Cuts to Detroit pensions set dangerous precedent

Detroit’s bankruptcy, the largest municipal case in U.S. history, has attracted wide media commentary as an example of the country’s “unsustainable” public pension obligations. But it’s time to train a magnifying glass on the substance of the bankruptcy itself, particularly with regard to how it will affect workers and their retirements — in Detroit and around the country.

Traditional legal interpretations of pensions have viewed their obligations as sacrosanct, especially once the passage of the Employee Retirement Income Security Act of 1974 created a federal guarantee for pensions in the private sector. But recent municipal bankruptcies in Pritchard, Alabama, and Central Falls, Rhode Island, have resulted in pension cuts as severe as 50 percent. These outcomes contradict historical precedent: In major municipal bankruptcies such as Orange County, California, in 1994 and Jefferson County, Alabama, in 2011, no cuts to pensions ensued.

Initial media reports have suggested that Detroit workers will suffer at most a 4.5 percent cut to their pensions and the loss of the annual cost of living adjustment. But there is a deeper impact.

If Detroit’s retirees vote in favor of the settlement, they agree to forfeit their right to contest any aspect of the city’s bankruptcy. (There are currently 18 ongoing lawsuits that challenge it.) They waive their right to contest the cuts to their pensions under Article IX, Section 24, of the Michigan constitution, which establishes public pension payments as inviolable — setting an effective precedent that will allow future cuts to be implemented during any time of financial distress for the city. Courts have consistently sided with the legal concept that pension payouts are inviolable, contractual rights. If retirees vote to waive those rights today in Detroit, previously guaranteed pension payments nationwide will be endangered.

Getting into the nitty-gritty of the proposal, there are two particularly problematic aspects. For one, control over the two city pension funds (serving more than 30,000 retirees) would be largely handed over to unelected “investment committees” with the power to override decisions made by the elected retirement boards and to reappoint themselves in perpetuity.

This creates a “foxes guarding the henhouse” situation for the city’s pension funds, as the investment committees will have zero accountability to either the retirees or the citizens of Detroit.

The other red flag is that the proposal eliminates any mandate that the city pay the health care costs of retirees, otherwise known as Other Post Employment Benefits (OPEBs). These too have been promised to public employees for generations. Currently, OPEBs are dispensed on a pay-as-you-go basis to retirees. Under the proposal, the city would issue $4 billion in bonds and then deposit the funds into OPEB trusts, which would in turn be invested in a single bank selected by a board of retirees and appointees of Detroit Mayor Mike Duggan. Neither the bank nor the board would have any legal obligation to pay out the $4 billion to retirees, much less the actual costs of retiree health care, which will likely be much higher. (Funds for retiree health care would be disbursed from the trust held by the bank.) 

While the proposal states that the bank is to be “compensated” for investing the assets, as of May 12 the details of how such compensation would be structured were not included in the final documents. This exhibits a distressing lack of transparency.

In both the case of unelected, all-powerful investment committees and an OPEB trust that is deposited entirely into a single bank, Detroit could be entering a brave new world of retirement provision. 

There is little evidence to indicate that retirees had anything to do with the financial crisis in Detroit — or even that there ever was a crisis. Detroit’s pension plans became “underfunded” — lacking the money to cover current and future retirements — only through the manipulation of the assumed investment rate of return for the funds.

Pension funds calculate how well funded they are by assuming what their future investment returns will be.

Emergency Manager Kevyn Orr was appointed to office in 2013 under the auspices of a highly controversial bill championed by Republican Michigan Gov. Rick Snyder. One of Orr’s first acts was to lower the assumed rate of return for Detroit’s pension plans to 6.5 percent from 7.9 percent (for the General Retirement System) and 8.0 percent (for the Police and Fire Retirement System). The 6.5 percent assumed rate of return is lower than any of the 126 major pension funds tracked by Plan Sponsor, a pensions trade publication. Orr implemented this rate despite the fact that the average stock market return over the past 142 years has been 8.84 percent. Prior to this, Detroit pension funds were funded above the national median.

Pensions have historically been the last thing cut in municipal bankruptcy. Indeed, public pensions have been cut only twice in history, both in the past five years. Precedent would indicate that Wall Street bondholders would have to be completely wiped out before a single cut reached pensioners. This is decidedly not happening in Detroit, with hundreds of millions of dollars still being paid to bondholders under the proposal. 

As for Detroit’s public pensioners, they’re eager to know their fates. Hassan Aleem, 64, is a former city building inspector. He retired in 2010 and has a monthly pension of $3,000. Unlike most of the media, he’s been closely following the issues surrounding the bankruptcy: Despite having no formal legal education, he has read all of the briefs filed in the case.

“Kevyn Orr and [Bankruptcy Court Judge] Steven Rhodes say that there will be only small cuts, but they haven’t mentioned that the settlement will get rid of the legal precedent that pensions are sacred,” he told me. “The plan is a fraud and they know it.

“We could lose everything,” he added.

The plan and its related documents (in total, more than 400 pages long) must be voted on by retirees within eight weeks.

Judge Rhodes has threatened retirees with worse cuts if the proposal is voted down. This is an audacious claim to make, given that if the proposal is voted down, the 18 lawsuits challenging the legality of nearly every aspect of Detroit’s bankruptcy will go forward. If the proposal is upheld, retirees could end up losing everything. For the sake of workers and retirees everywhere, they should vote no.