Detroit takes aim at its pensioners

By Felix Salmon
June 17, 2013

If you want to wade through some unutterably depressing reading on this Monday morning, you should spend some time with the official Detroit Proposal for Creditors. It starts by noting that the city’s per capita income, averaged over its 684,799 residents, is just $15,261 per year. (That’s less than half the income of neighboring Livonia.) Auto insurance alone eats up a good $4,000 of that, for residents with a car.

And then comes the litany of municipal woes: Detroit has the highest violent crime rate of any major US city, at five times the national average; there were 344 murders in 2011, of which just 39 were solved. Right now, the average response time, if you put in an emergency call to the Detroit Police Department, is 58 minutes.

Detroit’s infrastructure is crumbling: 40% of its street lights are out of order, and it has 78,000 abandoned and blighted structures, of which 38,000 are considered dangerous buildings. Those buildings account for a large proportion of the 12,000 fires Detroit has every year. At the moment, firefighters are instructed not to use the hydraulic ladders on their firetrucks unless there is an immediate threat to life, because the ladders have not received safety inspections for years. Detroit also has just 36 ambulances, of which generally no more than 14 are in operation at any given time. And in terms of the city’s IT infrastructure — well, you can probably guess; suffice to say that a recent IRS audit characterized the city’s income tax system as “catastrophic”.

As far as Detroit’s balance sheet is concerned, there is $9 billion of debt, excluding pension liabilities, and also excluding healthcare and life insurance obligations which are calculated at roughly $6 billion. Debt service in 2013 is projected at more than $240 million, or about 22% of total revenues. Worryingly, under the section of the proposal headed “Realization of Value of Assets”, one finds the priceless collection owned by the Detroit Institute of Arts:

Bill Schuette, the Michigan attorney general, has declared in no uncertain terms that DIA’s collection is off-limits when it comes to satisfying the obligations of the City of Detroit; he’s absolutely right. But you can be sure that there will be arm-twisting all the same: Detroit’s emergency manager, Kevyn Orr, doesn’t seem to think of DIA as anything beyond a store of recoverable value.

He wants to write down some of Detroit’s debt, as well — although far from all of it. Cate Long has a good round-up of how various bondholders will be treated under his proposal; she concludes that he’s treating bondholders in good faith, but that he’s behaving less fairly towards retirees. (It’s a combination you might expect, given that Orr was appointed by a Republican governor; it’s basically the opposite of how the Obama administration treated the bankrupt Chrysler and GM.)

It’s worth noting that even though Detroit is defaulting on millions of dollars of debt obligations, bondholders in general are not going to be hit, thanks to the wonders of third-party guarantees. For instance, Bloomberg reports that the 2028 general-obligation bond is currently trading at 96 cents on the dollar, “the lowest since March 2012″ (it’s backed by Assured Guaranty).

As a result, the real pain here is going to be felt by two main groups. The first is the companies who provide wraps for municipal debt — companies whose muni arms somehow managed to escape the financial crisis largely unscathed, and which had to expect some losses on all the debt they were insuring. It’s hard to feel any sympathy for them. But the second group — Detroit’s municipal retirees — had much less choice about taking on their unsecured exposure to the city’s finances. Looking at the straits Detroit is in, the bond default makes sense. But it’s not being driven by stratospheric pension costs, and the swipe at pensioners does look rather gratuitous.

As Long says, “this is merely an opening gambit by Orr”. Let’s hope that Detroit’s unions, as well as the people representing non-unionized workers, fight him aggressively. Because Detroit’s population is poor enough as it is. Those pension payments are needed — and what’s more, they will overwhelmingly be recycled straight back into the local economy. Unlike bond coupons.

26 comments

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…thus my distrust for relying on a public pension. These plans are not adequately funded and when push comes to shove, the public will renege on the promises.

If the assets are not in a personal account with your name on it, you can’t count on ever seeing them again. The only portion of my public pension that was truly guaranteed were the contributions that were taken out of my paycheck, plus the statutory 2% interest that was credited each year. Everything else was a promise, and one not adequately backed by assets or future revenues.

For all the flaws in the 401k system, at least there is no question that the money is legally yours.

Posted by TFF | Report as abusive

Your 401K isn’t much further out the government’s reach. If you think “laws” will prevent it, just think how hard it is for the “government” to change them, or as is the case with the current White House resident, just ignore them.

If it’s not under your pillow, it’s only 99% yours.

Posted by Twinkbait | Report as abusive

One of the things you might want to do, Felix, is find out just what fraction of those municipal pensions are actually staying in the Detroit area.
Remember this is a town that has lost 50% of its population over the last 30 years.
I know that a considerable number of autoworkers, once they retire, up and leave this place. “Snowbirding” to Florida straight down i-75 has been going on for decades. I think you might be suprised how much of those pensions are not staying local.

==RED

Posted by REDruin | Report as abusive

“Looking at the straits Detroit is in, the bond default makes sense. But it’s not being driven by stratospheric pension costs”

I don’t understand the information that drives this conclusion. The figures cited in the article below are that Detroit needs to pay $200 to $350 million per year to fund its pensions fully. (Apparently this figure is based on a higher than previously estimated unfunded pension liability. Detroit had been assuming an 8% annual rate of return, though, which is far too high in the current interest rate environment.)

