Broke Town, USA
Nonetheless, because governments are required to make catch-up payments to those funds, the pension problem is worsening the current budget squeeze. In some cities, the pressure is suffocating. In Miami, according to Fitch, the pension-fund obligation eats up 25 percent of the city budget. In Philadelphia, which has neglected to make payments, the pension fund could be exhausted as early as 2015, says Joshua Rauh of the Kellogg School at Northwestern. Rob Dubow, the city’s finance director, insists that “we’ll make contributions to make sure that doesn’t happen.” The city has budgeted a huge $460 million contribution next year. “The real story” of the pension debacle, Dubow says, “is that it will leave less money for police and fire and sanitation.”
For a long while, government budget-cutting obeyed a distinctive political calculus: pensions were considered untouchable, so jobs were eliminated instead. Now, governments are going after pensions. Many states have taken the easy step of reducing benefits for new employees. Benefits for existing workers were considered inviolable. But some, like New Mexico and Mississippi, are dunning employees for higher contributions, and Wisconsin may follow. Minnesota and Colorado have watered down pension cost-of-living increases; both have been sued.
Whether such efforts will significantly ease the states’ burdens may depend on the courts. In Illinois, where the pension underfunding is among the most egregious, the state constitution says that “benefits shall not be diminished.” This language has long been interpreted to mean that when a public employee is promised a pension that increases with each year of service, the rate of accrual can never be changed. Sidley Austin, a law firm in Chicago hired by a pro-business civic group, has circulated a memo arguing that the clause refers only to benefits already earned — not to the rate of accrual in the future. That interpretation, if acted on by the Legislature, would shatter previous notions of pension protections. Sidley also makes the even-more-explosive argument that if Illinois’s pension funds dried up, the state could not be forced to contribute more. Let pensioners go hungry.
That is unlikely. Even in Illinois, pensions will be paid. Failure to do so would embroil the government in court for years. That may be the hope of ideologues, who envision that the courts — or possibly even a bankruptcy filing — could be used to alter employee contracts. In the 1930s, progressives persuaded Congress to let cities declare bankruptcy to escape the clutches of creditors. Now, conservatives want Congress to authorize states to file for bankruptcy. “Some people on the right see it as a chance to whack the public unions,” says David Skeel, a law professor at the University of Pennsylvania who has written in favor of state bankruptcy. It’s not hard to fathom why Gingrich, who as speaker of the House in the 1990s briefly shut down the U.S. government, would favor default by the states.
But the fantasy of using bankruptcy to suspend government runs up against a hard truth: even in bankruptcy, cities and states don’t disappear — nor do their obligations. Orange County, Calif., which entered bankruptcy in the mid-1990s after its treasurer ran up massive losses in derivatives, ultimately paid every cent it owed. “Among the reasons so few [cities] choose to go this option is, it’s not clear what they gain,” Kurtter of Moody’s says.
Another reason is that cities are creatures of their states, which fear a negative impact on their own credit. Connecticut prevented Bridgeport from declaring bankruptcy in the ’90s, and Michigan is stopping Hamtramck now. In Pennsylvania, about 20 municipalities are operating under a program to nurse insolvent cities back to health. The program has helped Pittsburgh, despite its woefully underfunded pension plan, to slowly improve its credit.
Harrisburg is a different story. A former mayor wanted to create a destination city with a series of ambitious projects, including a Wild West museum. He also approved an expensive plan to refurbish an incinerator so that it could become a moneymaker — a project that has buried Harrisburg under a mountain of debt. There are other Harrisburgs, cities undone by foolhardy projects, but these cases are particular, not systemic.
Vallejo, which ran out of money when the economy imploded, is more representative. A blue-collar city of 110,000, it had been hurting since a naval base closed in the 1990s. In 2007, the Wal-Mart left town. Then, with the recession, property taxes crashed from $29 million to $20 million. Vallejo cut back on street repairs and vehicle maintenance and reduced its staff by a third. The city sought pay cuts from the police and fire unions, whose members’ pay and benefits accounted for about 80 percent of the budget; the unions offered to defer pay raises. The council considered, but rejected, the idea of putting a tax increase to a referendum. Rob Stout, the outgoing finance director, who noted that the police chief is retiring on a $200,000 pension, says the general attitude was one of resistance to footing the bill.
Vallejo was a failure of political will. It is also an example of why bankruptcies for cities don’t work. All the constituencies who might have hoped to avoid hardship are being walloped anyway. Labor costs are being cut (though not pensions) and holders of $54 million in city bonds will suffer losses — how much won’t be known for years. Even Marc Levinson, a partner with Orrick, Herrington & Sutcliffe, which represents the city, calls the bankruptcy a waste of money and time. “It’s better to cut a deal than go through the pain we have in Vallejo,” he says. Pain is coming regardless. In some cities, bondholders will be burned. But America’s failing governments may be one of those crises whose full impact is not registered in the muni market, or in any market. Until voters can agree on what government services they want and will pay for, it is possible that bondholders will bank the profits while taxpayers, employees and citizens share the losses.
Roger Lowenstein (email@example.com) is a contributing writer and the author of “While America Aged” and, most recently, “The End of Wall Street.”