Is there any good reason that pension and other retirement benefits should bankrupt a city or company for that matter? That’s an emphatic no! Except if you … use overly optimistic assumptions such as for investment returns, you will end up underfunding pensions, if you fail to make the required funding contributions, your plan will be underfunded.
If you agree to a generous defined benefit pension plan, you are going to have high pension costs, it’s that simple.
In other words, it’s not the pension plan that is the problem, it’s the people who run it. The sad part of the story is that the people who pay the price are innocent workers and taxpayers while the responsible politicians (and in some cases union leaders) go happily on their way to reelection.
Meanwhile, Detroit residents pay the highest property and income taxes in the state. Last year its business tax doubled. About 40% of revenues go toward retirement benefits and debt, much of which was issued in the last 10 years to finance pension contributions. Payments on $1.6 billion of pension-related certificates of participation consume nearly every dollar of property tax revenue.
Investors jumped at the high yields on Detroit’s debt because they expected the city to borrow and raise taxes to the hilt to avoid default. If Motown risked defaulting, creditors bet that the state or federal government would swoop in like Superman and save the city in the nick of time.
But no state bailout was forthcoming, and rightly so. Governor Rick Snyder appointed Mr. Orr to revive the moribund city, and he refused to take another pound of flesh from Detroit taxpayers. Instead, he plans to use bankruptcy to cut retirement benefits, slash capital-market debt and reinvest $1.25 billion in public services.
Unions that have propagated the conceit that pensions are inviolable are stunned to discover that they may have been wrong. Meanwhile, investors appear astonished that there’s no such thing as a risk-free return, which they should have learned from Greece and Argentina. One question to ask now is if Detroit isn’t too big to fail, is any city?
While few municipalities are as economically depressed or dilapidated as Detroit, many have borrowed heavily, raised taxes and hollowed out services to pay retirement and debt obligations. Some like Detroit may soon decide that clipping bondholders and pensioners is a better option than to keep whacking taxpayers.
Take Oakland, which is Detroit’s doppelganger on the West Coast. The run-down Bay Area city, which has the highest crime rate in California, recently laid off more than 100 police to fund retirement benefits and pension-obligation bonds. Murders and robberies shot up by nearly 25% last year. To avert steeper cuts, the city borrowed an additional $210 million to finance pensions.
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