December 22, 2010
For cities and towns facing unsustainable pension costs, the end game may look something like Prichard, Ala.
The financially troubled suburb of Mobile turned to bankruptcy court in October 2009 when it "simply ran of money to pay its pension obligations," says the city's lawyer Scott Williams.
Prichard proposed capping benefits to current retirees at about $200 a month, down from monthly payments of as much as $3,000. "That's not a hair cut, that's a scalping," said Larry Voit, who represented a group of 40 retired city workers in Prichard, population 27,500.
Though bankruptcy law remains murky on how far a city or town can go in scrapping deals for current retirees, cases like Prichard and other workout efforts stand to reshape the debate over how local governments deal with mounting public-pension problems.
The stakes are high for taxpayers, public workers and bondholders, as concerns escalate about whether governments can pay their debts.
The municipal-bond industry insists bankruptcy filings in that realm will remain rare. There were 10 municipal filings in 2009 and five so far this year, according to James Spiotto, a lawyer at Chapman and Cutler. Since the law was created in the 1930s, there have been only about 600 cases.
But legal and municipal-finance experts say rising pension costs, combined with dwindling state and federal aid, could push more cities to follow Prichard's lead, or at least raise the prospect as possible leverage in contract negotiations with public workers.
"Right now we are looking at a major squeeze on municipalities and I would fully expect more cases to be filed than traditionally have been," said David Skeel, a professor at the University of Pennsylvania Law School who focuses on bankruptcy law.
Mr. Skeel said the question of whether a municipality can cut benefits to current retirees is a "big issue" emerging from the smattering of recent cases in Chapter 9, which provides a route for municipal bankruptcies. He recently wrote a widely circulated article advocating that states be allowed to file for bankruptcy, which is currently not permitted under Chapter 9.
The Prichard case was dismissed in August on an issue unrelated to whether the city could rewrite vested contracts, and is on appeal. Meantime, about 150 retired city workers haven't received benefits in about 16 months.
In recent decades, bond holders in the $2.8 trillion municipal market have largely escaped big losses in Chapter 9 cases because much of their debt has been secured by special liens and tax pledges that are protected, said Mr. Spiotto. Prichard itself doesn't have public debt; it has been in bankruptcy twice this decade.
But Chapter 9 remains a largely untested corner of the bankruptcy code, and bondholders aren't necessarily insulated from loss, lawyers say. Vallejo, Calif., which sought bankruptcy protection in 2008, is still negotiating with holders of $52 million in debt over terms of a possible haircut, according to the city's lawyer.
Last week, a state receiver who took charge of Central Falls, R.I., earlier this year, issued a report saying bankruptcy protection remains an option of "last resort" if the city can't find a way to merge with a neighboring city or regionalize its services, among other measures, to control expenses.
Central Falls, which measures just over a square mile, has huge unfunded pension liabilities and poverty levels more than double the statewide rate, the receiver's report said.
"Pension reform by itself is not going to solve it and they can't tax their way out of it," the receiver, retired Rhode Island superior court judge Mark Pfeiffer, said in an interview.
Mr. Pfeiffer said that "by one reading" Chapter 9 would allow cities to target current retiree benefits. He also recommended that state lawmakers consider legislation that would make it easier for Rhode Island cities to file for bankruptcy without hurting their bondholders. So far, the city has continued to make timely payments on about $23 million in bond debt.
Many states have tight control over whether local governments can raise the white flag, partly out of concern about spooking investors. Twenty one states don't authorize their municipalities to file bankruptcy. In others, a city typically must demonstrate that is technically insolvent—an idea that is open to interpretation, lawyers say.
Mr. Skeel, the law professor, said the bankruptcy process isn't isolated from the local politics that can often complicate efforts to overhaul pensions.
Vallejo, the California city, didn't reduce pension payouts for current retirees in its reorganization; it did propose trimming their health-care benefits.
City Council member Stephanie Gomes said the city didn't go far enough in overhauling pensions.
"If there is one failure in bankruptcy it is not truly fixing the pension liabilities," said Ms. Gomes. "When you get into bankruptcy you should do everything in your power to scrub everything down to the ground and start over. But there was no political will to do that."
After failing to achieve necessary concessions through negotiations with employee unions, Mayor Osby Davis said "bankruptcy got us what we needed: we got to adjust collective bargaining agreements."
For example, the city was able to lower its pension obligations indirectly by curbing salaries upon which the benefits are calculated, Mr. Davis said. Firefighters also agreed to contribute more to their pensions.
