Municipal patient Zero

January 4, 2011 | Economics, Local issues, Local taxation, Sovereign bankruptcy, Speculation, Subprime, US News

By: David A. Smith


New York Times


For every unpleasant scenario, there is usually one worse – and that is the curse of free will. 


I’m happy and carefree – what harm could I possibly do?


However much we wish not to contemplate bad futures – especially financial ones – they get no better for our oblivion.  Only innumeracy or unusually shortsighted public-choice risk can explain the refusal of some states and cities to confront – and that means reduce – their structural budget deficits.  With that practicality in mind, we present the cautionary tale of municipal bankruptcy’s Patient Zero – the town that finally, unequivocally, ran out of money.


Alabama Town’s Failed Pension Is a Warning


PRICHARD, Ala. — This struggling small city on the outskirts of Mobile was warned for years that if it did nothing, its pension fund would run out of money by 2009. Right on schedule, its fund ran dry.


Funny thing about arithmetic – it works whether you approve it or not.


Then Prichard did something that pension experts say they have never seen before: it stopped sending monthly pension checks to its 150 retired workers, breaking a state law requiring it to pay its promised retirement benefits in full.


What choice did it have?


The city’s insolvency had cascade effects:


When the city goes busts, its beneficiaries go bust too


Since then, Nettie Banks, 68, a retired Prichard police and fire dispatcher, has filed for bankruptcy.


That’s doubly bad because Ms. Banks had every reason to rely on her pension, and whose reliance on that pension placed her at risk of the unthinkable.  But there is always worse:


Far worse was the retired fire marshal who died in June. Like many of the others, he was too young to collect Social Security. “When they found him, he had no electricity and no running water in his house,” said David Anders, 58, a retired district fire chief. “He was a proud enough man that he wouldn’t accept help.”


The situation in Prichard is extremely unusual — the city has sought bankruptcy protection twice —


Clearly the previous bankruptcy reorganizations were themselves too optimistic, too innumerate.


— but it proves that the unthinkable can, in fact, sometimes happen.


Unthinkability is not impossibility, as Herman Kahn should have said.


Why didn’t I think of that?


And it stands as a warning to cities like Philadelphia and states like Illinois, whose pension funds are under great strain: if nothing changes, the money eventually does run out, and when that happens, misery and turmoil follow.


Precisely.  By deferring the necessary discounting of overly generous and no longer affordable pensions, you may think you’re helping the retires, but as Prichard’s elderly now discover, there is something quite worse than having one’s benefits whittled.


It is not just the pensioners who suffer when a pension fund runs dry. If a city tried to follow the law and pay its pensioners with money from its annual operating budget, it would probably have to adopt large tax increases –


Large tax increases, whether real estate or business, are no panacea, because they merely accelerate the outflow of people from the town.


– or make huge service cuts, to come up with the money.


From the complete exhaustion of finances, we can presume that the town cut everything it could discretionarily cut, succumbing to previous commitments it had thought should be unbreakable.


Current city workers could find themselves paying into a pension plan that will not be there for their own retirements.


We’ve already seen California use a fiscal double standard – issuing scrip for payment of the state’s debts and then refusing to accept that same scrip for its receivables.  Such behaviors used to be the sole province of banana-republic dictators.  Not any more.


Hey, that was my idea, maybe I can nationalize it!


In Prichard, some older workers have delayed retiring, since they cannot afford to give up their paychecks if no pension checks will follow.


That’s more sensible – as Americans live longer, economically we will need to work longer – and besides, work is natural and prolongs your lifespan.


So the declining –


Declining is a major clue. 


Well, none of us did it.


Municipal or state bankruptcy and fiscal exhaustion often follow when revenues inexplicably weaken, because it is in the nature of elected officials to presume that all historical revenue streams are a given, and future revenue can only be higher than past.


– little-known city of Prichard is now attracting the attention of bankruptcy lawyers, labor leaders, municipal credit analysts and local officials from across the country. They want to see if the situation in Prichard, like the continuing bankruptcy of Vallejo, Calif., ultimately creates a legal precedent on whether distressed cities can legally cut or reduce their pensions –


The answer must necessarily be Yes, the money having dry.


