Strict Fiscal Oversight Keeps New Jersey Cities Out Of Bankruptcy

Detroit’s fiscal disaster raises questions about adequacy of state pension funding

Detroit’s bankruptcy sent shock waves through political circles and intensified the debate over whether state and local pension systems are underfunded, but don’t look for Camden or other distressed New Jersey cities to follow Detroit into bankruptcy court, municipal finance experts said.

While more than 20 counties and municipalities and authorities in 10 states have filed bankruptcy since 2003 because of poor financial practices or unsustainable pension debt, New Jersey has not had a local government bankruptcy since the Great Depression.

“Camden in many ways is in worse shape than Detroit, but Camden isn’t in bankruptcy and isn’t going to go into bankruptcy,” said Marc Pfeiffer, assistant director of the Local Government Research Center at Rutgers University’s Bloustein School of Planning and Public Policy.

“While New Jersey has a few municipalities that are severely distressed, we are considered one of the better states in oversight and managing funds, and it’s a system that continues to work. The states where municipalities have gone bankrupt were those with a lack of oversight and limited engagement by the state government until it’s too late,” said Pfeiffer, who spent more than 20 years tracking New Jersey municipal finances before retiring last year as deputy director of the state Department of Community Affairs’ Division of Local Government Finance.

Camden, Paterson, Trenton, Harrison, and Asbury Park are all under supervision by the state’s Local Government Finance Board and part of a special transition aid program “designed to keep municipalities afloat,” Pfeiffer said, and both Harrison and Salem City are under close fiscal supervision because of problems with development bonds.

“A bankruptcy like Detroit just isn’t going to happen in New Jersey,” agreed Jon Moran, the New Jersey State League of Municipalities’ longtime legislative director. “Here in New Jersey, for a community to declare bankruptcy, you have to get approval from the Local Government Finance Board, and before it gets to that point, the Board and the Director of the Division of Local Government Services will already have taken steps to fix the problem.”

New Jersey’s centralized system of six state-administered pension funds providing benefits for all of the hundreds of thousands of employees of state, county and municipal governments, school districts, public colleges and authorities also provides more stability than states with dozens or even hundreds of locally administered pension systems.

Fully Funded Pensions

However, the Detroit bankruptcy’s application of new national pension liability standards that revealed a $3.5 billion hole in two Detroit pension systems that were previously thought to have a manageable $734 million liability does raise questions about whether New Jersey is on track to fully fund its pension system even after the passage of the 2011 pension bill championed by Gov. Chris Christie and Senate President Stephen Sweeney (D-Gloucester).

Designed to make up for almost 15 years of state underfunding, the new pension law has created a budget nightmare by forcing the state to pump at least an additional $600 million each year into the pension system under a seven-year ramp-up to “full funding” of pension benefits that will cost taxpayers as much as $5.5 billion a year by Fiscal Year 2018. Those calculations, however, are based upon the same actuarial methods that previously estimated Detroit’s pension liability at $734 million.

The new Governmental Accounting Standards Board has adopted more conservative standards that would drastically increase the size of New Jersey’s current state and local government unfunded pension liability, which was most recently projected to be more than $43 billion under the old method.

The new GASB rules do not require New Jersey to change its pension contribution formula for the state, county, and municipal governments – which remains a state decision — but it does require state and local governments to report what their pension liabilities would be under the new GASB principles whenever they issue new government debt.

The Christie-Sweeney pension overhaul, which increased employee pension contributions at the same time that it set a seven-year schedule to ramp up state pension funding, strengthened the state’s legal commitment to retirees to fund their pension payments — although the inability to bind spending by future governors and legislatures forces state bond prospectuses to routinely contain warnings that “no assurances can be given as to the level of the state’s pension contributions in future fiscal years.”
That is why union officials in New Jersey and across the country are closely watching the Detroit case to see if it sets a national precedent for whether state or local governments can get out of paying their full pension obligations in the event of dire fiscal hardship.
Detroit’s state-appointed emergency manager proposed paying both regular creditors and pensioners just 10 cents on the dollar in order to maintain funding for vital police and fire services in the city budget, but both creditors and the unions refused, so the city went ahead and declared bankruptcy.

