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A federal judge today ruled that the city of Detroit has qualified for bankruptcy. Perhaps more importantly, Judge Steven Rhodes rules that pension benefits owed to public employees aren’t necessarily protected once the pension’s sponsor – the government – enters bankruptcy. This is consistent with my own interpretation of Michigan’s state constitutional protections for pensions: making pensions contractual means they can’t be cut arbitrarily, but bankruptcy is by definition a legal procedure by which contracts can legally be broken.
This doesn’t mean, however, that Detroit can cut pension benefits to the bone. Pension liabilities aren’t necessarily the same as debts owed to municipal bondholders. There’s a moral distinction, to be sure. Plus, Detroit’s pension plan still has $3 billion in assets held in trust, which can’t legally be withdrawn for non-pension purposes. I’ll surprised if we don’t see some cuts to benefits – say, lower COLA payments or perhaps some outright reductions for higher-paid retirees. But I don’t think you’ll see the kind of pennies-on-the-dollar recoveries that Detroit’s bondholders may receive.
My off-the-cuff solution: Detroit’s public employee unions claim that the pension plan is “fully funded,” and according to the (dodgy) accounting standards that public plans operate under, it’s at least close. (Under more economically rational standards Detroit’s pension is probably only half funded.) So Detroit should transfer to the unions the pension plan’s assets and its liabilities. The union manages the fund, and if the plan’s investments fall short then either the union or the participants will need to make up the difference. Going forward, Detroit can institute a more affordable plan for its employees.
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