– and if so, how.


And that is the object of interest – not the necessity for cutting pensions, but the  mechanics and principles.  Prichard is the Patient Zero in the coming epidemic of sub-sovereign defaults.


You thoughk we were phantasms.  You thought we were rare.


“Prichard is the future,” said Michael Aguirre, the former San Diego city attorney, who has called for San Diego to declare bankruptcy and restructure its own outsize pension obligations. “We’re all on the same conveyor belt. Prichard is just a little further down the road.”


Be careful when the economics are in motion


Mr. Aguirre is wise – not only in seeing the inevitability of sub-sovereign bankruptcy, but in recognizing that the sooner it manifests itself, both nationally and at the level of individual cities and states, the better.


Many cities and states are struggling to keep their pension plans adequately funded, with varying success. New York City plans to put $8.3 billion into its pension fund next year, twice what it paid five years ago.


From what?  New York is among the country’s most bankrupt states.


Good stuff, cheap!


Maryland is considering a proposal to raise the retirement age to 62 for all public workers with fewer than five years of service.


By all means do so, and soon.


Illinois keeps borrowing money to invest in its pension funds, gambling that the funds’ investments will earn enough to pay back the debt with interest.


Illinois’ borrowing (“making California look penurious and honest”) is virtually criminal, if not actually criminal.


New Jersey simply decided not to pay the $3.1 billion that was due its pension plan this year.


That’s a short dodge, one step closer to Prichard.


Colorado, Minnesota and South Dakota have all taken the unusual step of reducing the benefits they pay their current retirees by cutting cost-of-living increases; retirees in all three states are suing.


Without bothering to read any of the laws, I am fairly confident that the retirees are right on the legalities – and soon to be on the wrong side of the economics.


No state or city wants to wind up like Prichard.


Then do something about it now.


Driving down Wilson Avenue here — a bleak stretch of shuttered storefronts, with pawn shops and beauty parlors that operate behind barred windows and signs warning of guard dogs — it is hard to see vestiges of the Prichard that was a boom town until the 1960s.


The Times does its best to make Prichard look bleak


The city once had thriving department stores, two theaters and even a zoo. “You couldn’t find a place to park in that city,” recalled Kenneth G. Turner, a retired paramedic whose grandfather pushed for the city’s incorporation in 1925.


Towns are born and die in many ways.  Some simply dwindle out of existence.  Some are created as workers’ camps, then abandoned.  Some gradually wither back into fallow.  Some are absorbed into other communities.


The city’s rapid decline began in the 1970s. The growth of other suburbs, white flight and then middle-class flight all took their tolls, and the city’s population shrank by 40% to about 27,000 today, from its peak of 45,000. As people left, the city’s tax base dwindled.


Yet the legal obligations Prichard created took no notice of possible demographic and economic decline.


Prichard’s pension plan was established by state law during the good times, in 1956, to supplement Social Security. By the standard of other public pension plans, and the six-figure pensions that draw outrage in places like California and New Jersey, it is not especially rich. Its biggest pension came to about $39,000 a year, for a retired fire chief with many years of service. The average retiree got around $12,000 a year. But the plan allowed workers to retire young, in their 50s.


Which may have made sense if people were dying in their 60s and 70s, instead of living until their 80s and 90s.


And its benefits were sweetened over time by the state legislature, which did not pay for the added benefits.


Over and over again, we have seen the benign oppression of higher levels of government imposing mandates on lower levels of government, thoughtlessly presuming that each incremental burden could be paid for ‘somehow.’


Trouble ahead?


For many years, the city — like many other cities and states today — knew that its pension plan was underfunded.


When people’s innumeracy aligns with their profligacy, the result is inescapable insolvency.


As recently as 2004, the city hired an actuary, who reported that “the plan is projected to exhaust the assets around 2009, at which time benefits will need to be paid directly from the city’s annual finances.”


Not unlike the dozens if not hundreds of reports issued about the US social security system, and to equally deaf ears.


The city had already taken the unusual step of reducing pension benefits by 8.5% for current retirees, after it declared bankruptcy in 1999, yielding to years of dwindling money, mismanagement and corruption. (A previous mayor was removed from office and found guilty of neglect of duty.)


