Friday, December 6th, 2013

Some Implications of Detroit’s Bankruptcy

There’s been so much ink spilled over Detroit’s bankruptcy that I haven’t felt the need to add much to it. But this week the judge overseeing the case ruled that the city of Detroit is eligible for bankruptcy. He also went ahead and ruled that pensions can be cut for the city’s retirees. Meanwhile, the city has received an appraisal of less than $2 billion for the most famous paintings in the Detroit Institute of the Arts.

A couple of thoughts on this:

First, every city in America should be doing a strategic review of its assets, and moving everything it doesn’t want turned into de facto debt collateral into entities that can’t be touched by the courts. In the case of the DIA, the city owns the museum and the collection. Hence the question of whether or not art should be sold to satisfy debts. If it were typical separately chartered non-profit institution, this wouldn’t even be a question.

At this point, I’d suggest cities ought to be taking a hard look at whether they own assets like museums, zoos, etc. that should be spun off into a separate non-profit entity. Keep in mind, the tax dollars that support the institutions can continue flowing to it. But this does protect the assets in the event of a bankruptcy.

In the case of Detroit, it seems inevitable that at least some art work will be sold. Given that worker pensions are going to be cut, it would be pretty tough to say no to selling art. Assuming this is the case, post-sale the museum should be spun off as a separate entity to hopefully reboot its standing the museum world. As the trustees of the group that operates it have been adamantly opposed to any sale, one would hope other museums would not hold any violations of industry standards against them for, particularly if they acquire ownership of the building and artwork away from the city afterward. The city of Detroit doesn’t need to be in the museum business anyway. It has bigger fish to fry.

Secondly, public sector employees will have to start rethinking their approach to retirement benefits. The current mindset has been to grab as much as you can anytime you can because the taxpayer will always be forced to cover the promises no matter what. As the actual results in Central Falls, RI and now this show, that’s no longer a good assumption.

Detroit’s workers don’t have lavish pensions as these things go. But they weren’t shy about abusing the system either. They in effect looted their own pensions by taking out extra, unearned “13th checks”. They also used pensions funds to give a guaranteed 7.9% annual rate of return on supplemental savings accounts workers were allowed to establish. All told these “extra” payments drained about $2 billion out of the pension system.

This was not something the city did through an arm’s length transaction. As the Detroit Free Press reported, Mayor Dennis Archer was alarmed by the practice and wanted to stop it. But “the city doesn’t control its pension funds, which have been largely administered by union officials serving on two independent pension boards.” So he tried to amend the city’s charter to stop the practice. According the Free Press, “Archer backed an effort to block the payments through a proposed new city charter, which actually passed in August 1996. Enraged, several city unions and a retiree group sued and won. Archer tried again to block payments through a ballot initiative, called Proposal T, but it failed.”

The unions could brazenly loot their own pension plan because they felt rock-solid assurance that the taxpayers would ultimately be required to make them whole. This bankruptcy is showing that may not be the case after all. It should serve as a warning to unions everywhere not to get too aggressive with their shenanigans.

They’ll of course appeal the judge’s ruling and may win. But the Michigan constitution says pensions are a contract right. The very definition of bankruptcy is that you can’t pay what you’re contractually obligated to. Bankruptcy is all about breaking contracts. The bondholders have contracts that are not supposed to be impaired too, after all. I’m a fan of local government autonomy as you know, but as Steve Eide rightly points out, any freedom worth its name is freedom to fail. If cities and their various constituencies don’t suffer the consequences of their mistakes, they should be heavily micromanaged from on high.

When individuals fail, we have a safety net (unemployment insurance, for example). Plus we have personal bankruptcy to give people a fresh start. We don’t even worry about whether the person is at fault for their own position or not. We provide that backstop regardless. But that backstop doesn’t allow people to go on living like they did before as if nothing happened. Similarly, cities in trouble shouldn’t be abandoned, but they need to realize that there are genuine consequences for failure. A realization that failure has consequences for pension holders as well as the taxpayer should hopefully promote healthier decisions about how retirement benefits should be offered, funded, and administered.

