What Happens to Pensions When States or Cities Go Bankrupt?

Pension Check May Not Be in the Mail

August 10, 2010

Chicago Tribune - Illinois public employees who think the state constitution guarantees that they'll get all their pension benefits may have another think coming.

Politicians' and public labor unions' assurances aside, there's another, not-well-publicized school of thought that says if the pension funds go bust, the state has no obligation to step in to pay the benefits. This runs contrary to the popular view that the Illinois Constitution, on its face, guarantees that all public employee pension benefits will be fully paid.

This belief is based on Article 13, Section 5 of the Illinois Constitution:

"Membership in any pension or retirement system of the state, any unit of local government or school district … shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired."

Sounds solid, doesn't it? It's not, according to a legal opinion from the Chicago law firm Sidley Austin, provided to me by R. Eden Martin, president of the Civic Committee of the Commercial Club of Chicago.

The opinion acknowledges that the constitution creates a contractual agreement between the workers and the state's employee pension funds. But it concludes that neither the constitution nor the law say the state is a guarantor of that obligation.

The Sidley opinion argued that the state can become a guarantor only under section 2l2-403 of the Illinois Pension Code. That provision states that if a state pension fund runs out of assets" (a)ny pension payable under any law . . . shall not be construed to be a legal obligation or debt of the State . . . but shall be held to be solely an obligation of such pension fund, unless otherwise specifically provided in the law creating such fund."

So, does any law creating the pension funds "specifically provide" that the state would become the guarantor? Sidley examined the laws creating the five state pension funds and concluded that while each contains an "obligation of state" provision, none guarantees that the state will step in and pay the funds if they run out of money.

In simple language, that means if the pension funds run short of cash, public workers face the same sort of uncertainties that most workers in the private sector do.

And what are the chances of the funds running dry? Pew Center on the States ranked Illinois dead last in pension funding. The generally accepted view is that Illinois' unfunded pension liabilities come to about $80 billion — that's for a state whose total upcoming operating budget amounts to $26.1 billion, of which $13 billion is a deficit. Even if the state were to shut down every last thing it runs — such as Medicaid, transit funding, law enforcement, education and the legislature — and put all its money into eliminating the unfunded obligation, the entire state would go dormant for three years.

Well, not exactly. It would go dormant longer because the liabilities would have continued to increase during the three years. To get an idea of how fast, consider: From 2006 to 2010, the unfunded liability doubled, to $80 billion, from $40 billion, according to Martin.

Well, not actually. The unfunded obligation could even be greater, Martin said, because of a flawed formula that underestimates the actual benefit costs. If a more standard calculation were applied, the unfunded obligation could run to $200 billion, according to some analyses, he said.

To be clear, it's not that the state has taken $80 billion (or $200 billion) in cash out of the pension funds, a common misconception. Basically, much of the money was never there in the first place because the state has been unable to keep up with the payments needed to cover the ballooning benefits. One way to look at it: The state shorts the pension funds to keep the electricity on.

How that happened is a complex and dark political tale, extending over a half century of wanton spending, borrowing, self-deception and lies. But, if we're to climb out of this nightmare, everyone will have to sacrifice. That includes public employees who, Martin notes, should get on board to work out some solutions. They might have to put up with some small sacrifices, but it's better than waiting until the well runs dry.

Will Your Government Pension Be Reduced?

September 8, 2009

BNet - If you work for the government or a public employer, you may feel as though one of the best things about your job is your guaranteed pension. Before you put all your retirement eggs in that pension basket, consider what is happening to the public pension system.

Example. The Ohio State Teachers Retirement System recently issued a newsletter to its members about changes that are being considered to their pension program. Essentially, the system is significantly underfunded. If changes aren’t made, the newsletter indicates that eventually the pension system will not be able to pay members’ projected benefits.

Here are some of the changes that are being considered:

• Higher contributions from employees and employers.


• Changes in pension benefit formulas, which means employees may receive smaller pensions than anticipated.


• Changes to or elimination of the cost of living increases in pension benefits, which means pension lifestyles would be decreasing every year as inflation eats into the value of the pension.

These issues aren’t unique to the Ohio Teachers’ pension; many public pensions are under the same pressures. But the challenges facing Ohio highlight many of the problems with the public pension system.

