How Detroit’s bankruptcy filing will have national repercussions
Back when I was a rookie reporter at the Detroit Free Press nearly 30 years ago, the big debate the staff had over lunches was which would go bankrupt first: the big automakers or the city. And which experience would be worse.
The city of Detroit is about $20 billion in debt to over 100,000 creditors. The Detroit bankruptcy serves as a warning beacon for everyone expecting a pension and other retirement benefits. Chuck Jaffe explains on MoneyBeat. Photo: AP.
You could make arguments for each possibility, but most of the staffers thought there was no way either event would ever actually happen. They insisted that the early signs of trouble were an anomaly or something that could be reversed before it became a calamity.
Having just earned my degree in economics, I thought back then that both were possible — many years in the future — and that bankruptcies for the Big Three would be bad for the city, but that a bankruptcy for the city would be bad for the entire country.
Sadly, what was once little more than a theory is now a reality, but what’s worse is that so many people — like my old colleagues — don’t recognize what the city’s financial woes mean on a national level.
Detroit owes roughly $20 billion to over 100,000 creditors, but the big creditors people will be watching are the city’s public-sector labor unions, which fear that a bankruptcy judge might let the city reduce or cancel pensions and retiree health benefits.
Sure, the unions have the law on their side — Michigan’s state constitution protects workers’ pensions from being reduced — but they still have reason to be worried. After all, Michigan law also requires public pensions to be fully funded every year, and yet Detroit apparently only managed that using accounting tricks that, by some estimates, have left the city as much as $3.5 billion off the mark.
That’s why the Detroit bankruptcy filing serves as a warning beacon for everyone expecting a pension and other benefits when they retire, a signal that it’s dangerous to entrust your financial future to others, assuming they are going to keep their promises.
How much precedent Detroit will set for other communities remains to be seen, but clearly everyone is watching to see what’ll be allowed. Other communities on the brink will see how the Motor City comes through the experience financially and decide if they want to mark a similar course on the map, even if it is as a last resort.
There is plenty of precedent for corporations using bankruptcy to cut or eliminate pension obligations — Delta Airlines DAL+1.96% being the most-recent big-name company to go that route — leaving the Pension Benefit Guaranty Corp. to step in with smaller pensions and the workers with a much less secure future.
The Pew Center for the States estimates that public pension plans nationwide were underfunded by $1.4 trillion in 2010. While the stock market has reached record highs — narrowing the gap somewhat — since then, the undeniable problem is that most state and local government pension funds don’t have enough money to live up to the promises they have made.
If employers can’t live up to their obligations, you can bet that the Pension Benefit Guaranty Corp. — the nation’s pension backstop — will follow suit and run out of money too.
Even if the Detroit situation is resolved without setting some benchmark for other troubled municipalities to use and follow, the nation’s pension shortfalls aren’t going away; this story is going to play out again and again, and while it will be corporations, cities and towns in the headlines, it will be the nameless, faceless individuals who are the real story.
That’s not a story anyone wants playing out in their own home.
Now, back to the bankruptcy filings of the big automakers for a moment. They were big stories for Detroit, but they actually showed the underlying values of the businesses; allowed a break and a chance to restructure, they were able to improve their fortunes and move forward. Talk to auto-industry analysts and some of them are more bullish on the prospects of the domestic manufacturers than they have been in decades.
The problem for the city of Detroit, by comparison, is that there is no reason to believe it comes through a bankruptcy with greatly improved prospects. The court process will be more a respite than a solution; the city will still have the same high unemployment, dwindling work force and Rust Belt economics, with the same delinquent tax revenue collections and other conditions that make it hard to see any ability to improve the long-term numbers without reducing pensions or eliminating benefits.
Even during those conversations at the Free Press in the 1980s, colleagues who had seen the city and the automakers take care of generations of workers wondered if my worries about future bankruptcy meant that workers should not trust their pensions.
“Oh, they will get pension payments,” I said, “but maybe not of the size they expect, so the more they save now — rather than living as if they’re set and taken care of because that’s what the company or union says — the more secure they will be.”
That advice holds for anyone with a pension today: Take full responsibility for your future savings, or supplement the benefits you are earning now, just in case.
Anything less than that, and you have underfunded your future.
Companies and communities can get away with underfunding their futures, to some extent. Accounting rules, revenue projections and, well, bankruptcy courts have allowed it to this point, even as the numbers have become increasingly scary.
Individuals don’t have the same luxury.
If you don’t save enough — and if your pension benefits are cut because of the recklessness of your past employers — no one is going to bail you out. That’s what investors need to think about every time they hear about how Detroit’s bankruptcy is proceeding; trouble is going to show up, even if it takes a few decades to hit your home. Instead of crossing your fingers and hoping that you won’t be effected, make a plan.