Might this send the Unions over the edge ?
DETROIT—This city's emergency manager, in the midst of reorganizing the finances of America's most troubled large city, is threatening to take over one of Detroit's pension funds after a report found that retirees received extra payments while the funds lost value.
Kevyn Orr said in a recent interview that at the current pace, the city's General Services System pension fund could lose its ability to pay pensions owed to current and future retirees within 12 years. A takeover is a "right, if not an obligation, that I have to consider under the statute, and we're considering that right now," he said.
Representatives of the pension board said Mr. Orr's figures were faulty.
The talk of takeover comes as struggling cities and states across the country are watching to see how Detroit will fare in cutting its $18 billion in debt, including pension payments, as part of the nation's largest municipal bankruptcy case.
The Oct. 25 draft report by the city's auditor general and inspector general, which was reviewed by The Wall Street Journal, found that during the 12 years ended in fiscal year 2012, the pension funds paid $1.22 billion of interest credits into retirees' savings accounts while the funds had losses of $2.05 billion, or 29% of their net asset value.
Earlier this year, Mr. Orr unveiled a proposal calling for the city to pay 20 cents on the dollar for the $3.5 billion that the city says it owes its two pension funds, one for 20,500 non uniformed retirees and one for 12,700 retired police and firefighters.
Pension-board representatives said that their systems are sufficiently funded to be run independently, and that Mr. Orr inflated the estimated shortfall in future funding. They have argued that the funds are underfunded by about $650 million, not $3.5 billion.
"The only people we have heard that from is the press," said Michael Van Overbeke, general counsel for the General Retirement System, referring to the possibility of the unseating of the pension trustees.
The funds also say the practice of paying a fixed interest rate on pension holders' annuities when the funds lost money had been approved by city government and was ended in 2011.
Such guaranteed interest payments from pension funds losing value might be without precedent, said Keith Brainard, research director at the National Association of State Retirement Administrators.
On Tuesday, U.S. Bankruptcy Judge Steven Rhodes said that Detroit's public pension holders aren't entitled to special protection from potential cuts—despite a Michigan state constitutional provision aimed at shielding pensions. Unions and pension funds moved to appeal the judge's groundbreaking ruling that granted the city eligibility for bankruptcy protection.
"When workers in Chicago and L.A. realize that their pension benefits are no longer inviolate, unions are going to say what they really want is not bigger benefits but better funding. And that's going to put enormous pressure on current budgets," said Robert Novy-Marx, associate professor of finance at the Simon Business School at the University of Rochester.
For years, the city borrowed millions to meet its pension obligations in a series of complicated deals involving swaps. But state and city officials have also recently blamed the pension system for poor management and generous benefits that contributed hundreds of millions of dollars to the city's debt.
Earlier this year, Mr. Orr stopped making payments into the system, including a scheduled $39 million July payment.
A person familiar with the matter said Mr. Orr would like to engineer a takeover of the city's General Retirement System for non uniformed employees and retirees. Mr. Orr's office estimates that the fund has only 64% of what it needs to meet its obligations, while fund officials put the figure at 80%. The separate fund for the city's police and firefighters is in better shape, both Mr. Orr and fund officials say.
Michigan's emergency-manager law allows for the takeover of a municipal pension system that is less than 80% funded.
In a takeover of the General Retirement System, Mr. Orr could run into criticism for trying to cut city payments to the very funds he would now control.
"It might be a little awkward at that point" if Mr. Orr became both the representative for the city as debtor, as well as the person in charge of the city's largest creditor, according to Mr. VanOverbeke.
Juanita Sailes-Jackson, 64 years old, a Detroit retiree who worked as a typist and parking enforcement officer, said she opposed the idea of any takeover of the city's pension funds, because she believes the system works well. Ms. Sailes-Jackson, who collects $500 a month in pension, said, "I can't have any cuts because I wouldn't be able to pay most of my bills."
Detroit bankruptcy ruling reverberates in Scranton
A federal bankruptcy ruling that would allow Detroit to cut union pensions and reduce debt could also apply to Scranton if the city sought Chapter 9 protection, some experts say.
The ruling by Judge Steven Rhodes essentially holds that federal bankruptcy law allowing for restructuring of contracts, including pensions, supersedes Michigan's state constitution that says pensions can't be touched, according to Juliet Moringiello, a law professor at Widener University's Harrisburg campus.
"To have an opinion on this at least gives some people some guidance," Ms. Moringiello said of Judge Rhodes' decision. "Federal law does trump state law."
Scranton, which has been designated as financially distressed since 1992 under state Act 47, is facing a $20 million budget deficit next year and large tax and garbage fee increases that still may not cover the gap.
"Without a doubt, every city in the U.S. is watching the Detroit situation unfold. However, it is unknown what the outcomes or effects will be until they are further along or complete with the process," said Steve Kratz, spokesman for the state Department of Community and Economic Development.
The Detroit ruling presumably could serve as leverage to strengthen Scranton's hand in reducing growing pension and legacy cost obligations even if the city did not file for bankruptcy, said Gary Lewis, a consultant specializing in distressed debt. Mr. Lewis, who ran briefly for Scranton mayor earlier this year as a Republican before dropping out of the race, had advocated for the city filing for bankruptcy protection to resolve its longstanding financial problems.
