By: Rich Danker
Commentary: Retiree costs must be brought under control
Detroit’s status as an iconic American city has been reduced to a pathetic 16-page official plea for help. Its financial management team rushed a bankruptcy filing through federal court minutes before a lower level judge could preemptively rule against it, which she later did anyway in a move that will probably be moot.
Emergency manager Kevyn Orr believes that Detroit must discharge most of its $11 billion in unsecured debt, the bulk of which is retirement liabilities. Will Detroit be a unique case or could other large cities also seek to roll back unfunded pension and health-care obligations?
For starters, it’s unlikely that another large city would reach the point of having to resort to “free-fall” bankruptcy like Detroit. Its dysfunction and insolvency is so widespread that no obvious fix exists, unlike typical Chapter 9 cases that stem from busted public works projects or investments. So Orr is operating from the principle that the pain should be distributed evenly, meaning that pensioners and bondholders will incur similar losses on what they are owed. That figures to be upwards of 90 cents on the dollar.
So far, the major cities plagued by exploding retirement costs have done exactly what everyone thought they would — raise taxes, squeeze some public services, employ accounting gimmicks, and shovel billions more into their pension funds. They passively made the decision to pay up and let retirement costs soar to absurdly high proportions of their budgets that would never be tolerated in other line items.
In Los Angeles, pensions grew 25% annually the last decade, according to a report from the group California Common Sense. Public works, by contrast, grew 1.6%.
The sacrifice-for-pensions model is becoming more visible in human terms. Chicago Public Schools announced its third round of layoffs in as many months because its pension payment this year is tripling in size to $600 million. Schools chief Barbara Byrd-Bennett summed up her dilemma: “Driven by the lack of reform in Springfield, the pension crisis has arrived at our schools, and while we have reduced central office, administrative, and operations spending by nearly $600 million since 2011 to mitigate the impact on our classrooms, we cannot cut our way out of this crisis.”
There are middle ways between doing nothing and going down like Detroit. Cities could offer pension buyouts as large companies like Ford have done recently. Retirees would have the benefit of getting the money now (whether it’s the full present value of their future benefits or something less) and cities could get a fresh start in setting up cheaper pensions plans for their workers. Considering that the rating agencies have been fairly generous to debt-burdened large cities, they should be able to finance these buyouts through the bond market at favorable terms.
In states like Illinois and California where pensions are constitutionally protected, cities can probably only void them in bankruptcy. But health and other post-employment benefits, which in Detroit are two-thirds of its retirement obligations, are typically not construed as contracts and courts have approved recent efforts to downsize them. That trend is likely to accelerate, and some cities will probably follow Detroit’s lead and try to move their retirees onto Medicare or the Obamacare health exchanges.
What’s amazing about the situation in Los Angeles, Chicago and other large municipalities in financial distress is that this is happening at a time of national urban renewal. Both millennials and baby boomers are flocking to city centers for lifestyle preferences like short commutes and diverse culture. They are taking chances on unproven neighborhoods and accepting high taxes. Cities would see this success reflected in their finances had they not been reconfigured into cash cows for their public employees.
Thriving big cities will learn more from Detroit than its low moment now suggests. The series of moves it will have to make will provide a template for balancing the competing interests of retirement obligations and public services. The birthplace of the automobile and Motown is going to give us a case study in government reorganization.
Rich Danker is economics director of American Principles Project, a Washington-based policy organization, working on public pension reform.