Why is this happening? In general, the main problem with public pensions is that the retirement benefits have been consistently increased over the years but the required contributions have not. This means that not enough money has been going into the pension plans to support the promised benefits to current and future retirees.

• During the bull markets of the 1980s and 90s, the funding deficits were masked by the out-sized stock market returns. Also, those big stock market gains encouraged increases to pension formulas without corresponding increases to the funding obligations.


• But the last 10 years of terrible stock market returns has exposed this funding mismatch between contributions and promised benefits.


• To correct the funding problems, pension managers now have to consider cutting benefits for future retirees and also increasing contributions for current employees.

Hot Potato. One of the risks of a traditional pension plan is that your retirement money is basically pooled with everyone else’s money in the plan. Consequently, if one group of workers was promised benefits that weren’t fully funded, another group of workers may end up paying for some of that shortfall. The funding deficit is like a hot potato. And the question is, who will get stuck with it?

What to do. If you’re a public employee, you should recognize the possibility that you may not get as big a pension as you thought. Thus, you should consider saving outside of your pension plan so that you have additional resources to address potential declines in your pension benefits. Most public employers offer 403(b) or 401(k) plans that you can use to save additional amounts for retirement.

Also, read all the notices you get from your pension plan and stay informed about the plan’s funding status. Next time they discuss benefit increases or decreases, make sure you voice your opinion and insist that the system be run under conservative financial assumptions. Otherwise, that hot potato may get even hotter.

Bottom line. One danger with public pensions is that there is a lot of incentive to increase benefits but not much discipline to increase contributions, which leaves the systems vulnerable to underfunding. So to protect yourself, squirrel away a little extra.

As with all financial matters, consult your individual financial advisor before making any decisions.

Are Pensions Fair Game in Bankruptcy?

March 1, 2010

Voice of San Diego - Since last fall, talk of municipal bankruptcy has wormed its way back into public debate at the city of San Diego.

Mayor Jerry Sanders and City Attorney Jan Goldsmith decided they'd had enough. Last month, both dismissed the idea -- and Sanders used particular vigor -- by saying it distracted the city from its real financial problems. Besides, they argued, it would cost as much as $300 million and couldn't affect the city's most crushing debt: the $2.1 billion it owes for employee pensions.

"You can't touch the pensions, which is the big nut," Sanders said in an interview. "Why not use that $300 million to balance the budget in the long term instead of continuing this talk about there's an easy solution out there? I think people who say that either don't understand it, or they're demagoguing."

The issue is important. If San Diego can't do anything about pensions in bankruptcy, is it even worth discussing? Especially since Wall Street flips out any time a city mentions the word.

I set out to explore the question: Can a bankrupt city reduce core pension benefits that have been guaranteed in the past?

I started with Goldsmith's argument, which the mayor used as the foundation for his opinion. Goldsmith says pensions can't be touched.

The California constitution makes pension benefits permanent. They can't be changed unless a municipality gives their employees comparable perks. San Diego's city charter protects pensions, too.

No bankrupt municipality has overturned guaranteed pensions before. To do so in San Diego, a federal bankruptcy judge would have to overrule the city charter, the state constitution and in effect create new law. If it happened, the case would almost certainly go to the U.S. Supreme Court. Goldsmith believes justices would think the ruling impinged on state's rights and overturn it.

It would be "foolhardy" for San Diego to declare bankruptcy solely to overturn its pension obligations, said Harvey Leiderman, a California lawyer who has lectured on municipal bankruptcy. Leiderman's San Francisco-based firm is representing the largest bondholder trustee in the current municipal bankruptcy case involving the Bay Area city of Vallejo. Leiderman also used to be fiduciary counsel for San Diego's retirement system.

"There are some things that it's not even worth betting on could happen," Leiderman said. "It's just like traffic lights turn red after yellow. So it's possible that a light could turn green after yellow, but I wouldn't bet on it."

Recent events support this position. In the initial plan Vallejo is proposing to emerge from bankruptcy, the city is not touching pensions even though they are its single largest debt. The reason? Vallejo says pensions are protected by state law.

