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.
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.