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Nothing Sacred In Bankruptcy

Two federal judges have concluded that public pensions are not sacred when a city goes bankrupt, but the message does not seem to be getting through to everyone who should hear it.

Maybe we are asking the wrong people to opine on this topic. Perhaps it will take a word from the pope, or the Dalai Lama, or at least the archbishop of Canterbury before the folks who are in chronic fiscal denial will finally see the light.

Unfortunately, none of those eminences have attended the proceedings in which the city of Stockton, California, is seeking relief from a mountain of debt. So it was up to U.S. Bankruptcy Judge Christopher Klein to rule that Stockon’s obligations to the California Public Employees’ Retirement System (CalPERS) are not untouchable.

We don’t yet know exactly what this means. Klein is expected to rule on the city’s reorganization plan around the end of this month. In the meantime, however, Klein has signaled that he may not be willing to hold Stockton’s current and future pensioners essentially harmless while forcing deep cuts on the city’s other unsecured creditors.

Late last year, another bankruptcy judge, Stephen W. Rhodes, reached a similar conclusion involving the city of Detroit. While public sector advocates fumed, Detroit workers wisely agreed this summer to take a haircut on their pensions rather than face the potentially draconian cuts that the bankruptcy court might have imposed.

The two bankruptcy judges are not breaking any unplowed legal ground. Federal laws such as the bankruptcy code typically trump state legislative or constitutional mandates, especially on financial matters that have implications for interstate commerce. Yet CalPERS has already issued a defiant statement disagreeing with Klein’s ruling, most likely because the ruling threatens to influence several other California municipal bankruptcies that are in progress and more that are likely to occur in the future.

Many public pensions are woefully underfunded. I wrote about the systemic problems as early as 2008, and I was not the only one. As I have said many times between then and now, you can be sure that the impossible won’t happen and the inevitable will. The yawning gap between what states and municipalities have promised and what they can actually pay makes it inevitable that something will have to give.

The problem exists at the state level in many places, not just in cities. States, however, are not covered under the federal bankruptcy law. You may think this is good or bad, depending on whether you are more interested in collecting a state pension one day or in ensuring that states that have seriously mismanaged their liabilities (Illinois and California sit at the top of a fairly long list) remain financially viable in the 21st century as they struggle to pay the debts they racked up in the 20th.

Even if bankruptcy is not an option, drastic measures of some sort will eventually become unavoidable. A lot of promises will inevitably be broken; what remains to be seen is which ones and how soon.

Public sector unions are not going to take Klein’s decision, and its fallout, lying down. They will call on their customary allies in statehouses, where the unions provide votes to politicians who then sign off on rich benefit packages that private-sector workers seldom see. If bankruptcy courts are going to attack municipal obligations, the unions are likely to ask states to assume those debts and thus take them out of the bankruptcy code’s purview. This won’t actually produce more money to pay the pensions; it will merely make the process of avoiding reneging on debts a political exercise rather than a legal one.

The action may not be limited to state capitals. I would also expect the public workers unions to go to Washington and push for changes to give their workers priority in the fight for a limited pool of municipal cash.

Maybe the unions will get what they want; maybe they won’t. But neither judges nor lawmakers can perform fiscal miracles. If that’s what unions want, they ought to call an expert. The Vatican switchboard operator is standing by.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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