13 Comments
Topics: Public Policy
Cities: Detroit

13 Responses to “Some Implications of Detroit’s Bankruptcy”

  1. Derek Rutherford says:

    I wonder how many other public pension funds are being looted by the pensioners? After all, the only reason the shenanigans in Detroit are getting notice is because the city went bankrupt. Does anyone think that Detroit is unique in these abuses? Could Illinois’ and Chicago’s pension holes be in part be due to similar abuses there?

    All public pensioners should be shifted to a 401(k) defined-contribution arrangement. It serves two purposes: (1) protects taxpayers by preventing such abuses, and (2) protects public workers by protecting their earned retirement savings from being taken if/when the government entity runs out of money.

    The problem, of course, is that to provide the same level of benefits as currently promised would be expensive. Politicians prefer to promise big benefits and fund small benefits, hoping they are out of office by the time the bills come due.

  2. Actually, Detroit’s workers are still claiming they are entitled to 13th checks:

    http://www.bloomberg.com/news/2013-09-27/detroit-union-seeks-to-revive-13th-pension-check-policy.html

    Apparently they are very common:

    http://dealbook.nytimes.com/2013/10/22/case-in-detroit-highlights-costs-of-a-common-pension-practice/

    I think the term the “skim fund” used in the NYT piece captures it best.

  3. AIM says:

    “The unions could brazenly loot their own pension plan because they felt rock-solid assurance that the taxpayers would ultimately be required to make them whole. This bankruptcy is showing that may not be the case after all. It should serve as a warning to unions everywhere not to get too aggressive with their shenanigans.”

    I’ve seen this claim made several times. What evidence is there to back up this assumption? There are hundreds of standalone pension plans in Michigan in addition to MERS, which is a statewide system for municipalities. Many of those plans are fully funded or have made significant progress towards recovering from the losses of the stock market crash in 2008 – 2009. If the Michigan Constitution’s provision emboldens unions to “loot their own pension plan”, shouldn’t there be more evidence of this than the actions of one pension system?

  4. AIM, the link I gave previously showed that 13th checks for surpluses are a common practice. In any case, if unions in those places aren’t doing the same thing, then good for them.

  5. myb6 says:

    Extremely educational, thank you Mr Renn. Also made my blood boil; my sympathy for public employee unions has been steadily dropping for years now.

  6. Alon Levy says:

    I never thought about the museum spinoff idea. It sounds very useful for cities. It’s especially useful for cities that aren’t on the verge of bankruptcy – i.e. for the Atlantas rather than for the Providences – because they can usually find many willing private patrons in addition to giving municipal grants.

  7. Rod Stevens says:

    Alon,

    I think the whole idea of city services needs to be re-thought. Detroit owns and operates the art museum. New Rochelle picks up the garbage, New York City (now) controls schools. Sacramento provides electricity. Some place undoubtedly operates its own transit service. What are the criteria for bundling a given service with the rest?

    This is not so easy to answer, and so often it seems to “depend”, mostly on the management of the moment. For example, for a century a private non-profit owned and ran the libraries. Then the board screwed up and the county government took over. A lot of people don’t think the libraries work as well as before.

    Bad management and financial debacles are private on both the private and public side. In the 1980s leveraged buy-out artists raided private pension plans. Now we’ve seen that public employees effectively raided their plans i the 2000s. Maybe the real issue is regulation: do we need to loosen some and tighten others? Seems like its time for a new definition of what we expect from cities and what protections we need to make sure they attain those goals and are well-run along the way.

  8. David Holmes says:

    It is worth noting that not every rust belt city with the same “structural” economic challenges as Detroit (declining population, large numbers of retirees relative to current population, local and regional economic challenges associated with transition from a manufacturing based economy) is in the condition of Detroit or Chicago. In fact, the most fully funded pension plan for any major city in the US is that of Milwaukee (funded at 113%). The State of Wisconsin pension system (currently at 100% funding level) ranks 2nd best among states. The current status of both plans by the way, is not attributable in any measure to the recently enacted anti-public union policies of Governor Walker. A report published by the Pew Charitable Trusts earlier this year on “A Widening Gap in Cities, Shorfalls for Pensions and Retiree Health Care” presents data for the states and 61 major US cities.