In addition to that, Detroit is spending $177 million per year on retiree health care. So the order of magnitude of each of pension benefits and retiree health care benefits is similar to debt service costs.

http://www.detroitnews.com/article/20130 614/METRO01/306140120/1409/METRO/EM-Sign ificant-pension-cuts-ahead-Detroit-emplo yees-retirees

Posted by realist50 | Report as abusive

What’s with this belief that the government is going to start raiding 401ks? Taxes are already paid when withdrawals are made, no? And wouldn’t it just be simpler, and far less politically damaging, to roll back if not entirely eliminate the tax preference?

Posted by bjssp | Report as abusive

I understand the aversion people have to public pensions, even if I don’t agree with it, but nothing frustrates me more than seeing governments not fund them, especially to mask over problems and then proclaim a surplus, and then act surprised that there are problems down the line.

Posted by bjssp | Report as abusive

“If it’s not under your pillow, it’s only 99% yours.”

In the case of my IRA, I figure it might be 75% mine. Or 65% mine. But probably at least 50% mine. Very hard to put any lower limit on the value of an underfunded pension plan, and the government can tax pension payments just as easily as they can IRA distributions.

Posted by TFF | Report as abusive

I concur with REDruin. I speculate that a limited percentage of retirees who are receiving a pension continue to live in Detroit proper, even if they still live in Michigan.

In addition, when I see payments for retiree health care in that range, what that tells me is that many of these retirees are under the age of 65, or receiving benefits in excess of what they could get through Medicare.

I understand that a deal is supposed to be a deal, and I am not in favor of throwing out pension benefits, but the circumstances here seem extreme, both in terms of the dire finances of the city, and the likely generosity to the retirees in question. Yes, it’s pretty depressing.

Posted by rb6 | Report as abusive

Perhaps Detroit should consider privatizing key city functions

Posted by 2000sux | Report as abusive

@Felix

” it’s basically the opposite of how the Obama administration treated the bankrupt Chrysler and GM”

It’s very worth while to review that little fiasco. Senior secured bonds are like mortgage loans or auto loans. If the debtor doesn’t meet their obligations the creditor takes possession of a pledged asset generally worth a bit more than the debt. Now in return for that added security the senior secured bondholders accept a lower interest payment.

So what happened…

http://www.nakedcapitalism.com/2009/05/d id-chrysler-secured-lenders-get-raw.html

The last people who were suppose to get hosed got hosed worse than the first people who were suppose to get hosed.

Detroit is pretty much where the Greek were 2 years go… lots of promises to keep and too little money. One thing they could do would be toreclaim all the abandon property give it to the creditors and let them build whatever they want with with blank slate zoning.

Posted by y2kurtus | Report as abusive

“I understand the aversion people have to public pensions”

In my case, the aversion was to contributing hundreds of thousands of dollars to a pension plan that was making promises it could not politically keep. Felix has been a vocal proponent of pensions, failing to recognize that they are prone to generational raiding as exhibited here.

As a newer teacher, I was contributing 11% of my salary to the state pension fund. An 11% contribution is sufficient to fund most or all of the basic pension promises, if invested sensibly.

Then the state voted for accelerated retirement benefits, available even to those about to retire (who had contributed 5% for most of their career), with only a nominal additional contribution. As soon as this passed, the pension was severely underfunded.

Then the market crashed, and pension returns stagnated. Those hedge funds didn’t pay out as hoped. The situation became dire (and the 8% planned returns untenable).

Even before the crash, people openly complained about the “rich” benefits that public employees received, so you could see there would be no political will for backing them when the pension funds ran out.

Pensions are too political, not a sound foundation for retirement.

Posted by TFF | Report as abusive

One of the claims being made against the board that administers the pension is that it diverted contributions to other purposes. Until public pensions are required to maintain adequate levels of funding the way private pensions are, this problem will not go away.

The SEC has been using the fact of underfunding in bringing actions against municipalities for failing to disclose the level of underfundedness of pension benefits in bond offering prospectus materials. But this is a weak substitute for actual rules, and is intended to protect bondholders, not retirees. The problem is finding an appropriate federal hook for imposing uniform national rules.

On the other hand, part of me says that it’s ridiculous that municipalities should play the bond market the way they are forced to for infrastructure such as sewers and schools. Why shouldn’t states be in charge of those things? As it stands, pushing them to the local level only exacerbates and entrenches inequality between municipalities, especially in the area of schools.

Posted by rb6 | Report as abusive

@rb6 – strictly speaking, municipalities are not in charge of schools most places. Local school districts are. Funding does depend on the local tax base, but most states engage in some sort of transfers to reduce funding differences – whether through the state general fund or some other mechanism.

As for areas like sewers or water infrastructure, those are a near perfect example of construction that should be funded with local municipal bonds. Build (or repair/improve) the infrastructure, and pay it off over time with revenue from water and wastewater fees. Throwing all of those revenues and costs into a state-wide pool would just create a massive political fight over where the money is spent. I imagine what we’d see a mix of neglect of some urgent needs and the water infrastructure version of building bridges to nowhere.

