Thursday, December 5, 2013

Pensions and Bankruptcy: a fix is available and should be enacted by Congress

  - by New Deal democrat

Yesterday a bankruptcy judge decided that, Michigan's Constitution notwithstanding, the city of Detroit could be admitted into bankruptcy and its pensions attacked.

As an initial matter, the decision is probably correct as far as it goes, i.e., Federal laws are supreme over state laws, so US bankruptcy law trumps Michigan's Constitution.  Where I have a real problem is that Michigan, at its most fundamental level, sought to make it ultra vires (outside of their lawful powers) for any actor to file for municipal bankruptcy in that State.  You an I can't simply march into US bankruptcy court and put General Electric into bankruptcy.  We have to have the lawful right to make the filing.  Michigan said that nobody had the right to make a lawful filing as to its municipalities.  In my opinion, that should have been enforced against the State-appointed city manager who made the filing.

But there is a deeper problem, and that is the cavalier attitude towards pensions that has been allowed to exist in US bankruptcy courts for 25 years.  If you haven't seen it yet, watch the interview with the elderly, retired Detroit municipal worker who worked for his pension for 40 years and now faces having his retirement income severely cut (and remember that many of these workers do not qualify for Social Security).  He asked, "What do they expect me to do now?"

Since pensions were allowed to be cut in bankruptcies, Congress - including Democrats - has simply shrugged and said, "Too bad."  That doesn't have to be the case, and it shouldn't be the case.

In many cases in private industry, corporate raiders attack a well-functioning company sitting on a pile of cash, including its pension funding.  After the corporate treasury is raided, the company files for bankruptcy and the pensions are cut or even entirely negated.

There is simply no justifiable reason for this rule.  Pension liabilities are publicly known and quantifiable.  In many cases the contractual benefits were earned years, and maybe decades, before.  All subsequent contractual liabilities are made (and should be deemed made) with full knowledge of those pre-existing liabilities to employees.  If there is a bankruptcy, nobody who became a creditor after the vesting of the pension benefits should be allowed to participate in any distribution until those prior contracts are honored.

This doesn't mean that pensions are sacrosanct.  It simply means that creditors who obtain their rights under subsequent contracts have to stand in line behind pensioners who earned their rights in previous contracts.   In the case of Detroit, it means that somebody who bought a bond issued by Detroit 5 years ago shouldn't get paid until that retired worker's pension previously earned benefits are honored in full.

There are public entities, and corporations as well, that promised too much in pensions.   Further, in the case of a necessarily ongoing entity like a municipality, pensions can't be honored in full at the expense of providing necessary municipal services to current residents.  But there is simply no reason to put recent bondholders on the same footing as, let alone ahead of line as, pre-existing pensioners.

Under the rule I am discussing here, if I am a potential new bondholder for a city or company that has huge pension liability, I am either not going to buy their bonds, or else I am going to demand a very high interest rate to hedge against the likelihood that the bond issuer is  going to default. The net effect is that profligate municipalities will go into bankruptcy sooner, when their finances are in less dire straits - which is a good thing.

In short, there is a federal legislative fix for this problem.  It ought to be on the Democrats' agenda, and applicable prospectively to any contracts entered into subsequent to its enactment.

In the meantime, the last several decades have taught workers a brutal lesson:  never trust assurances of future payment.   I want the retirement funding up front, hived off in a defined contribution account that belongs to me, not my employer.