Virtually every time I dig into a municipal or state bankruptcy, there is malfeasance and corruption.  I wonder why that is?


I’m a blogger, but I have my principles


The city paid off its last creditors from the bankruptcy in 2007.  But its current mayor, Ronald K. Davis, never complied with an order from the bankruptcy court to begin paying $16.5 million into the pension fund to reduce its shortfall.


Davis said the city’s out of money


A lawyer representing the city, R. Scott Williams, said that the city simply did not have the money.


Something’s missing from the story.  A court has no business confirming a plan of reorganization unless the funds are there to cover the costs.  So how could the city emerge from a 2007 bankruptcy and be unable to make its 2009 payments?


“The reality for Prichard is that if you took money to build the pension up, who’s going to pay the garbage man?” he asked. “Who’s going to pay to run the police department? Who’s going to pay the bill for the street lights? There’s only so much money to go around.”


Workers paid 5.5% of their salaries into the pension fund, and the city paid 10.5%.


That’s whopping funding.


But the fund paid out more money than it took in, and by September 2009 there was no longer enough left in the fund to send out the $150,000 worth of monthly checks owed to the retirees. The city stopped paying its pensions. And no one stepped in to enforce the law.


For the simple reason that one cannot get blood from a stone.


Prichard’s story shows there is a gigantic hole in our bankruptcy jurisprudence – courts have the power to enforce debts but they have no power to print money, nor is there a mechanism for cities to escape municipal debtor’s prison through voluntary bankruptcy (states have to approve their filing). 


The retirees, who were not unionized [What does that have to do with anything? – Ed.], sued. The city tried to block their suit by declaring bankruptcy [October, 2009], but a judge denied the request.


Prichard’s retirees, out of luck on their pensions


So the city can be a struldbrug – immortal yet senescent, financially paralyzed and wasting away to nothingness.


Immortality … and incapacity


The city is appealing. The retirees filed another suit, asking the city to pay at least some of the benefits they are owed.  [Also denied – Ed.]  A mediation effort is expected to begin soon.  


What goo will that do, pray tell?  The city has no money.


The part where I don’t get paid, that’s what


Companies with pension plans are required by federal law to put money behind their promises years in advance [Under ERISA – Ed.], and the government can impose punitive taxes on those that fail to do so, or in some cases even seize their pension funds.


Yet somehow the government, which is quite free to impose standards on private companies, failed to impose such standards upon itself.  Curious, that.


I can think of a reason


Companies are also required to protect their pension assets. So if a corporate pension fund falls below 60 cents’ worth of assets for every dollar of benefits owed, workers can no longer accrue additional benefits. (Prichard was down to just 33 cents on the dollar in 2003.)


Government is not so obligated.


And if a company goes bankrupt, the federal government can take over its pension plan and see that its retirees receive their benefits. Although some retirees receive less than they were promised, no retiree from a federally insured plan in the private sector has come away empty-handed since the federal pension law was enacted in 1974.


Thus the law allows in effect a pension-fund receivership, where the government, in exchange for having compelled companies to comply with ERISA, provides the same ‘guarantee protection’ FDIC provides bank depositors – with the additional proviso of the ability to compel discounts.  So Federal receivership of a pension is in effect a one-stop bankruptcy reorganization, the Federal government acting as both judge and settlement expert.


The law does not cover public sector workers.


To be precise, the law does not cover public sector employers.


Last week several dozen retirees — one using a wheelchair, some with canes — attended the weekly City Council meeting, asking for something before Christmas. Mary Berg, 61, a former assistant city clerk whose mother was once the city’s zookeeper, read them the names of 11 retirees who had died since the checks stopped coming.


“I hope that on Christmas morning, when you are with your families around your Christmas trees, that you remember that most of the retirees will not be opening presents with their families,” she told them.


Many retirees say they would accept reduced benefits.


Now they would, given that there is no money.  Where was this reasonableness before?


Cities need a means of discounting their pension obligations through bankruptcy.  If Prichard is not the Patient Zero, then some other American city will be – and soon.


They’re coming …