Posted by realist50 | Report as abusive

UTC, no doubt you are correct as far as it goes, but even with funding from the state, there are massive disparities in education funding in most states. I agree with your point about sewers and other infrastructure, though. I used to live in North Carolina, which does not permit local governments to build roads, which led to massive competition between rural and non-rural places for access to state funding for roads. That goes on everywhere, of course, but the fact that the local governments could not meet their own needs even when they wanted to made it particularly ugly (not to mention that it resulted in horrible traffic in fast growing parts of the state).

Posted by rb6 | Report as abusive

rb6 – I can see the argument for statewide funding of schools with local administration. Question then would become local funding on top of state funding, whether through additional local taxes or other fund-raising.

Posted by realist50 | Report as abusive

“it’s basically the opposite of how the Obama administration treated the bankrupt Chrysler and GM”

Wrong. The unions got a gift, the bondholders got screwed. Perhaps you don’t think you need to double-check anything disdaining the hated GOP (which I loathe as much as I do the Dems), but you are way off if you think the auto money was “fairly” handled. Ha ha ha ha ha … dang, man, grow up.

Posted by erikjay | Report as abusive

90% of unsecured debt to be written down isn’t “far from all of it”?

Detroit purchased those municipal insurance policies in order to sell the debt in the first place at a much lower rate to fund those massive pension contributions.

Posted by KRock36 | Report as abusive

One thing that has occurred to me is that the federal government could prohibit municipalities from participating in the bond market on a tax preferred basis unless its pension plans are actuarially sound. The point would be to establish a shorter time frame around the potential consequences of underfunding, so that they (1) don’t become so dire that there is basically nothing anyone can do about it and (2) they cannot be pushed so far out to the future that a politician effectively never pays a political price for being responsible for underfunding decisions (whether refusing to raise money or mindlessly agreeing to increased benefits without a plan to pay for them).

Posted by rb6 | Report as abusive

@rb6, you are assuming that anybody cares whether or not retired government workers receive their pensions. Survey 100 Americans and most will answer, “Take it away from those lazy bums.”

That’s a very dangerous situation for somebody paying 11% of their income into a pension scheme. Sooner or later, a Tea Partier will find a way to take that money away, and will feel self-justified in the process. Rule of Law isn’t completely dead, but it has been severely eroded in the last decade. And public pensions will never be politically popular, no matter what the terms.

Posted by TFF | Report as abusive

UTC, my point is that the situation will be more stable and sustainable if everyone knows that whatever is agreed to has to be funded. It will make it harder for municipalities to push hard negotiation off by just agreeing to benefits in the future, which is basically the real source of the current problem. And if the municipality will only agree to lower benefits, it will still be more advantageous to workers because they will not have to worry about the rug being pulled out in the future because promised benefits were only illusory.

It’s almost too late for any solution, truth be told, but if you wanted to do something about it, funding requirements (already in place for private pensions) would be the way to do it.

Posted by rb6 | Report as abusive

I’d like to take a step or two back from the current conversation to make a general observation. Detroit once proudly and rightfully represented the pinnacle of American industrial capitalism. Now it is the rotting corpse of a failed American dream. We have let financial capitalism (which produces nothing but debt) suck the lifeblood out of our productive, entrepreneurial, industrial sector. As long as we bail out banks while letting manufacturing starve, we can expect more Detroits.

Posted by changeling | Report as abusive

@rb6, A very sensible suggestion that has application beyond Detroit’s case at hand – enforcing chronological primacy of obligations. Where was/is diligent oversight prior to engendering debt that obviously conflicts with prior obligations? A pension is an unrealized portion of an overall compensation package, and is calculated as such by potential employees when assessing the opportunity costs of various options. To alter that contract after the fact is certainly unethical, and should be illegal unless explicitly described to a potential employee beforehand.

Posted by Nurgle | Report as abusive

Applying to public pensions something similar to the ERISA rules that govern funding of private defined benefit plans – and the PBGC premiums and backstop that go along with that – would address a lot of TFF and RB6′s concerns. That system is far from perfect, but it would prevent the egregious underfunding of pension plans that we’ve seen in states like Illinois.

The problem at this point is that some plans are so badly underfunded that the transition period to full funding would need to be over a period of decades. There’s also the risk that the whole thing turns into a federally funded bailout of underfunded state and local pension plans if the PBGC doesn’t charge high enough premiums. That said, stricter funding rules could be applied even in the absence of PBGC insurance.

Posted by realist50 | Report as abusive

Total chaos in Detroit. Obama is taking the nation down the very same path. And nobody seems to care. The art collection should be sold to help satisfy all claims.

Posted by willieloman | Report as abusive

Il a à voir avec le théorème central limite. Je ne peux pas vraiment trouver un bon exemple, mais vous pouvez l’utiliser pour déterminer quand il est logique d’utiliser des statistiques sur un ensemble de variables (groupe de personnes) et quand vous devez les traiter individuellement.

Kan niet geloven dat je het hebt gezet zo goed dat zelfs een newbie zoals ik het kan begrijpen. veel dank