For cities and towns facing unsustainable pension costs, the end game may look something like Prichard, Ala.
The financially troubled suburb of Mobile turned to bankruptcy court in October 2009 when it "simply ran of money to pay its pension obligations," says the city's lawyer Scott Williams.
Prichard proposed capping benefits to current retirees at about $200 a month, down from monthly payments of as much as $3,000. "That's not a hair cut, that's a scalping," said Larry Voit, who represented a group of 40 retired city workers in Prichard, population 27,500.
Though bankruptcy law remains murky on how far a city or town can go in scrapping deals for current retirees, cases like Prichard and other workout efforts stand to reshape the debate over how local governments deal with mounting public-pension problems.
The stakes are high for taxpayers, public workers and bondholders, as concerns escalate about whether governments can pay their debts.
The municipal-bond industry insists bankruptcy filings in that realm will remain rare. There were 10 municipal filings in 2009 and five so far this year, according to James Spiotto, a lawyer at Chapman and Cutler. Since the law was created in the 1930s, there have been only about 600 cases.
But legal and municipal-finance experts say rising pension costs, combined with dwindling state and federal aid, could push more cities to follow Prichard's lead, or at least raise the prospect as possible leverage in contract negotiations with public workers.
"Right now we are looking at a major squeeze on municipalities and I would fully expect more cases to be filed than traditionally have been," said David Skeel, a professor at the University of Pennsylvania Law School who focuses on bankruptcy law.
Mr. Skeel said the question of whether a municipality can cut benefits to current retirees is a "big issue" emerging from the smattering of recent cases in Chapter 9, which provides a route for municipal bankruptcies. He recently wrote a widely circulated article advocating that states be allowed to file for bankruptcy, which is currently not permitted under Chapter 9.
The Prichard case was dismissed in August on an issue unrelated to whether the city could rewrite vested contracts, and is on appeal. Meantime, about 150 retired city workers haven't received benefits in about 16 months.
In recent decades, bond holders in the $2.8 trillion municipal market have largely escaped big losses in Chapter 9 cases because much of their debt has been secured by special liens and tax pledges that are protected, said Mr. Spiotto. Prichard itself doesn't have public debt; it has been in bankruptcy twice this decade.
But Chapter 9 remains a largely untested corner of the bankruptcy code, and bondholders aren't necessarily insulated from loss, lawyers say. Vallejo, Calif., which sought bankruptcy protection in 2008, is still negotiating with holders of $52 million in debt over terms of a possible haircut, according to the city's lawyer.
Last week, a state receiver who took charge of Central Falls, R.I., earlier this year, issued a report saying bankruptcy protection remains an option of "last resort" if the city can't find a way to merge with a neighboring city or regionalize its services, among other measures, to control expenses.
Central Falls, which measures just over a square mile, has huge unfunded pension liabilities and poverty levels more than double the statewide rate, the receiver's report said.
"Pension reform by itself is not going to solve it and they can't tax their way out of it," the receiver, retired Rhode Island superior court judge Mark Pfeiffer, said in an interview.
Mr. Pfeiffer said that "by one reading" Chapter 9 would allow cities to target current retiree benefits. He also recommended that state lawmakers consider legislation that would make it easier for Rhode Island cities to file for bankruptcy without hurting their bondholders. So far, the city has continued to make timely payments on about $23 million in bond debt.
Many states have tight control over whether local governments can raise the white flag, partly out of concern about spooking investors. Twenty one states don't authorize their municipalities to file bankruptcy. In others, a city typically must demonstrate that is technically insolvent—an idea that is open to interpretation, lawyers say.
Mr. Skeel, the law professor, said the bankruptcy process isn't isolated from the local politics that can often complicate efforts to overhaul pensions.
Vallejo, the California city, didn't reduce pension payouts for current retirees in its reorganization; it did propose trimming their health-care benefits.
City Council member Stephanie Gomes said the city didn't go far enough in overhauling pensions.
"If there is one failure in bankruptcy it is not truly fixing the pension liabilities," said Ms. Gomes. "When you get into bankruptcy you should do everything in your power to scrub everything down to the ground and start over. But there was no political will to do that."
After failing to achieve necessary concessions through negotiations with employee unions, Mayor Osby Davis said "bankruptcy got us what we needed: we got to adjust collective bargaining agreements."
For example, the city was able to lower its pension obligations indirectly by curbing salaries upon which the benefits are calculated, Mr. Davis said. Firefighters also agreed to contribute more to their pensions.
Closed November 2010
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