Now a resident of the state of Indiana, Mr. Lewis said of Judge Rhodes' ruling, "This is really kind of a watershed moment. It sets the groundwork for really using Chapter 9 as a key lever in restructuring long term obligations." That's because the prospect of a city seeking Chapter 9 protection could bring creditors to the negotiating table, he said.
While state laws typically make pensions untouchable, federal bankruptcy law allows for "impairment of contracts," Ms. Moringiello said. She added that from its inception in the late 1980s, Pennsylvania's Act 47 has contained a provision that, should it fail, then a federal bankruptcy action could be an option.
"One thing the state can't do is impair contracts, but you can do that in bankruptcy," Ms. Moringiello said. "Bankruptcy is provided for in the U.S. Constitution. According to the Supremacy Clause, federal law should take precedence over a state constitution."
Ms. Moringiello said she was not surprised by Judge Rhodes' ruling, but said it was noteworthy for his stressing that restructuring of pensions is not off limits under Chapter 9.
"If pensions can't be cut, what's the point of a municipal bankruptcy?" she asked. "You can always adjust your obligations if all parties agree. The Detroit judge said it was not time to confirm a (bankruptcy) plan, but said these pensions can be adjusted - deal with it."
The judge encouraged Detroit and its unions to negotiate. No one in Scranton leadership positions - either current officials or elected incoming leaders - has pushed or is pushing for bankruptcy. It is not clear the state would approve such a move, but also in question is whether the state could prevent it.
When Harrisburg sought a Chapter 9 petition two years ago, the state quickly stepped in and amended the law to allow the state to instead install a receiver to oversee that city.
However, the amendment applies only to third-class cities, and Scranton is the only Class 2A city in Pennsylvania, according to Mr. Kratz of the DCED.
A few months ago, an Act 47 Task Force proposed amending state law further to allow the state to appoint a receiver in any municipality, but that proposal has not been made law. Mr. Kratz said.
For Chapter 9 to come into play in Scranton, it appears the city would have to voluntarily seek it, and no city leaders want to do that. The state would have to allow the city to seek Chapter 9 protection, but the state also cannot appoint a receiver for Scranton. What's left? The DCED is hoping the city sticks to its revised Act 47 recovery plan, adopted last year, Mr. Kratz said.
"Continuing to implement the amended recovery plan should result in a balanced budget that meets Scranton's critical needs and ensures the health and safety of the public, while avoiding any further action," Mr. Kratz stated. "We are currently engaged with city officials, including the mayor-elect (Bill Courtright) and will continue working with the city officials and the Act 47 coordinator (Pennsylvania Economy League) to look at any and all options to improve Scranton's financial position."
While no city leaders are publicly pushing for bankruptcy, the lone bank that submitted a bid to lend the city a tax anticipation note (TAN) of up to $16 million for next year is contemplating the prospects of Scranton having either a state-appointed receiver or bankruptcy protection.
That lender, Amalgamated Bank, submitted a bid proposal in October contingent on the bank determining the city's 2014 budget is realistic. This TAN would be secured by the city's earned income tax (EIT) revenues.
Amalgamated's TAN bid raises the issue of where the bank would fall in a creditors pecking order to be repaid should either a receiver or Chapter 9 bankruptcy become reality with a "stay," or freeze, on paying debts taking effect.
Amalgamated's contingencies for lending a TAN include:
- "Legal diligence with respect to whether an appointed receiver or bankruptcy court could divert or withhold EIT revenues from the bank, (and) to also include an analysis of the automatic stay provision in Chapter 9 as well as the concept of preference" among creditors"
- "Legal diligence with respect to the Pennsylvania bankruptcy process as it applies to the city of Scranton as an Act 47 city and as a Second Class city"
- Discussions with DCED about the "concepts of receivership and bankruptcy with respect to the likelihood of the continued repayment of the 2014 TAN through 2014 from EIT revenues"
- "The bank reserves the right to negotiate further with the city with respect to the payment of fees related to any special counsel advising the bank on issues pertaining to bankruptcy and receivership, and/or related issues of structural protections."
New York City-based Amalgamated, the largest union-owned commercial bank in the nation, provided the city with a lifeline TAN during the city's cash flow crisis of 2012, and then provided a 2013 TAN to the city.
Now, as it mulls whether to lend the city a TAN for 2014, the bank also is potentially willing to consider providing the city with a smaller loan on Jan. 2 to help the city meet payroll. But the bank would provide a smaller, unspecified loan only if the bank is convinced that substantial progress is being made with its contingencies and the city's stalled efforts to obtain separate, unrelated financing of $28 million from another institution to pay a landmark union arbitration award and mandated pension contribution increases.
Amalgamated declined to comment on the status of its consideration of lending Scranton a TAN for 2014.
After borrowing heavily, the city has not experienced a cash crunch this year. But the city's deficit for 2014 is expected to soar to $20 million, an amount so large it would require a 117 percent property tax hike to cover if it were to be covered only with property taxes, PEL has estimated.
Mayor Chris Doherty last month introduced a $130.2 million budget for 2014 that carries a 57 percent increase in the real estate tax millage rates and a 69 percent increase in the garbage collection fee, or a hike in that fee from $178 a year to $300. The combined increase in the property tax and trash fee on the average homeowner would be around $409.
Council is expected to vote Thursday, on adopting an ordinance to fund the budget.