can predict what the future holds.  For everything else in life beyond the mortgage payment, we should probably try to apply the golden rule of personal finance:  spend less than you make.  At least if something bad happens to us, financially, we have a fighting chance.  I continually need to work on this myself.

Lesson #3 – Cash can become king

Liquidity, having an emergency fund, is always a good thing.  While cash is a long-term loser to inflation, in a short-term bind it can be a life-saver.  Consider building up an emergency fund to cover expenses like car repairs and home appliance failures when they happen without relying on any credit.  When $hit hits the fan, you’ll be thankful you have some money tucked away.  Regarding our emergency fund we’ve got some more work to do to build it to our target level but by early next year we should be there.

As someone who wasn’t as prudent with his money as he could and should have been years ago, I’ve learned to change my ways through some of my own financial lessons.  While Detroit’s bankruptcy is on a totally different worldly-scale than the household affairs of you and I, there are definitely some lessons learned for all of us to bring home.

What are your thoughts on The Motor City’s economic collapse?  What lessons (if any) do you take from such sad events to sustain your financial health?

Filed in: Investor Behaviour, Saving, Spending

8 Responses to "3 personal finance lessons learned from Detroit’s bankruptcy"

  1. If only all politicians would read this post. It is not the first city to go bankrupt, and I fear it will not be the last. Some are saying that munis are the next subprimes, with the only difference being that the muni bond market is many times larger than the subprime market ever was… Investors beware!
    Matt
    The Dividend Theory

  2. This is sad. Some parts of the US are more like Greece than we think. Detroit’s museum collection is worth around $19B which would be enough to cover the debt. Pundits are arguing to keep this collection for the good of the city. Meanwhile pensions for city workers are being cut. I think the key takeaway is to live within your means. That goes for everyone, even cities and states.

    • Very sad Zach.

      Some U.S. cities are in a total mess.

      We totally agree, living within your means is essential. Doesn’t matter if you run a multi-billion-dollar city or manage your paycheck every two weeks. The same principles apply just different economies of scale.

  3. When I hear about what we did with Detroit it’s just another sign that we need to get our $hit together and stop procrastinating. I agree keeping money aside for emergencies is very important, heck we do it and it’s helped us on more than one occasion. When you said “Borrowed money to invest can be a smart move, but only if you have the financial security and income to pay it back” is important because many people start something they can’t finish and when they need to finish they have no money in their pockets.

  4. It’s terrible what has happened with Detroit. I can’t believe a house is selling for $500. That’s incomprehensible. Great lessons to be learned, though.

  5. Sandra says:

    a. Great article indeed! I very much appreciate how the financial sector is so much more open to bankruptcy as an option. I had a meeting with a trustee the other day and I am very glad I did. She was very helpful to my husband and I. For anyone interested in information on filing bankruptcy on their own, I suggest you go to this website http://howtodeclarebankruptcy.ca/ . The will set you up with 3 trustees in your area immediately, well worth it.

    Sandy.

  1. […] MyOwnAdvisor.ca shares the three lessons that we can all learn from infamous fall of Detroit’s economy. […]

  2. […] July 2013 – We learned Detroit was bankrupt this past summer and I took this opportunity to share some personal finance lessons from this disaster… […]

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