Detroit bankruptcy ruling shows that public pension promises can be broken

by Grace

The Detroit court ruling that weakens public pension protections should be a wake-up call for taxpayers and government employees in other states.

DETROIT — In a ruling that could reverberate far beyond Detroit, a federal judge held on Tuesday that this battered city could formally enter bankruptcy and asserted that Detroit’s obligation to pay pensions in full was not untouchable.

The judge, Steven W. Rhodes, dealt a major blow to the widely held belief that state laws preserve public pensions, and his ruling is likely to resonate in Chicago, Los Angeles, Philadelphia and many other American cities where the rising cost of pensions has been crowding out spending for public schools, police departments and other services.

The judge made it clear that public employee pensions were not protected in a federal Chapter 9 bankruptcy, even though the Michigan Constitution expressly protects them. “Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy,” he said.

In particular, the Detroit ruling could be a game changer for California municipal bankruptcy cases.

The ruling by Judge Steven W. Rhodes, who is presiding in Detroit’s bankruptcy case, that public pensions are not protected from cuts could alter the course of bankrupt cities like Stockton and San Bernardino, Calif., that had been operating under the assumption that pensions were untouchable.

Uncertainty looms for Detroit retirees.

Are retirees going to lose their pensions?
Maybe. Rhodes ruled Tuesday that pensions, like any contracts in bankruptcy, can be broken. But he also warned city officials that they’ll need to justify any deep cuts that could threaten the lives of retired workers. There are about 23,000 retirees and 9,000 city workers. Most of them receive pensions that are less than $20,000 annually. Michigan’s Attorney General Bill Schuette says he will continue to fight Rhodes’ assessment that pensions can be cut, since public pensions are protected in the state’s Constitution.

What about New York?

I’m unaware of any New York municipalities or school districts that are in danger of bankruptcy.  But with pension costs overpowering the ability of New York public schools to maintain student services and escalating 5,000% over the last decade in some towns, this latest development may diminish the perceived sanctity of guaranteed pension payouts.  In any case, it’s hard to see how taxpayers can continue to pay the skyrocketing pension costs that have been the norm in recent years.  We will have to wait to see how the pension crisis plays out in New York and other states.

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10 Comments to “Detroit bankruptcy ruling shows that public pension promises can be broken”

  1. They may be legally allowed to do this, but morally it is the wrong thing to do. Sorry, I am appalled

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  2. If I may offer an altenative point of view. . .

    Many of these contracts were negotiated at less than arms length, and were unrealistic to start with. Lifetime salary and healthcare is phenomenally expensive. It’s great if you have it, but too much if you have to pay for it.

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  3. Rmd — I agree that transactions between politicians and unions are not arm’s-length deals, and this is a main reason why I oppose public unions. These deals lead to agreements that benefit the politicians and the unions, at least in the short term. But they are often unsustainable, and hurt taxpayers as well as rank and file members in the long term.

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  4. One of the big problems is that in many states, the politicians never put money into the pension fund at the mandated amounts. That would not be allowed in private industry, where pension funds are more tightly regulated. If state government had be required to put money in, with real enforcement, two things would have happened: 1) there would be more money in the funds now 2)politicians (and taxpayers) would have been more aware of the actual costs of the contracts. Personally, I think politicians who simply did not put money into the funds so they could balance their budgets should go to jail now.

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  5. CSProfMom, I agree that what the politicians (and bureaucrats—it wasn’t just the elected folks) did was immoral and imprudent, and we’re all paying the price now for not insisting on honest and careful leaders. But if we imprisoned our politicians for being stupid and greedy, who would we have left to run the government? A big chunk of the problem was that actuaries were not good at explaining the risks of under-investing, and politicians are not good at the math for long-term investments. (Look at Federal tax law, which defines long-term capital gains as “more than a year”.)

    The University of California made the same mistake (and I did protest it 20 years ago, though my voice was not heard), and the faculty and staff are now paying for the 20-year lack of investment in the retirement funds.

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  6. “But if we imprisoned our politicians for being stupid and greedy, who would we have left to run the government?”

    Sad but true.

    From what I’ve seen, most of the shady actions were technically legal. Look at Social Security “promises” to pay out retirement benefits. Very few younger people believe these promises will be fulfilled. Unlike many of the state pension obligations, Social Security is not constitutionally guaranteed. But we are letting politicians get away with “immoral and imprudent” legislation, IMO.

    My solution would be to cut down on the amount of taxpayer money politicians are allowed to control, IOW shrink the government. 401k-type retirement plans instead of pensions.

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  7. I’ve argued in the past for defined-contribution rather than defined-benefit plans. The defined-benefit plans tend to favor those employees who are close to retirement, while defined-contribution plans more fairly spread the benefit to all employees. Unfortunately, it is very hard to switch from one system to the other, unless the defined-benefit program is really fully funded.

    Social security is different from most pension plans, in that it is set up as a pyramid scheme—current contributions go to pay pensions of existing retirees, rather than being saved to pay for the retirements of those contributing. The system works if you think of it as support from the working-age people for older people, and not as a pension system where people accumulate savings from their working years to support themselves in retirement.

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  8. Social Security is definitely a way of supporting elderly people via payments from working people. That is OK, though. Caring for our elders is always going to cost a lot of money, and there is no one else to get that money from except working people. Social Security is simply a method to smooth out the costs, so that one family doesn’t have to declare bankruptcy supporting their elders while another has few costs. In some sense, it functions the way that medical insurance is supposed to function. But the idea that if we got rid of social security, the “burden to the younger generations” will simply go away as people like Robert Samuelson like to argue is incorrect – the younger generation will always have to support its elders.

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  9. Yes, Social Security is different from pension plans in its structure. However, it’s similar in the way politicians have failed to address insolvency issues and continued to kick the can down the road. Even simply suggesting that the retirement age should be raised earns strong criticism from certain sectors, so the reluctance to deal with it is certainly understandable.

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