Detroit Bankruptcy Potential Precedent-Setter on Pensions
If a federal judge decides the city should cut pension benefits, it could have nationwide repercussions
By Danielle Kurtzleben
July 25,
2013 - U.S.News & World Report
With a federal judge quashing legal challenges that could have held up the
Detroit bankruptcy, the process rolls on. Now might be time for public employees
nationwide to take notice.
Among the lawsuits that U.S. Bankruptcy Judge Steven Rhodes ruled on this
week was a challenge filed by city employees about pension cuts. That suit will
be decided in federal court. The Michigan state constitution, however,
explicitly prohibits cutting employees' accrued pension benefits. But since
seven other state constitutions have similar language and plenty of other cities
face fiscal difficulties ahead, bankruptcy experts say Detroit will be the case
to watch in determining how future bankruptcies might play out.
"It may be the most important bankruptcy ruling in the history of bankruptcy
law." says Robert Novy-Marx, a public pensions expert and associate professor of
finance at the University of Rochester's Simon School of Business.
"If Detroit is able to impair these pension plans from workers' point of
view, despite the fact that there's constitutional language preventing this, it
basically is going to let workers everywhere know that they're only protected up
to the assets that are set aside," he adds.
In his June
restructuring plan for the city, emergency manager Kevyn Orr estimated
Detroit's unfunded current and future liabilities at nearly $3.5 billion,
meaning they make up nearly one-fifth of the city's total debt.
City employees have responded vigorously to the prospect of those liabilities
being restructured. One local union of public employees has
organized a rally scheduled for Thursday afternoon, where members will
protest potential pension benefit cuts, alongside other demands, like a call for
federal funds.
Sharon Levine, an attorney representing AFSCME, the union that represents
Detroit city workers, told
the Associated Press that cutting pensions will make hard economic times
even harder for many recipients.
"Our members who participate at most are at or below $19,000 a year. There is
no safety net," she said. The local AFSCME council also says the city did
not try to bargain with unions before filing for bankruptcy, as the Wall
Street Journal reports.
Detroit may have particularly large fiscal problems to face, but it is not
alone. One 2011 paper from California based think tank The
Milken Institute showed Chicago, New York City, San Francisco, and Boston
had even more unfunded pension liabilities per household than Detroit, and
Novy-Marx says those unfunded liabilities persist in many large cities. A rash
of medium- to large-sized cities have also been filing
for bankruptcy in recent years, including Vallejo, Calif., in 2008;
Harrisburg, Pa., in 2011; and both Stockton and San Bernardino, Calif. in 2012.
As more municipalities fall victim to bankruptcy, the decisions in the Detroit
case could be all the more important on a national scale.
"If Detroit can make at least modest adjustments to its pensions, and
restructure its other obligations as well, the city and other municipalities in
dire financial straits may have a fighting chance. If not, the downward
financial spiral of too many American cities is likely to continue," said David
Skeel, a professor of bankruptcy law at the University of Pennsylvania Law
School, in a Wednesday
Wall Street Journal opinion piece.
Detroit's bankruptcy is the largest municipal bankruptcy in U.S. history, and
because of both the size and the legal question of cutting pensions, it could
mean a battle in a much higher federal court.
"It would be a significant ruling, and one given the stakes involved would
likely find its way to the Supreme Court, because a proceeding in a federal
court would presumably be overriding a provision of a state constitution,
raising the question of the ability of a federal bankruptcy court to intrude on
the sovereignty of a state," says Paul Maco, a partner at Bracewell &
Giuliani LLP, and a former director of the SEC's Office of Municipal
Securities.
Pensions are a sizable share of the city's $18 billion debt, but there are
plenty of other issues the city will have to deal with. The city also faced $5.7
billion in retirees' health care benefits as of 2011, and also estimates that as
of June 30, it had $5.3 billion outstanding in revenue bonds, a type of
municipal bond.
In addition, there is the problem of restoring growth to a city whose
population has dwindled, from more than 1.8 million in 1950 to just around
700,000 in 2010. That decline is bad for both economic growth and city
revenues.
Some of Detroit's problems may be unique, but Maco says that one unifying
factor across city bankruptcies is the political struggle that goes with
readjusting a city's finances.
"Overcoming the differences in political views and personal differences
really is going to be a key to moving from getting what you can of what's left
to," says Maco. "If properly marshaled, political leadership can make all the
difference."
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