On Dec. 3, federal bankruptcy Judge Steven W. Rhodes ruled, in a landmark decision and over the fierce objections of union leaders, that pension obligations would be treated just like other contracts in Detroit’s municipal bankruptcy proceedings. Despite specific protections enshrined in the Michigan Constitution, Rhodes’ reasoned that pension liabilities were “contractual obligations” that could be abrogated in bankruptcy court.
While I’m sad for Detroit’s pensioners who will see their benefits reduced, Rhodes’ decision was not only correct, it was inevitable.
For decades, public employee union leaders across the country have made several key assumptions about pension benefits. First, they assumed that any changes to pension benefits for current or retired public employees were, per se, illegal due to contract law protections and, in some states, constitutional guarantees. Second, they assumed that governments couldn’t really go bankrupt because they could always raise additional revenue. Third, they assumed that their sole purpose was to negotiate for the best possible “deals” for their members, regardless of overall financial health of government entities. The convergence of these assumptions has caused intransigent attitudes toward meaningful pension reforms among union leaders.
Detroit’s death spiral guts these assumptions. First, legal protections for pensions, even if they are enshrined in state constitutions, are meaningless if the pension systems and the municipalities that sponsor them run out of money. At that point, pensioners, like every other unsecured creditor, would end up with nothing, even if they were at the front of the line. Aside from a few million dollars worth of art, Detroit has very few marketable assets to offset its estimated $18 billion debt (equating to over $25,000 per resident). It must, somehow, find a way to keep operating, generating enough tax revenue to provide services to its remaining residents, pay its debts and fund its pensions obligations, or its pensioners would get nothing. Bankruptcy was the only option left, and pension liabilities, which are estimated to be as high as $8 billion, had to be included in the bankruptcy proceedings for any long-term restructuring of Detroit’s finances to work.
Second, governments can go bankrupt. Over the last 30 years, rather than restructure its debt and reform its pension systems, Detroit leaders chose to borrow more money, raise taxes and cut core government services. Now Detroit fields no more than a skeleton police force allowing criminals to rule the streets, retiree benefits consume more than one-third of the city budget, and 53 percent of citizens can’t or don’t pay their property taxes. Even before filing for bankruptcy protection, Detroit was bankrupt, operating, in Rhodes’ words, in a state of “service insolvency”. Is it any wonder why so many residents fled the city?
Finally, union leaders, especially in states where they are a dominant political force, can no longer afford to ignore the financial strains their demands place on already stressed government entities. In many instances, like Detroit, union leaders were complicit in the systematic underfunding of pensions, negotiating for wage and other benefit increases while signing off on pension contribution holidays, “collared” contribution schedules, or continuous re-amortization of pension debts. Without exception, those municipalities that are closest to bankruptcy are those where unions wield significant political influence. Unless union leaders in these municipalities come to the table and participate in meaningful pension reform efforts, bankruptcy courts will inevitably take over.
Rhodes’ ruling on Detroit’s bankruptcy petition is a watershed moment for municipal pension reform in this country. Union leaders can either choose to participate in reform efforts, or leave the courts to sort things out. Either way, pension changes are coming.
Dan Liljenquist is a former state senator and U.S. Senate candidate.