Carrie Sheffield
Contributor
Opiniontime - 11/17/2014
Forbes
Stockton Highlights Nationwide Risk Of Conflict Between Muni Investors And Public Sector Unions
Fixed-income investors are now on notice that their rights could be trumped
by public-sector union bosses, following a
court ruling granting Franklin Templeton Investments just pennies on the
dollar for its muni bonds from bankrupt Stockton, California. And the case is
only one of many across the country. (Therefs no word yet on whether Templeton
will appeal.)
The ruling, while distressing, should not be surprising. In part, because
investors are subject to an unfair information asymmetry at the hands of state
and local governments. Itfs well-documented
that government pensions tend to understate their pension and other obligations
to workers and retirees, potentially hiding some risk
from bondholders.
Yet, itfs not all bad news for investors. While this most recent ruling
clearly favored public employees over investors, in an earlier
ruling the same judge made history in the Golden State by designating
pensions as impairable—subject to a haircut in the event of bankruptcy. Pensions
may still get favorable treatment, but no longer in automatic fashion.
Stockton is not alone. A new report from Moodyfs Investors Service shows just
how widespread the risk runs as investors weigh whether to put their trust in
municipal officials. The question is whether Stockton could be a wake-up call
for city managers and union leaders across the country to tighten their belts
and lower the temperature at the negotiating
table.
gWhen municipal credit deteriorates to the point of service insolvency and
results in bankruptcy or receivership, bondholders can find themselves in fierce
competition with pensioners and current employees over resources and priority of
payment,h wrote my former colleague Al Medioli, vice president and senior credit
officer at Moodyfs.
In my former life as municipal bond analyst with Moodyfs (I rated hospitals
that behave like businesses in many ways but receive the tax benefits of a
not-for-profit and thus fall under the muni umbrella), one of the factors we
considered was whether a debt-issuing entity was unionized, a status that was
inherently viewed as a gcredit negativeh due to unionsf ability to disrupt
operations. When we observed a history of obstreperous union leadership, we
noted this to investors.
gDespite this decision to confirm Stocktonfs plan leaving pensions intact,
local governments will now have more negotiating leverage with labor unions, who
cannot count on pensions as ironclad obligations, even in bankruptcy,h Moodyfs
wrote in another report after the ruling.
This will also help cities better with Other Post-Employment Benefits
(OPEBs), which typically include life insurance, health care benefits, and
deferred-compensation. In the Stockton bankruptcy, only 1 percent of OPEBs were
recovered. During restructurings, OPEBs are often used as a bargaining chip to
cash in favor of pension protections. And as with pension obligations;
oftentimes the OPEB obligations are obscured. The sheer irregularity of such an
arrangement and the politicization of these benefits will no doubt be red flags
to potential bondholders as they choose where to invest in the future.
Mediolifs report examined the seven substantial municipal restructurings
that have occurred since 2008. Of the seven, just one (Central Falls, Rhode
Island, where bonded debt made up a small fraction of liabilities) took a
haircut on pensions while making investors whole. The other five (San Bernadino,
California, is still pending) favored pensions: four paid 100 percent to their
pension funds while skimming from investors. Detroit was ordered to pay 82
percent for pensioners and only 25 percent to investors.
Such thumb-on-the-scale restructurings in favor of union leaders creates
economic moral hazard: City stewards are less likely to enact urgently needed
pension reforms if they know accountability is unlikely. Workers and retirees
put their hard-earned money into pension systems and are understandably anxious
to enjoy the fruit of their labors. Yet cities that make unsustainable defined
benefit promises do a disservice to their workers. Some muni bond issuers have
shifted
to a hybrid model with features of a 401(k)-type defined contribution
structure with some guaranteed contributions. This is more sustainable for both
taxpayers and workers.
gReality is not negotiable,h former Utah state Sen. Dan Liljenquist, a
Republican who helped push a hybrid model in his state, told The Wall
Street Journal. gThe fact is somebody bears the risk. Ultimately, the
state is bearing more risk than it can.h