The Impact of Detroit’s Bankruptcy Ruling on Other Cities
On December 3, 2013, a federal judge ruled that Detroit was eligible for bankruptcy protection that cleared the way for municipal pensions to be cut. U.S. Bankruptcy Judge Steven Rhodes found that Detroit, once the nation’s fourth-largest city was insolvent, could not pay its debt, that city officials had filed their petition in good faith, and was therefore allowed to enter Chapter 9 bankruptcy protection, making it the largest municipal bankruptcy in U.S. history. (1) Judge Steven Rhodes said, Detroit has an opportunity for a fresh new start.
Judge Steven Rhodes also ruled that the pension checks of retirees could be reduced as part of the bankruptcy proceedings. This means that that state protections against reducing pensions do not trump Federal bankruptcy laws. In his ruling, Rhodes said Michigan’s protections “do not apply to the federal bankruptcy court,” adding that pensions are not entitled to “any extraordinary attention” compared with other debts. (1)
The decision signaled the start of a new legal round. The city’s employee unions, whose members, current and retired, are likely to face benefit reductions, are expected to appeal the ruling to a higher court, though any appeal is not likely to slow the bankruptcy proceedings. The unions maintain that Detroit’s state constitution protects pensions from being cut, an issue that could end up being decided by the U.S. Supreme Court. The political differences between the city and its unions have not dissipated, nor has the economic reality of trying to reduce about $18 billion in debt by deciding how to apportion the painful economic reality of cuts. Detroit has not been contributing to its pension funds, and by the end of the year it will have deferred $100 million in contributions. The City presently has $3.5 billion in unfunded liabilities. (1)
The goal is for Detroit to exit bankruptcy protection by the end of September 2014. Under Kevyn Orr, the state-appointed emergency manager, the city will introduce its proposal to restructure its debt and reshape government services and operations, with details due out by early next year. The city will be asked to present a disclosure statement, which is an outline of a reorganization plan. Creditors will weigh in on the statement, and Rhodes will rule on it. This will require creditors as well as labor partners to work with Orr, to achieve the sorely needed reform the city needs to become solvent again. (1)
Unions worry that if pensions in Detroit are cut back, other cities and states across the country could soon follow suit. Steve Kreisberg, director of collective bargaining at the American Federation of State, County and Municipal Employees, or AFSCME, said, “It’s part of their political strategy to undercut pensions.” For decades, representatives of public-sector pensions have depended and relied on constitutional provisions in various states, including Michigan and Illinois, that protected pensions. Now, U.S. Bankruptcy Judge Steven Rhodes’ ruling has shown that federal bankruptcy laws preempt those state provisions.
It’s not just Detroit retirees who are worried about their pensions. Financially troubled cities in California, Illinois and Pennsylvania will soon face decisions on what to do with chronically underfunded pension funds, and experts say the Detroit ruling has made it easier for cities to argue that pensions must be cut. Any city that has underfunded pensions and troubled finances could soon look to bankruptcy as a way out of paying pensions, experts say, as long as their state allows them to file for Chapter 9 protection.
Few experts believe that pensions of current retirees will be cut significantly, and many cities probably will renegotiate with unions on pension payouts rather than go through bankruptcy to avoid doing so. But the timing of the Detroit ruling is especially worrying for some public employee unions because public employees have become big targets as struggling states and cities deal with the effects of the Great Recession. Some States have reduced employees’ ability to collectively bargain. Rhodes’ ruling could have implications in California cities such as San Bernardino, which was deemed eligible for bankruptcy this year but is still battling with the California Public Employees’ Retirement System over what it owes the pension fund and what it will pay into it in the future.
Robert Novy-Marx, a professor of finance with the Simon School of Business at the University of Rochester said, “The threat of bankruptcy now gives municipalities a little more power at the bargaining table.” Pensions for retirees are undergoing changes too: On the same day that Rhodes declared Detroit eligible for bankruptcy, the Illinois Legislature voted to cut back retirees’ cost-of-living adjustments to slightly reduce pension costs. Everyone is watching Detroit as it decides how to pay its pensioners and other bondholders while still being able to provide essential city services. (2)
CalPERS, whom the City of Glendale is contracted to manage its pension fund, Is Worried. The California Public Employees’ Retirement System issued the following statement: “The Detroit court failed to recognize the difference between a two party contract and the unique nature of a state public employee retirement system, which creates a three-way relationship among a public agency, its employees and the retirement system. In California, our members’ vested rights to their pensions are protected by the California constitution, statutes and case law. (3)
· “Unlike Detroit, CalPERS is not a city pension plan. CalPERS is an arm of the state and were formed to carry out the state’s policy regarding public employees. The Bankruptcy Code is clear that a federal bankruptcy court may not interfere in the relationship between a state and its municipalities. CALPERS believes that the ruling in Detroit is not applicable to state public employee pension systems like CalPERS.
