Detroit has lots of company in long-term-debt quagmire
Chicago recently saw its credit rating downgraded because of a $19 billion unfunded pension liability that Moody’s ratings service puts closer to $36 billion, and Los Angeles — by some estimates — could be facing a liability of more than $30 billion.
Detroit Free Press
Detroit may be alone among the nation’s biggest cities in terms of filing for bankruptcy, but it is far from the only city being crushed by a roiling mountain of long-term debt.
At the heart of Detroit’s problem is a growing unfunded debt on benefits owed to current and future retirees — some $3.5 billion, according to its emergency manager, Kevyn Orr — which mirrors a circumstance being seen across the U.S.
From Baltimore to Los Angeles, and many points in between, municipalities are increasingly confronted with how to pay for these massive promises. The Pew Center on the States, in Washington, estimated states’ public-pension plans across the U.S. were underfunded by a whopping $1.4 trillion in 2010.
For years, watchdog groups and public-sector analysts have warned of the threat posed by unfunded liabilities. Much like the legacy pension costs that weighed on Detroit’s automakers before the Chrysler and General Motors restructurings of 2009, the worry is that revenues can’t keep up with growing debt and that rosy predictions for market returns downplay the financial risk.
As examples of the results: Chicago recently saw its credit rating downgraded because of a $19 billion unfunded pension liability that the ratings service Moody’s puts closer to $36 billion. Los Angeles could be facing a liability of more than $30 billion, by some estimates.
It’s no surprise — given the pressure public pensions are putting on municipal budgets — that any move to ease those liabilities, especially through a bankruptcy-court order like what’s happening in Detroit, is being watched carefully nationwide by state and municipal officials, union leaders, bond traders and retirees.
“We’re just at the front of the line here,” Michigan Treasurer Andy Dillon said. “It could be a landmark case.”
“Secure” pensions? Not so much
This year, the Pew Research Center released a survey showing that 61 of the nation’s largest cities — limiting the survey to the largest city in each state and all other cities with more than 500,000 people — had a gap of more than $217 billion in unfunded pension and health-care liabilities. While cities had long promised health care, life insurance and other benefits to retirees, “few … started saving to cover the long-term costs,” the report said.
Public-sector pensions, given a municipality’s supposed ability to raise taxes and set its level of services, were expected to be secure all the same. Corporations might seek relief from pension and health-care costs in bankruptcy court, but laws in many places are supposed to protect public-sector pensions. Michigan’s Constitution, for instance, says they constitute “a contractual obligation … which shall not be diminished or impaired.”
But, barring a settlement with public-sector unions, it’s hard to see cuts not being part of Orr’s plan in Detroit: relying on a bankruptcy judge to rule that federal law trumps the state constitution.
Such a ruling, once made, could change how public employees across the country see their futures, how their unions negotiate contracts and how their retirees — some of whom, such as police and firefighters in Michigan, don’t contribute to or receive Social Security benefits because their pensions were expected to be guaranteed — pay the bills.
Last week, Lee Saunders, president of the American Federation of State, County and Municipal Employees, noted that public workers aren’t protected by federal pension insurance, like many private-sector employees. He wondered whether Republican Gov. Rick Snyder and Orr want public employees “to have to work until they die.”
Possibly precedent setting
Hyperbole aside, the situation in Detroit just took a big stride onto the national stage. Even the Obama administration said it is monitoring the case — and offering help — though it stopped short of any action that could be seen as intruding on a court dispute involving the city, the state and creditors, knowing any such move could be fraught with political overtones.
“I do think unions and political leaders are going to wake up and say this is something we really need to address,” said Eric Scorsone, an expert in local-government finances at Michigan State University. “The perception now is that these problems are widespread.”
No one expects a rush on the bankruptcy courts nationwide, unfunded pensions and health-care liabilities notwithstanding. In a sense, that’s why the Detroit bankruptcy filing, at $18 billion or more the largest municipal bankruptcy ever, is unique. Its potential outcomes also are possibly precedent-setting.
Municipal bankruptcies are rare, considering the 1.2 million personal and business bankruptcies filed last year. Governing magazine says there have been 36 municipal bankruptcies since 2010, including Detroit’s. Before that, there were very few.
New York City’s storied financial problems in 1975 never led to bankruptcy, even after President Ford said he’d block any attempt to bail out the city. He later relented on low-interest loans after the city began to repair its finances. Cleveland and Mayor Dennis Kucinich defaulted on loans in 1978 but never went into bankruptcy.
The taint of bankruptcy
There are many good reasons for a municipality not to file bankruptcy, among them: The stigma, the fact that it effectively blocks a city from the regular bond market for years and state laws that often remove it as an option in the first place.
“It’s a black mark against the city,” said Matt Fabian, managing director for Municipal Market Advisors, a Massachusetts research firm. “Bankruptcy is just bad. There’s no mayor who wants to put his city in bankruptcy.”
The reasons, Fabian said, are clear enough: Unlike in a Chapter 11 corporate bankruptcy proceeding, a Chapter 9 proceeding can’t lead to restructuring government; that’s a political decision outside a judge’s purview. In addition, debt might be wiped away, but the underlying issues of things such as poor governance and management, or of a shrinking population and tax base, won’t be.
“It doesn’t solve the problem,” he said.
Generally speaking, municipal finances across the U.S. have been looking up, according to the National League of Cities, which reported that a majority of city finance officers, some 57 percent, said their cities were better able to meet fiscal targets in 2012 than they were in 2011.
But it doesn’t mean the fallout from the Great Recession and the buildup of municipal deficits haven’t led to some high-profile fiscal collapses. And while the bankruptcies in the California cities of Stockton and San Bernardino may be dwarfed by Detroit’s, many of the same issues regarding public pensions are coming up.
Officials at CalPERS — the California Public Employees’ Retirement System, which also has been defending public-sector employee benefits against municipalities that want to shave them in bankruptcy court — are watching the Detroit case.
On Friday, U.S. Rep. John Conyers, a Detroit Democrat, asked the chairman of the House Judiciary Committee to hold hearings on the Detroit bankruptcy.
“I am concerned that the bankruptcy process is being misused to unilaterally abrogate obligations otherwise protected by law,” Conyers said in the letter to Republican Rep. Bob Goodlatte of Virginia. It could, he said, “have a deleterious effect in Michigan and nationwide.”
Bond-rating house Moody’s on July 15 also downgraded Cincinnati’s general-obligation bonds, citing “budgetary pressure” from pension contributions. Its downgrade was to Aa2 — still a lot higher than Detroit’s Caa3 for its general-obligation bonds — but part of the trend.
So is the situation in Baltimore, where budget shortfalls are expected to run $745 million over 10 years, largely because of a growth in pension costs.
The Pew Research Center calls it “the widening gap” and says it’s not going away anytime soon, and there won’t be any quick fixes.