Vallejo's case already saw a major decision when the bankruptcy judge allowed the city to rip up contracts it had with its labor unions. The impact of that decision would be nothing compared to a bankruptcy judge taking on pensions.

"It would make Vallejo look like a small-claims court case," Goldsmith said.

But both Leiderman and Goldsmith believe such a case will happen someday. A municipality, they said, will attempt to reduce its pension obligations through bankruptcy because it won't have any other choice.

The law does leave space for a challenge.

Federal bankruptcy code trumps state law, meaning protections offered by the state and cities don't have to apply, said John Ryan.

He's a retired federal judge who should know. Ryan presided over the largest municipal bankruptcy in history, Orange County's 1994 case.

No one has said that a bankruptcy judge couldn't erase pension obligations. That doesn't make it likely, though.

"I think probably politically as well as from a general fairness standpoint it would be very difficult to do that," Ryan said. "I think probably the reason we haven't seen the issue and haven't seen it attempted through a plan is that it would be a very tough sell."

To recap: It appears legally possible for a city to reduce pension benefits through bankruptcy. No one has tried it before, but someone will. That bankruptcy will be a costly war with an uncertain outcome.

Yet the risks in bankruptcy go both ways.

Unions and retirement systems have a lot to lose as well, no matter how strong their legal position. They might not want to imperil the billions of dollars they have at stake in a bankruptcy filing and risk legal precedent that could affect the hundreds of billions in unpaid pension debts nationwide.

It's an uncertainty that might force unions and retirement systems to take a deal without forcing a judge to rule on the issue.

Such deals are the point of municipal bankruptcy, said Pat Shea, a lead attorney in the Orange County case and a former San Diego mayoral candidate. It encourages consensus and certainty much more than legal battles in state court.

In short, bankruptcy levels the playing field. Everyone owed money must jockey for position. It's more likely in bankruptcy, Shea said, for a party to settle than to bet on victory particularly when so much money is at stake.

The riskiness of a court ruling for everyone, Ryan said, creates much of the angst over pensions in bankruptcy.

"This is the reason most of these things get resolved consensually," he said. "People don't want to have a judge or the Supreme Court say it's this way."

A bankruptcy might not wipe pension obligations away, but it could make the debt smaller.

♦♦♦

The most prominent San Diego politician to use the "B" word recently is longtime City Councilwoman Donna Frye. Frye told the Union-Tribune last month she believed the city would eventually have to file for bankruptcy.

She told me the same thing this week. She doesn't know if San Diego could reduce its pension costs in bankruptcy. But that isn't the point. Her point is nothing more than this: If the city runs out of money, it will have to file for bankruptcy.

"At some point, yes, I believe the city will for all intents and purposes be out of money," Frye said. "I think if we're not there yet, we're darn close."

Still, Frye said there was plenty the city could do outside of bankruptcy to reduce its costs. She cited pension reforms she's suggested with colleague Carl DeMaio.

"There are things that can be done to address these problems," she said. "Until people start taking that seriously, every single year we are going to see ourselves more in debt with more deficits and more cuts and no solutions."

Her larger point is one Goldsmith and Sanders have both made: The city has long-term budget problems and the city has ways of fixing them.

Sanders said he's recognized that. He's promised to unveil his own solution within 18 months.

Will Miami Declare Bankruptcy and Start a Nationwide Trend?

May 27, 2010

Business Insider - I keep waiting for some large city to take initiative and declare bankruptcy to escape onerous burden of public pensions. Perhaps Miami is that city.

NBC Miami reports Miami Budget Begging for Bankruptcy

Please click on the above link to see a very interesting video. The video is not embeddable.

Partial Transcript

The city of Miami is in such financial dire straits that commissioner Marc Sarnoff is using the "B" word, bankruptcy.

• Two Year Treasury Yields Drop Below .5% First Time Ever; 30Yr/10Yr Spread Widens Again


• Jobs Decrease by 131,000, Rise by 12,000 Excluding Census; Unemployment Steady at 9.5%; June Revised from -125,000 to -221,000


• Will Quantitative Easing Spur Inflation? Job Creation? Credit Expansion? Do Anything?

"We are not the only city, municipality to be going through this. It looks like Los Angeles sometime next week or the week after will be going bankrupt. It looks like there will be 30 more cities following suit."

