The Issue that Just Won’t Go Away

With unfunded state and local government pensions and retirement medical benefits still hovering around the $2.7 trillion mark, our local politicians deal with this monster in the yard sporadically and generally ineffectively. In better times, politicians seeking governmental union campaign support and votes from large bureaucracies – amazingly from both sides of the aisle – rewarded uniformed services (e.g., police, fire, etc.) with early retirement at high rates and other state and local civil service workers with substantial benefits after fewer years than many in the private sector.

What’s worse, with many retiring in their 50s and taking up a second career, they are reaping benefits long before the rest of the world that has to wait until 65 or older to retire. While the federal government just “prints money” to fund its pension obligations, state and local governments simply owe the money, often allocating money necessary to fund current operating costs to run cities, schools and basic services instead to fund past services through retirement benefits. And most of these plans were created in a different era with profoundly different economic realities.

Defined benefit plans (where you get a fixed dollar amount per month, often with cost of living escalators) are virtually gone from the most-non-unionized private sector, replaced fairly uniformly with a defined contribution plan (one that simply releases what has been accruing in that retirement account). While defined contribution is creeping into the public sector, most government retirement plans are a function of the retiree’s earnings in the last key-earning years.

But as a wave of high-profile municipal bankruptcies (filed under Chapter 9 of federal bankruptcy law) – from Detroit to San Bernardino – has swept through too many cities, a conflict has risen between state laws, which often do not release municipalities from their pension obligations regardless of any change in their fiscal status under any law, and federal requirements that seem to subordinate state and local mandates to the preemptive power of federal statutes. “The problem is that it remains unclear whether… federal bankruptcy law trumps state pension laws. A federal judge hearing the Detroit bankruptcy case ruled, for instance, that federal laws took precedence in that case, so the benefits of city workers in Detroit could be reduced in defiance of state law.” New York Times, April 20^th. 

But that ruling has fallen on deaf ears in the battle between California’s state pension administration giant, Calpers (which controls about $280 billion in California pension money), and bankrupt San Bernardino. In 2012, San Bernardino stopped funding its pension obligations. Calpers wants San Berdu to pay up, while the city is pushing back under federal bankruptcy law, saying that money is subject to determination under federal and not state law.

Detroit’s government pensioners side-stepped that judicial intervention by working out an agreement: According to new court filings from the city late [on April 25^th], the tentative agreements included smaller-than-expected cuts to retirees’ pensions. Municipal retirees could expect cuts to their pension checks of 4.5 percent, although those who took part in the annuity savings fund, which city officials now say distributed overly generous interest earnings in past years, would be required to repay portions. But such cuts, even for those who took part in the annuity savings fund, would be capped at 20 percent, the court filings say.” New York Times, April 25^th. But would San Bernardino follow the same path… or bring the issue of federal preemption up the appellate ladder?

“At issue is the $17 million in back payments and penalties that San Bernardino failed to make between declaring bankruptcy in August 2012 and resuming payments in July. Calpers has maintained that it is owed in full. But now in bankruptcy negotiations, the city is hoping to pay only a fraction of that, arguing that the city’s creditors must all share in the bankruptcy pain. The amount may be small, given the system’s assets, but if San Bernardino gets a reduction, the precedent could be huge, opening the door to other struggling municipalities using bankruptcy law to justify delaying or withholding payments to the pension system.” NY Times. California law mandates the payments; federal law seems to subject such absolutes to its jurisdiction once formal bankruptcy is filed.

It seems likely that California will work this out, because the last result Calpers wants to risk is a high court ruling that federal bankruptcy preempts local law. But think of this matter as the canary in the coal mine, reminding us all that local governments owe a whole lot more than they can pay over the coming years in pension benefits… and sooner or later, those chickens are coming home to roost. We need a ground-up examination of those obligations, both to insure that there will be substantial funding (perhaps not enough to cover 100% of the obligations) to cover retirees who worked hard to earn those benefits and to guarantee that states and local governments have enough money to cover current operations at necessary and expected levels.

I’m Peter Dekom, and eventually the can we are kicking down this pension road will slam hard against the wall.