“The lesson here is that ignoring the reality of what these benefits require for funding can lead cities with weak finances into a ditch. ‘A Perfect Storm’ scenario,” said Eileen Norcross, Senior Research Fellow at George Mason University’s Mercatus Institute who has written extensively about pension finance liabilities in a half-dozen states, including New Jersey.

“It’s war,” George Orzech, who heads Detroit’s Police and Fire pension fund, declared after the unions filed a petition challenging the city’s right to declare bankruptcy, which they view as an effort to avoid paying pensions whose sanctity is guaranteed in the Michigan State Constitution — which should provide stronger legal protection than New Jersey’s pension statutes and the current body of contract law.

Saying ‘No’ to Stockton

Central Falls, RI, slashed its pension benefits by 55 percent when overwhelming pension liabilities pushed the small town into bankruptcy, and Pritchard, AL, also cut benefits after declaring bankruptcy. But a federal bankruptcy judge barred Stockton, CA, a city of 300,000 whose 2012 bankruptcy was the nation’s largest before Detroit, from cutting its pension benefits.

Stockton is part of the massive California Public Employees Retirement System (CALPERS), just as New Jersey municipalities are part of the New Jersey Public Employees Retirement System and the New Jersey Police and Fire Retirement System, and the judge ruled that California state law forbid any alteration of CALPERS benefits, even though other creditors would have to take less money as a result.

Pfeiffer noted that Stockton got into trouble by issuing too many development bonds, and that Jefferson County, AL, got into trouble because of corruption and because it issued risky financial derivatives that would never have been permitted by New Jersey’s Local Government Finance Board, which oversees county and municipal government finance.
Pfeiffer said the bankruptcies of Asbury Park and other municipalities that went under because of bad development loans in the Great Depression led to a series of strict financial controls in New Jersey, including the creation of the Local Government Finance Board.

“We set limits both on the amount and the type of debt that municipalities can issue,” Pfeiffer noted. “We give cities a long leash, but there is a leash, and when they get too far out there, we can yank them back.”

State controls over local governments were further stiffened with the passage of legislation authorizing state takeovers of failing local governments and school districts.

It was to avert a pending state takeover of Camden’s municipal finances that Camden Mayor Milton Milan tried to declare the city bankrupt in the 1990s, Moran recalled.

“The federal bankruptcy judge threw the bankruptcy petition out because Milan didn’t have approval from the Local Government Finance Board, the state took over Camden, and Mayor Milan went to prison,” Pfeiffer noted.

Tammori C. Petty, communications director for the state Department of Community Affairs, said the state agency would have no comment on the impact of New Jersey’s distressed cities programs on averting bankruptcies like Detroit and Stockton.

While New Jersey’s centralized pension system insulates local governments here against the pension fund management issues that helped drive Central Falls, RI, into bankruptcy, it also leaves the state’s municipalities with relatively little ability to affect their future pension liabilities. New Jersey state law bars municipalities from setting aside money for prepayment, and towns simply wait every year for the state Division of Pensions and Investments to send them a bill.

Two years ago, that bill dropped by a cumulative $110 million statewide as a result of lowered long-term pension liability changes as a result of the Christie-Sweeney pension overhaul. “Regardless of what anyone thinks of the merits of particular aspects of the bill, the state’s pension system is clearly healthier in the long run as a result,” Pfeiffer said.

It is an open question if the new GASB principles barring states from anticipating aggressive long-term rates of return on their pension investments eventually leads to the nation’s state and local governments being forced to put hundreds of millions of dollars more into their pension funds to guarantee that there is enough money to pay future benefits.

Doing so would create immediate sticker shock for state and local government pension systems across the country, but it would also avert future scenarios like the one in Detroit when the state-appointed executive brought in to devise a bailout plan suddenly realized that the city’s pension debt was $2.8 billion higher than had been assumed.

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