Tuesday, July 23, 2013

Making the Least Culpable Pay: Detroit Retirees

Making the Least Culpable Pay: Detroit Retirees

With the city of Detroit in bankruptcy, retirees have legitimate fears that their pension benefits will be cut in order to reduce the city’s liabilities to manageable levels.[1]   At some point in the proceedings, the courts will have to figure out if Michigan’s constitution or the bankruptcy law takes precedence as the pain is doled out to the creditors.  Lamentably, the retirees will be the most poorly represented creditors when bankruptcy is eventually sorted out.  Of course, Wall Street and money managers, who are the most culpable actors in this saga, will have the best representation in these proceedings.

The retirees are innocent victims in Detroit’s tragic demise.  They worked the requisite number of years and deserve their benefits.  Moreover, those benefit payments aren’t making the retirees rich.  Rather, they are allowing these folks to subsist.  Some of you are probably thinking about the various news stories highlighting abuses in which the benefit formulae were manipulated to accelerate eligibility or final salaries were spiked.  From time to time these abuses occur, but in my experience, it was almost always legislators or senior officials in the executive branch that played these games for their own benefit.  During my tenure in New York working for the late Governor Hugh Carey, we vetoed numerous bills to pad legislative pensions.
 
Repairs (1999)
The Pew Charitable Foundation just issued a study of the Illinois pension plan[2], which is in dire straights.  Their report showed that 34% of Illinois’s gaping pension deficit was the result of inadequate funding, 32% was due to insufficient investment returns 19% was the result of changes in actuarial assumptions, and 11% was caused by other factors.  Increases in pension benefits only accounted for 4% of the problem.  I suspect that the causes of Detroit’s pension woes fall into a similar pattern.  In other words, the retirees in Detroit aren’t culprits.  They are victims.

It’s easy to point fingers at politicians for failing to properly fund and manage these pension plans.  However, I think money managers deserve the biggest share of the blame.  Whether it is the city of Detroit or state of Illinois, money managers invested in their debt and thereby funded the public excesses.  In other words, Detroit wouldn’t have gone over the precipice and Illinois wouldn’t be on the edge of the precipice if money managers had performed the necessary due diligence and acted with restraint.  Obviously, some retail investor didn’t have the means to investigate the affairs of the motor city.   However, money managers, insurance companies, and other institutions hold large slugs of municipal debt.  I guess we shouldn’t be surprised by their willingness to lend to Detroit and other distressed public entities.  After all, the institutional community failed miserably in reigning in the excesses of the mortgage crisis.

I’m hoping the bankruptcy proceeding will hit the bondholders particularly hard.  In the credit crisis they were generally treated with leniency and learned nothing from their excessive lending to banks.  It’s time to teach them a lesson about risk.  As for the retirees, they should be spared any pain.  However, I’m wagering that the moneyed-interests will protect their own and sacrifice the retirees.

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