However, if CalPERS was to prevail on its argument, the California taxpayer will be stuck paying the bill even if it means your city effectively dissolves — with all police, fire, parks, roads and other functions canceled — and the city only existing to pay the pensions of long-retired workers. Also, CalPERS has faith that the California Constitution presides; that the courts will interpret it according to the wishes of CalPERS; and that the federal government won’t say federal courts, federal laws, and the federal Constitution don’t trump California legalisms. Technically, state’s can’t go bankrupt; but they can become insolvent. So they’re letting CalPERS and the other pension funds know that the funds better start getting a little more reasonable, or they’ll all end up like Detroit. (3)
In Illinois, the state legislature recently passed a public pension reform that will save $160 billion and fund the retirement system over 30 years by reducing benefits for workers and retirees. Cities in California cities are no different. They’re struggling with fiscal problems that are wrapped around unsustainable salaries, overtime, salary perks, pension and health care liabilities. Everything must be on the table. (4)
Judge Rhodes said that, “it has long been understood that bankruptcy law entails the impairment of contracts.” That argument is at issue in the San Bernardino bankruptcy debate and could arise again in Stockton. Other California cities facing difficult fiscal conditions due to heavy pension burdens will take note. The pension decision in Detroit will now become front and center as city officials sit down with union leaders to discuss resolutions to budget problems. The decision also gives a boost to other California cities to find a resolution on the pension issues that are threatening the budget in cities across the state. Perhaps public employee unions should attempt to find common ground. (4)
Desert Hot Springs isn’t on the national radar, but its situation is hardly unique. With only 27,000 residents and only 55 full-time city employees, Desert Hot Springs lacks the financial heft that allows larger cities to put off their day of reckoning. For the “FY 2013-14 Budget with Revenue & Expenditure Adjustments,” Desert Hot Springs is expecting to collect $13.9 million and expecting to spend $18.1 million. It expects to spend 30% more than it makes, a deficit of $4.2 million. The average full-time employee working for the city of Desert Hot Springs earned direct pay plus employer paid benefits during 2011 of $144,329. The average public safety employee working for Desert Hot Springs earned direct pay plus employer paid benefits during 2011 of $164,621. Once you eliminate the part-time workers, you get representative averages. This is in a city where the median household income is $31,356 and the median home selling price is $133,500. (5)
Unionized government employees” in the case of Desert Hot Springs, are making more per year than the average home costs in that city. If the city implemented an across the board 27% reduction in pay and benefits to all Desert Hot Springs employees, this would reduce the average pay plus employer paid benefits for a full time employee of Desert Hot Springs from $144,329 per year to $105,360 per year. (5)
Will Glendale become the next Desert Hot Springs? In 2012, Glendale had 595 city employees that earned in excess of $100,000 exclusive of City contribution to their pension, health, and retirement benefits. This represented 33% of its workforce. These elites have used the system to their advantage to earn over 15 million is overtime and salary perks. It’s absurd that the top brass, including fire and police deputy chiefs, battalion chiefs, lieutenants, sergeants, etc… earned time and half pay, rather than compensating time off at straight time. No salary employee earning over $75,000 in base pay should be entitled to any paid overtime.
Glendale’s Unfunded Pension Costs in 2013 was $28.5 Million. The Actuarial Accrued liability (AAL) is $1.487 Billion, in 2013, from $688 million in 2001, and the unfunded AAL portions was $238.9 million ($205 million in 2011). The funded status of the City’s Other Post Employment Benefits plan (OPEB) as of June 30, 2011, the plan’s most recent actuarial valuation date showed a $191 million Unfunded Actuarial Accrued Liability. The City’s contribution is currently based on a pay-as-you-go funding method, that is, benefits are payable when due. The City’s annual (OPEB) required cost for the year was $23.6 million. Yet, the City contributed just $2.7 million in benefit payments. The current Net OPEB increased in 2013 from $38.2 million to $58 million.In addition, CalPERS will begin to take a bigger bite of state and local government budgets. A new CalPERS projection shows employer rates may increase 27 percent over the next six years
The only conceivable way to reverse the trend is to force City leaders to live within its means by stopping GWP electric revenues from being transferred to the General fund ($20.857 million) in 2013, as General Appropriations. These funds should have been reserved for the repair and replacement of Utility plant & equipment. Also, the GCC in prior years approved a Utility User Tax (UUT) on utility charges, transferred to the General fund ($26.5 million) in 2013, as General Appropriations. These funds should have been redirected to GWP for infrastructure. Rather, it was used to support unsustainable employee salaries, overtime, salary perks, pensions and benefits. The unintended consequences of the GCC’s action, resulted in future increases in our water and electric rates, and the GCC seeking new sources of tax revenue and fees for residence and businesses, i.e. the GCC just this week approved the hiring of a tax consultant to gauge the likelihood of a possible tax measure on the June 2014 ballot, that would successfully get voter approval.
The primary obstacle is the City Council members who are beholden to the unions for their re-election support. Therefore, we need to elect responsible City Council members who are independent and not beholden to the unions. By doing so, we can level the playing field, by lowering the amount of revenue receipts available for general appropriations, that can only result in the unions having to renegotiate the terms of their collective bargaining contract, to accept reduced salaries and pensions, in accordance with reduced revenue. Otherwise, without the unions agreeing to reduced salaries, pensions and benefits, the GCC will have no alternative but to lay off city employees and outsource many city services, or ultimately be forced to file for bankruptcy.