Detroit 101 - Return to the Elephant in the Room: Governmental Pension Reform

Back on April 23^rd, I presented my views on desperately needed governmental pension reform. Then, in July, the first (Detroit) of what I expect to be a whole pile of state districts and major municipalities to seek protection from creditors under federal bankruptcy laws, filed, mostly under pressure from unfunded pension (and concomitant healthcare for retirees) obligations. With Detroit being lesson number one, I would like to repeat that blog, but this time with a little additional opening excerpt from the July 27^th Economist: “By one estimate, the total pension gap [beyond that section which has been funded] for the states is $2.7 trillion, or 17% of GDP. That underestimates the mess, because it omits both the unfunded pension figure for cities and the health-care promises made to retired government workers of sorts…

“Some of this is the unfortunate side-effect of a happy trend: Americans are living longer, even in Detroit, so promises to pensioners are costlier to keep. But the problem is also political. Governors and mayors have long offered fat pensions to public servants, thus buying their votes today and sending the bill to future taxpayers.  They have also allowed some startling abuses. Some bureaucrats are promoted just before retirement or allowed to rack up lots of overtime, raising their final-salary pension for the rest of their lives. Or their unions win annual cost-of-living adjustments far above inflation. A watchdog in Rhode Island calculated that a retired local fire chief would be pulling in $800,000 a year if he lived to be a 100, for example. More than 20,000 retired public servants in California receive pensions of over $100,000.” It is a smoking gun with potentially devastating near-term consequences for us all.

Now back to the April 23^rd’s message: I’ve blogged on the reality that with economic downsizing and increasing longevity, Social Security (the federal retirement program for most of us) justifiably needs to phase in “retirement” within increasingly older qualifying ages. Retirement at age 65 should increase a year to the qualifying date for anyone under age 55, and 2.5 years for anyone under 50. This will increase the earning power of the system, which may still be underfunded, but it is good start.

For governmental pensions, the solutions need to be more drastic and will inflict more pain. We cannot, however, bury our heads in the sand and hope somehow that the estimated $2.7 trillion of unfunded state and local pensions will simply go away or find a magical source of financing that no one can foresee. Let’s start with a couple of basics. Early retirement for everyone from uniformed services (state and local fire and police, federal military) either has to stop or at least the funding for such pension, absent disability, needs to be postponed until a realistic retirement age is reached. Retire at 45 with 25 years of service? Great! But you really shouldn’t be able to collect that retirement until, at a minimum, age 60. The retirement funds would have more time to generate value.

Second, the notion of “defined benefit” plans needs to die. Defined benefit plans provide precise dollar benefits, regardless of what has been funded in the pension account, upon retirement. It has almost vaporized in the private sector, replaced by the “defined contribution” plan, where you retire on what has accumulated in your retirement account. The ups and downs of economic and political reality no longer afford us the luxury of paying a fixed sum (usually based on the retiree’s highest years of compensation) of monthly benefits no matter what has happened in the economic real world. Oh, and this would apply to pensions of our elected officials as well. One term of Congress should hardly create a massive retirement benefit.

But the truly complex issue is what to do with already-vested but tragically underfunded government pensions across the land. These threaten the integrity of the United States itself, potentially throwing hundreds of municipalities into full-on Chapter 9 bankruptcy, states into a quagmire of bankruptcy-without-a-statutory-solution quagmire. Local services, police protection, infrastructure, etc. could easily stop functioning altogether in the absence of funding that such events might cause. And in most instances, that statutory or de facto bankruptcy is likely to have been caused in significant part by underfunded or unfunded pension obligations. As America gets demographically older, as statistical trends clearly project, there will be fewer workers supporting more retirees, a truly uncomfortable situation.

This too has a solution, rooted in federal bankruptcy law. In order to keep entire political units from filing for bankruptcy protection under Chapter 9 of our federal bankruptcy code, I propose that there be an amendment to the code, call it Chapter 9A, dealing exclusively with state and municipal “pension” bankruptcy. It would allow either or both (i) the state or municipality facing pension insolvency or (ii) three or more separate constituencies of workers (retired or currently working with pension benefits) to file under this proposed amendment. The individual employee constituents would either be a recognized union representing a body of relevant employees or a federally-certified designee (as “fairly and adequately representing the affected class of employees, including managers”) where no union has jurisdiction.

The court would have to make an initial finding that the state or municipality in question is substantially unlikely, under then-current funding structures (reasonably expected taxes and revenues less reasonably anticipated operating costs) to meet its relevant pension retirement obligations. Once this ruling is made, a court-appointed “trustee for pension insolvency” would be designated. Under the guidance of this trustee, all of the relevant constituencies of pension beneficiaries and the designated representative of the relevant governmental body would have 90 days to meet and resolve the underfunding. All pension beneficiaries would be impacted equally, and no pension beneficiaries could have an exemption from the process. A “pension creditors committee” could be formed under court guidance if there were too many constituencies to allow a meaningful negotiation without such concentration of negotiators.

In the event that a majority of the labor constituencies (based on the sheer number of affected individuals) and such governmental designees are unable to reach a solution within the designated time limit (which they can extend by another 90 days by mutual consent), the trustee would have the right to architect a plan, subject ultimately to court approval and modification, to implement a restructuring plan that could include replacing the defined benefit plan with a defined contribution plan, reducing the level of pension benefits, extending the time for payment of such benefits (but only for individuals who have not yet retired) but not beyond the time that Social Security benefits would accrue under federal law, imposing an increase in local sales, property and income tax, which increased revenues could only be used to fund pension obligations.

The trustee would be required to take into consideration and to make findings in connection with demographic trends, the burden imposed on local taxpayers, the disincentives to local business to remain in the relevant governmental jurisdiction and the overall impact on the quality of life and governmental services. This is a careful balancing of interests would also be subject to judicial review. Both the governmental and labor interests would submit their objections to the submitted plan within 30 days of receipt and would be entitled to commit to a different solution based upon a majority of labor constituencies and the governmental designee’s mutual agreement to a different plan. After a thorough review and assuming no such alternative plan is accepted, the court would have the right to remand the plan back to the trustee with specific recommendation or to make the modifications itself. The final decision of the court would be subject to review and appeal under federal law, but the trustee would be empowered to implement the court’s ruling.

At the end of the day, a solution is necessary. While unions might fiercely resist this new statute, they would be infinitely worse off if they triggered a complete Chapter 9 bankruptcy. This is the lesser of two evils and definitely creates a path to get money into those pension systems to pay retirees, which has to be attractive to unions whose members might get slammed by full insolvency. This is also a solution that should be embraced on a non-partisan basis, something that might find its way as the basis for a House of Representatives otherwise unable to compromise. Perhaps it is precisely the kind of “give” that Democrats need to make to entice Republicans into revenue enhancements as part of the overall budget process.

I’m Peter Dekom, and it’s time to find solutions for our biggest problems!