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Tuesday, November 12, 2013

Howdy, partner: Detroit's bankruptcy and the 16% solution

I have not commented on the Detroit bankruptcy as of yet for several reasons, mainly because it has been widely covered in the news, but also because any bankruptcy in its preliminary stages has to go through several legal steps before anything concrete comes into view.  However, this October 30, 2013 Fox News story by Perry Chiaramonte gives some idea what the future might look like for Detroit's public employees.

Detroit has been in dire financial straits for many years, and its bankruptcy, by far the largest municipal bankruptcy in history, was really more a matter of when than if.  The city has essentially been taken over by the state of Michigan.  Kevyn Orr was placed in charge of the city as emergency manager, whose authority supersedes that of Detroit's mayor and council, and he attempted to negotiate with Detroit's many creditors, including its pension funds, to accept reduced payment of the city's debts.  In the case of the pension funds, this would mean a reduction in benefits to current retirees and promised future benefits of current workers.  When these negotiations were unsuccessful, Detroit filed for Chapter 9 bankruptcy on July 18, 2013.

A Michigan state judge attempted to overturn the bankruptcy filing as a violation of the Michigan Constitution clause that prohibits the diminishment or impairment of pension benefits.  This clause is similar to Article 29 of the Arizona Constitution, which is at the heart of several legal challenges to SB 1609's changes to PSPRS.  However, the federal bankruptcy court overruled the state judge and mandated that all legal actions regarding Detroit's bankruptcy be decided exclusively in federal court.  Currently, parties to the bankruptcy are awaiting the decision of a federal court judge to determine if Detroit is eligible to enter bankruptcy.  The nine-day trial allowed those opposed to the bankruptcy to make their cases.  Numerous issues, including the allowability of pension cuts, will have to be negotiated and settled in the federal bankruptcy court if Detroit is deemed eligible for bankruptcy.

The Fox News story states that Detroit believes that it can only meet its pension obligations to the tune of sixteen cents on the dollar.  That means a pension of $3,000 per month would decrease to $480 per month.  That gives an idea of how bad Detroit's finances are, and the likelihood that it will be declared eligible for bankruptcy.  Mr. Orr's plan is for Detroit to be out of bankruptcy sometime in 2014, and hopefully with a clean slate for the city and its residents.  Of course, for retirees, employees, and others who will have to accept a "haircut" on the money owed them by the city the future will not look so rosy.

Fortunately for Arizona, there are no cities in anywhere near the financial distress that Detroit is in.  It took decades of almost deliberate neglect and abuse of a once-great city to get into its current sorry state.  As a cautionary tale, though, it has value to PSPRS members.

Texas conman Billie Sol Estes was reputed to have said, "When you owe someone a thousand dollars you're in debt; when you owe someone a million dollars, you've got a partner."  Public sector employees, particularly public safety personnel, have committed their long-term financial security to the belief that government will always have the ability to pay what it owes.  They have long believed that they can steer the political process in their favor financially by allying with friendly politicians, who are more concerned about getting elected than they are with fiscal sustainability.  After all, why shouldn't we spike our pensions or give ourselves end-of-career bonuses via the DROP if politicians acquiesce to our demands?  Governments don't go out of business, and anyway, that is something people in the future will need to figure out.

I wonder if that is what Detroit's (non-public safety) retirees and city employees thought when they were drawing 13th checks for years.  So what happens when the future happens now and the money finally runs out?  Detroit's retirees and city employees are about to find out when they go from being creditors to partners in Detroit's financial disaster.

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