Public Pension Perversion

Muni Threat: Cities Weigh Chapter 9

February 18, 2010

WSJ - Just days after becoming controller of financially strapped Harrisburg, Pa., in January, Daniel Miller began uttering an obscure term that baffled most people who had never heard it and chilled those who had: Chapter 9.

The seldom-used part of U.S. bankruptcy law gives municipalities protection from creditors while developing a plan to pay off debts. Created in the wake of the Great Depression, Chapter 9 is widely considered a last resort and filings under it are more taboo than other parts of bankruptcy code because of the resulting uncertainty for everyone from municipal employees to bondholders.

The economic slump, however, is forcing debt-laden cities, towns and smaller taxing districts throughout the U.S. to consider using Chapter 9. As their revenue declines faster than expenses, some public entities are scrambling to keep making payments on municipal bonds. And that is causing experts to worry about the safety of securities traditionally considered low risk.

The News Hub panel discusses Chapter 9, which is what cities turn to when their debt obligations exceeds their budgets.

"People believe that municipal debt is safe based on assumptions that are no longer true," says Kenneth Buckfire, managing director and chief executive of Miller Buckfire & Co., an investment bank that has worked with corporations on restructurings and now is advising municipalities. For example, it isn't safe to assume that governments can raise taxes to cover shortfalls, he says.

Even threatening bankruptcy signals that municipalities are willing to compromise the security of bondholders, says Richard Raphael, an analyst at Fitch Ratings. That makes it harder for cities and towns to raise money from investors and will slow the U.S. economic recovery.

In Harrisburg, which is Pennsylvania's capital and has a population of about 47,000, a March 1 deadline is looming on a payment of $2 million out of the $68 million due this year for the financing of an incinerator plant. The facility has about $288 million in overall debt.

"Bankruptcy is inevitable," Mr. Miller says. "We are in a terrible bind." A budget passed Saturday by Harrisburg's city council didn't include any funds to cover the debt payments, according to the city clerk's office.

Harrisburg Mayor Linda Thompson, a Democrat elected in November, opposes a bankruptcy filing and has presented an emergency plan that includes selling some of the city's assets. She couldn't be reached for comment. A spokeswoman for the mayor says Ms. Thompson is working on the plan.

Michele Torres, executive director of the Harrisburg Authority, which oversees the incinerator plant, says there are sufficient reserve funds to make the March 1 payment to bondholders. But that doesn't fix the problem.

"No matter how perfect the facility runs, it just can't generate enough … to meet the $288 million debt," she says.

Since Chapter 9 was enacted in 1934, just 600 cases have been filed under the code, partly because they require state approval. Some municipalities have found escape hatches, such as raising taxes. The largest Chapter 9 case was filed in 1994, when Orange County, Calif., lost $1.6 billion on wrong-way bets on interest rates.

But many experts fear that a surge in municipal bankruptcy filings is unavoidable.

"The day of reckoning is coming," says Michael Pagano, dean of the University of Illinois at Chicago's College of Urban Planning and Public Affairs.

To keep cities and towns from toppling into Chapter 9, more states are likely to make use of state laws to assume oversight of financially distressed municipalities, he predicts. Pittsburgh, for one, has been operating under such a law since 2004.

Vallejo, Calif., a city of about 116,000 people near San Francisco, has been trying to rejigger worker contracts in bankruptcy court since it filed for Chapter 9 in 2008, after buckling under declining real-estate values. Some union contracts expire later this year, and Vallejo is attempting to scrap them and start over.

In San Diego, political leaders have faced outside pressure to file for Chapter 9 bankruptcy protection as a way to get around benefits packages for public workers. San Diego Mayor Jerry Sanders has publicly dismissed the idea.

Last month, Las Vegas Monorail Co., a nonprofit with over $600 million in municipal bonds, filed for Chapter 11. The company runs a 3.9-mile monorail system along the Las Vegas Strip that has been hammered by the downturn. Ridership shrank 21% last year from 2008. According to Fitch, while the monorail is covering its operating costs, default "is virtually certain" on a payment due in July.

Ambac Assurance Corp., the bond-insurance unit of Ambac Financial Group Inc., is seeking to have the case converted to a Chapter 9 proceeding. The insurer contends that the company is akin to a municipality. A judge is set to decide on the petition later this month.

Sandy Hoskins, interim chief executive of Sierra Kings Health District in Reedley, Calif., worked for nearly 30 years as an auditor and financial consultant. He says he never heard of Chapter 9 until October, when Mr. Hoskins filed a bankruptcy petition for the hospital system.

"There was no other way around it," he says. With low cash balances, "there were vendors not even willing to do business with us. It was a critical situation."

Mr. Miller, Harrisburg's controller, also sees no way out of the financial squeeze. The city's per-capita debt of $9,500 is the highest in Pennsylvania and triple the debt load of Philadelphia, he says. And selling parking facilities or other properties in a fire sale would cost Harrisburg future revenue. A spokesman for Pennsylvania Gov. Edward Rendell says Harrisburg hasn't sought help from state officials.

"We can't raise taxes; they're already very high," Mr. Miller says. "If we did, people would just leave. It's cheaper to move out to the suburbs."

Needed: A Federal Role

May 20, 2010

Room for Debate NYT Blog - Many states are in deep trouble. As many as twenty states could see their pension funds run out by the end of 2025, even if they earn 8% on their investments. The federal government should be worried, as insolvent states will turn to them for help. Given the funding gaps in state pension plans, the total size of a federal bailout of states and their pension programs would exceed the recent bailout of the U.S. financial system — and would be likely more than $1 trillion.