Increases in public worker salaries is one of the main reasons why the budget is so tight. The average salary for a Miami city employee is $76,000; the average salary for a Miami city resident is $29,000.

Employee pensions are choking the budget too. In 2000, pension payouts cost taxpayers $16 million; in 2009 that number spiked up to $70 million.

Should the city go into bankruptcy, the commissioners and their politics would no longer be in charge of city finances, the judge would be.

"You no longer have 5 people making political solutions. You now have one person who is looking after the best interest of the taxpayer of the city of Miami, without any politics getting into his or her way," said Sarnoff.

The Judge could order union contracts be renegotiated. He or she could decide what creditors get paid or not get paid.

....

Commissioner Sarnoff offers 3 options to avoid bankruptcy.

1. Renegotiate those union contracts

2. Layoff about 800 city workers

3. Raise your property taxes

In this economic climate that last option is not likely at all

.....

I see no indication Los Angeles is about to declare bankruptcy anytime soon as Sarnoff suggests. However, it is perfectly clear that Los Angeles is indeed in pathetic shape and bankruptcy is the best option.

The same applies to Houston and many other large cities as well. I look forward to the day one of these big cities finally tells their public unions where to go.

All it takes is one big city to start the ball rolling.

Inquiring minds are reading New Jersey Careening `Toward Becoming Greece' as Costs Rise, Christie Says.

New Jersey Governor Chris Christie said the state is “careening our way toward becoming Greece” and can’t afford the cost of benefits and pensions for current workers.

The governor, speaking today to members of the Manhattan Institute, said his state must reduce its tax burden and control government spending. He has proposed a constitutional amendment to cap growth in property taxes, the main source of funding for schools and towns, at 2.5 percent a year.

“Higher taxes are not going to solve the problem,” said Christie, a Republican who took office Jan. 19. “We’ve got to change the course.”

New Jersey, like Greece, has a high proportion of public workers who have been entitled to benefits such as free health insurance that outstrip taxpayers’ ability to pay for them, Christie said. In the past decade the state added 11,000 public- sector jobs as it lost more than 120,000 private positions, he said.

Politicians in New Jersey have bowed to public unions for too long, failing to cut teacher benefits and enacting civil- service laws that have tied governments’ hands in trimming workforces, Christie said. Over the last decade, municipal spending has grown by 69 percent, and property taxes have climbed by 70 percent, according to the governor’s office.

The average New Jersey household paid $7,281 in property taxes last year, the highest rate in the nation, according to the state Department of Community Affairs.

Senate Budget Committee Chairman Paul Sarlo, a Democrat from Wood-Ridge, proves he is mathematically challenged and unfit for office by stating:

"The governor’s spending cuts may lead to property-tax increases of as much as 8 percent next year".

I salute Chris Christie. We desperately need more governors to follow his lead. I also salute commissioner Marc Sarnoff. Bankruptcy is the only option that makes any sense for Miami.

Will Public Unions Force California Into Receivership?

July 26, 2010

PRNewswire-USNewswire - As the Public Pension Crisis in California heightens and municipal governments are bracing for the possibility of insolvency, the Full Disclosure Network® presents a special Video News Blog featuring Orange County Supervisor John Moorlach. He is one of the few elected officials in the State with a financial background as a former Certified Public Accountant. While serving on the Orange County Board of Supervisors, Moorlach has been very vocal about the excessive influence of public safety unions using their political clout with campaign contributions electing politicians who supported their retroactive pension benefits that now threaten a County on verge of a second bankruptcy. Watch here:

State Receivership Commission?

In this (8 min) video news blog, Moorlach describes how the public employee unions are threatening the entire state and the only way out would be to place the State of California into a receivership commission. He hopes that Governor Schwarzenegger will appoint a "Receivership Board" that will take the checkbook away from the state legislators who cannot balance the books. And he suggests the same should be done in the federal government.

Retroactive Raise in Benefits Challenged in Court

In the meantime, at the urging of Supervisor Moorlach, the County has filed a lawsuit to roll back the retroactive pension benefits given to the public safety unions. Moorlach predicts dire circumstances if something is not done and suggests that elected officials are part of the problem when they accept campaign contributions from the public employee unions.