What the future holds for cities and their unfunded pension liabilities

With Detroit’s recent bankruptcy filing in the news, here are the views of attorney Michael Sweet on unfunded pension obligations in cities and states. Sweet is with the Fox Rothschild law firm, which has its headquarters in Philadelphia.

Sweet specializes in restructuring and bankruptcy legal work. He assisted the city of Richmond, Calif., in restructuring its finances to avoid filing for bankruptcy. Sweet is based in Fox Rothschild’s San Francisco office.

GPN: What can cities and states do if they are facing unfunded pension obligations?

Michael Sweet: States are not eligible for protection under Chapter 9 of the bankruptcy code. It’s important for cities to sit down and have an honest conversation about their unfunded pension obligations. They are paying a lot of money for people who don’t work for the city anymore. All of the stakeholders need to come to the table with an open mind about how they can work together to help the government get through these tough financial times.

Ultimately, a legislative fix may be the only viable option for local governments.  It remains to be seen whether governments, employees, retirees and the various Wall Street interests have the wherewithal to address these issues head-on before they snowball out of control.

GPN: Are unfunded pension obligations a long-term problem for governments?

MS: Yes, this will likely continue to be a problem. Even as the economy continues to rebound, municipalities will likely find themselves unable to meet the commitments they made to employees when they were more flush with cash. It will be very difficult for pension fund managers to make up for ground lost during the recent years that the markets so underperformed.

Reducing payrolls today does not create a reduction in pension distributions for many years. Because of the way pensions and retiree health benefits are structured, the percentage of general fund resources dedicated to these costs is going to continue to grow when compared to other expenditures.

GPN: Is the problem getting worse?

MS: Yes, because people are living longer, and many pensions include healthy COLA increases, the unfunded portion of pensions is likely to grow. Additionally, many local governments have committed to paying for retiree health care benefits that will continue to cost more as the expense of health care increases.

GPN: Can cities and states expect a federal bailout?

MS: A “bailout” per-se is unlikely. The government bailed out the auto industry, but that was different. Car companies make something. The government could reasonably expect that if it propped the automakers back up that they would eventually become profitable again and be able to pay back the debt. Which is precisely what has happened.

But local governments are not designed to generate profits — and we wouldn’t want them to be. Government’s job is to provide for the health, safety and welfare of its citizenry, not to generate profits. A “bailout” by the federal government without changing the fundamentals of the way local governments deal with their finances will not solve anything in the long run. It will simply prolong the problem.

GPN: Should residents expect higher taxes as a result of the solution?

MS: A tax increase could be a component of a debt adjustment effort (whether in or out of bankruptcy). Cities will need to both reduce costs and increase revenues. One of the ways they can increase revenues is by collecting more taxes. So increased taxes are certainly an option in places where the local government is free to impose greater taxes. However there are some places where a tax increase is not an option for local government.

GPN: What regions will have the most challenges meeting their obligations?

MS: According to a report by the Pew Center on the States, Connecticut, Illinois, Kentucky, and Rhode Island ranked the worst in terms of unfunded pensions. All were under 55-percent funded in 2010.

GPN: Thank you, Michael Sweet.