The federal government should cut a deal with states. They should allow a state to issue tax-subsidized bonds for the purpose of pension funding for the next 15 years — if and only if the state government agrees to take three specific measures to stop the growth of unfunded liabilities:

• The state must close its defined benefit plans to new employees and agree not to start any new defined benefit plans for at least 30 years.


• The state must annually make exactly its actuarially required contribution left over from the existing underfunded plans; only the amount of that contribution will be subsidized.


• The state must include its new workers Social Security, and provide them with an adequate defined contribution plan, again for at least 30 years. To this end, the federal government should start a Thrift Savings Program for state workers and operate it alongside the existing Thrift Savings Program for federal workers.

The tax subsidies for these new Pension Security Bonds would work like Build America Bonds, with the federal government paying 35% of all coupon payments directly to the state. The cost of this subsidy will be in large part offset by the gains to the Social Security system of bringing in new state workers. On net, this plan would cost the federal government $75 billion today, and would prevent a trillion dollar crisis in less than a decade.

Can My Pension Be Reduced?

If you retire tomorrow at age 64 and live to 89 (very reasonable assumptions in California), a $100,000/year pension has a present day value of $1.55 million -- a big check to write for every retiree. Compare to the private sector: begin work in 1970 at 3,000K/year, 2.5% annual raise every year, work 40 years, retire at 64 with $100,000 year salary -- 401K balance (employer contributions) of $330,000 assuming investments grow at current treasury yield of 4.5%.

October 21, 2008

CNN Money - Question: Does the current crisis have any effect on my defined-benefit pension plan? I just turned 55 and was getting ready to start drawing from it. Will the amount I receive change now? —Lynn, Hephzibah, Georgia

Answer: The short answer is no. Just because the stock market has been reeling and the economy is in a major funk, your employer can't reduce the size of the pension you've earned or take it away from you.

If nothing else, the current financial crisis has highlighted a major difference between traditional check-a-month defined-benefit pensions and defined-contribution plans like 401(k)s.

With a 401(k), a market meltdown can dramatically reduce your account balance. And if that happens after you've retired or are close to doing so, you may have to cut back on the income you draw from your 401(k) to avoid running out of money late in retirement.

With a traditional defined-benefit pension, on the other hand, the amount you receive is based on the number of years you worked for your company and your salary (typically the average for your last five years or your highest-earning five years). Once you're "vested" in your plan - which usually takes five years in a traditional defined benefit plan - your employer is obligated by law to pay you the pension you've earned, regardless of how the financial markets perform (although you'll typically have to wait until you're 55 to 65 to collect it).

In short, if you have a 401(k), you assume the market risk. If you have a defined-benefit pension, your employer is on the hook.

The risks

Of course, plummeting stock prices have put a strain on the value of pension fund assets, and those assets are what employers are counting on to pay the pensions of current and future retirees. Generally, pension funds invest about 65% of their assets in stock and spread the rest among bonds, real estate and other investments. So when the stock market takes a dive, it cuts into the amount available to pay pension benefits.

That said, pension funds overall went into this year in pretty good shape. According to benefits consulting firm Hewitt Associates' Pension Risk Tracker, the overall "funded ratio" of the pensions of companies in the Standard & Poor's 500 index was 98% at the beginning of the year, which means the value of the assets in the funds was just about sufficient to cover the benefits due to plan participants. By mid-October, however, falling stock prices had pushed that ratio down to just over 80%.

The safety nets

But that doesn't mean pension funds won't be able to meet their commitments. Pension funds pay out their benefits over many decades. Indeed, a 35-year-old worker may not begin collecting for another 20 to 30 years and even then the payments will likely stretch over another 20 to 30 years. So there's plenty of time for asset values to bounce back.

What's more, the Pension Protection Act of 2006 set tough new standards for how much money employers must contribute to their pensions annually to maintain their plan's financial health. (The PPA doesn't apply to defined-benefit plans of state and local governments, but those benefits are protected by state law and ultimately backed by tax revenues.)

Besides, even if your company were to go bankrupt and the pension plan's assets were insufficient to meet its obligations, you would still likely collect all or most of the pension you have coming to you. That's because the Pension Benefit Guaranty Corp., a government agency charged with assuring the payment of private-sector pensions, would step in and make payments up to certain limits.

The PBGC's maximum payment for plans ended in 2008 is $4,312.50 a month, or $51,750 a year, for a 65-year-old. This ceiling is higher if you're older and it's lower if you retire earlier or if your pension includes payments for a survivor.

There are instances when the maximum payments aren't enough to cover someone's full pension, as has been the case with many pilots of airlines that went bankrupt. But more than 80% of the people whose pensions are taken over by the PBGC see no reduction in payments.

There's one other way that the current crisis could affect defined-benefit pensions, however. If pension funds' investment losses are deep enough, employers could be required to inject big sums of cash into their plans at the very time when their profits are being squeezed by the weak economy. If that happens, more companies might follow the example of companies like IBM, Unisys, Gannett, Equifax and others that have already frozen their pensions or announced plans to do so.

In the event of a freeze, you would typically no longer accrue additional benefits in the frozen plan for additional years on the job, although companies that freeze plans may enhance benefits other ways, such as by adding a 401(k) or improving the 401(k) if the firm already offers one. In any case, you would still be eligible for whatever benefits you had accrued before the freeze. Any pension benefit you've earned can't be taken away. (If you think you have been unfairly denied pension benefits, check out your rights.)

So unless your pension plan is seriously underfunded and your company is in financial trouble and your pension is significantly above the PBGC ceiling, you can cross your defined-benefit pension off your list of things to worry about. And then turn your attention to your 401(k) and other retirement savings accounts to be sure you're following the right investment strategy there.