    Although Detroit has far greater structural challenges, other cities really have no excuse if it is possible for another major rust belt to be in the position of having the most fully funded plan. Comes down to poor decisions at the local level, wherever that may be (with Fargo ND, Omaha NE, Portland OR ranked among the 10 least funded plans, and many fast growth sunbelt cities – with what should be significant structural advantages – such as Austin, Oklahoma City, Atlanta, Fort Worth, Las Vegas, San Diego, and Tuscon, among others – also significantly underfunded).

  9. Chris Barnett says:

    Re city services: many are mundane, and no doubt once someone made a good argument for in-house vs. outsourced. Cities have had paving crews, maintenance garages, body shops, print shops, sign shops, and the like. In Indy, Steve Goldsmith famously applied a “Yellow Pages” test back in the 90s: if he found a city service in the Yellow Pages, it was a candidate for privatization.

    He never came out and said so, but it was obvious to me then that getting defined-benefit pension costs off the city’s budget was his goal.

  10. Rod Stevens says:

    Chris,

    The problem with the yellow pages argument is that you can find almost every service in the world there. Every organization, public or private faces these make make/buy arguments. The basic question is which services are best kept in house because they are both an integral part of the final product and because they can be managed well. It may be, though, that you have to cycle in and out of some services over time just to let those departments know they have to remain competitive. In the private sector this is the equivalent of periodically taking a long-established contract out to bid.

  11. Chris Barnett says:

    Rod, I agree: there is an independent contractor doing almost everything today, and there are clear management challenges to utilize government contracting schemes as opposed to simply managing employees.

    My first career was in procurement (non-government) and I periodically participated in “make vs buy” decisions. I can tell you that most such calculations didn’t include pension costs unless they were defined-contribution pensions (percentage of wage) included in a union contract. They often didn’t include facility costs, on the theory that such costs were “sunk costs” (never mind the needs for maintenance and reinvestment).

    So for a variety of reasons, once something is in-house, there is an inherent bias toward keeping it there.

  12. Rod Stevens says:

    Chris,

    In business school I took an accounting class in which we supposedly figured out how to accurately allocated overhead. When I ran the concepts by my father, a CFO, his comment was something to the effect that the theories sounded fine, but that in practice the only way to keep down overhead was to load up service fees so much that the divisions cried out for relief. The real moral of his story was that even his central office couldn’t stand up to the politics, only those with line responsibility for making profit targets.

  13. Eric says:

    I’ll add a third issue, this one for states, is population-based revenue sharing the best route when Midwest cities and states are losing population? This is only compounded by states like MI and OH reducing revenue sharing at the same time as population is going down. It’s a double-whammy.

    Report: Detroit’s collapse caused more by declining revenue than legacy costs

    From The Detroit News: http://www.detroitnews.com/article/20131120/METRO01/311200082#ixzz2n0axoRSw

The Urban State of Mind: Meditations on the City is the first Urbanophile e-book, featuring provocative essays on the key issues facing our cities, including innovation, talent attraction and brain drain, global soft power, sustainability, economic development, and localism. Included are 28 carefully curated essays out of nearly 1,200 posts in the first seven years of the Urbanophile, plus 9 original pieces. It's great for anyone who cares about our cities.

About the Urbanophile

about

Aaron M. Renn is an opinion-leading urban analyst, consultant, speaker, and writer on a mission to help America’s cities thrive and find sustainable success in the 21st century.

Full Bio

Contact

Please email before connecting with me on LinkedIn if we don't already know each other.

 

Copyright © 2006-2014 Urbanophile, LLC, All Rights Reserved - Click here for copyright information and disclosures