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  • Bailouts or Bankruptcy for State and Local Government Pension Problems?

    The year 2011 will be the year of decision for underfunded state and local governments with pension and debt problems. The end of federal money from the stimulus package that many cities and states have used to prop up their finances, combined with the outsized cost of meeting their pension promises, will force a growing number of these governments to act.

    The immediate reaction for many will be to try to pass the cost onto the federal taxpayers in the form of a bailout, but Congress should strongly resist any such move. While the troubled state and local governments would promise to mend their ways and characterize the bailout as “time to work out the problem,” many of them have long histories of fiscal mismanagement and would soon revert to their old bad habits. A federal bailout would have no more long-term effect than taking away a shopaholic’s old credit cards while new ones are already in the mail.

    As a recent survey of the problem shows, most academic attention has focused on the overall size of the underfunding, with a number of studies using differing methods to decide how large the aggregate deficit is. However, while the aggregate underfunding proves that this is a major problem that must be dealt with before it gets worse, big numbers do little to guide specific cities and states toward a solution. In addition to the level of underfunding, the solution will depend on the government’s willingness and ability to either change pension promises for new or existing workers or require them to pay more for those benefits. These are not easy decisions, and none will be popular among the affected workers, who can be expected to use every possible avenue to resist them.

    In many areas, past laws or even state constitutions may sharply limit the ability of cities and states to change any of their existing pension promises. Already, three states that have changed the way pension benefits are indexed have been sued by employee unions seeking to overturn the reforms. Local governments can get around these restrictions by filing for bankruptcy under Chapter 9 of the federal bankruptcy code, but currently, states have no such outlet.

    In this environment, Congress should consider a way for states to file for bankruptcy or its fiscal equivalent. Of course, there are serious constitutional questions to be addressed, in particular concerning federalism. One recent article makes a convincing case that a bankruptcy process for states would be constitutionally acceptable so long as a state enters into it voluntarily.

    Given the current horrible fiscal condition of both Illinois and California and their lack of real progress back toward fiscal responsibility, there is a clear practical need for such a procedure. As the economy continues to experience a very slow recovery, other states are certain to approach the same level of fiscal crisis and will come hat-in-hand for federal tax dollars to pay for the cost of their irresponsibility. One option should be bankruptcy, and Congress should start thinking about that option now.

    Such a process should not be part of a deal under which states can also receive a federal bailout. State and local governments made the mess of their finances, and they should have to clean them up. Congress should provide a mechanism to make the process more direct, giving the states the flexibility to address their fiscal problems consistent with federalism and the principles of limited constitutional government.

    Posted in Economics [slideshow_deploy]

    9 Responses to Bailouts or Bankruptcy for State and Local Government Pension Problems?

    1. John Cincinnati says:

      The writer ignores the deflationary effects of state & local government pension default. In many areas of the country, state & local government is the largest employer, with the largest pool of retirees. If these pension funds go down, cascading debt default and deflation can't be ruled out.

      But the pension situation is an ungainly, unsustainable mess. This crisis offers an opportunity for reform. The feds should provide guarantees for the funds, conditioned upon reforms designed to make them fully-funded upon sound actuarial principles.

    2. George Colgrove, VA says:

      If public employees are really doing their work for the service of the people, their town or city, their state or their country, then prove it. These ponzi pension shemes are going to sink states and the nation if they are not redone. We cannot bail them out – we are done with those scheme that are only making government workers all over, richer. We simply need a national law that makes all public pensions null and void.

      I think we all agree people ought to get what they paid in to the plan plus a reasonable interest rate. An interest rate equivalent to the market growth over that period. Beyond that amount is nearly impossible to pay for. These are bad deals and the taxpayers who had nothing to do with writing them or voting on them should be held with the bill.

      These pensions, be it the FERS/CERS at the federal level on down to the pension a dog catcher may get at the local level are often funded by a very small portion contributed by the pubic worker and the rest by taxpayers who now have no disposable cash. Many of which are USING CREDIT CARDS to pay income taxes!!! The ratio of the public employee contribution to taxpayer contribution can be up to 8 to 10 times – or more! For a nation that has liberally defined government to be a dictator to force equality, this is very unfair. Often private sector workers do not get any retirement and if they do, they get meager matching funds at best. The newer feds not only get a 401k like investment program they also get a pension (FERS). Government employees are getting a really good deal at the cost of cash producing taxpayers.

      Instead of bankruptcy or bailouts, let’s create Equivalent Long-term Investment Accounts (ELIA) that comprises of the principal paid by these public workers plus a reasonable interest rate. These accounts will be funded by current means and paid out by priority of older recipients down to newcomers. The ELIA will be taken by the employee to be put into a retirement account of their choosing. After that time, the employee will manage their own retirement using the private sector. We need to keep this money away from government as they cannot be trusted to not abuse the pension funds. Let the employee take all the risk they want. Failure is limited to only that employee. Failure of a governmental pension can affect the entire nation as can be seen this year with the multitudes of pension plan bailouts paid out in the $100’s of billions if not over a trillion dollars.

    3. Daniel Ryan, Park Ri says:

      The author properly notes that while there are big numbers involved in pension underfunding, it is an issue that varies greatly from state-to-state or city-to-city. Pittsburg is funded in the 20% to 30% range. The Illinois Municipal Retirenent Fund (not the state fund or teacher's fund) is stable in the 82% range.

      Look for the worst locations to consdider state constitutonal amendents that will allow them to change the non-accrued benefits for existing employeees going forward. This sitaution is going to get that bad. Changing earned benefits in the future and inceasing contributions may well get America out of this mess.

    4. Bobbie says:

      John, i must say, government shouldn't ever be the biggest employer. Not in a free country. As George writes, if local governments were doing their job, their pensions shouldn't be in question. But because the government holds themselves unaccountable to their own actions and the consequences their actions put on innocent lives, there should be no question on bailouts or bankruptcy. It's time governments at all levels, suffer their own consequences. Now, the people who have suffered under their leadership can be certain of government reprimand. The productive human mind learns from mistakes. This running government wants to convince otherwise.

      I say neither to bankruptcy or bailouts. Use your minds to avoid the needless sacrifices on the people that fulfill governments own interests and greed.

    5. John, Cincinnati says:

      Bobbie, I've got to disagree with you. Reform is necessary, but society can't tell a cop who patrolled the streets for 30 years keeping us safe from crime that he's just flat out of luck as far as that retirement goes. He bears no responsibility for the fund's insolvency. You do realize that these people are ineligible for Social Security, don't you (unless they have sufficient additional work history in the private sector)?

      As for my largest employer remark, I wasn't making a value judgment about it. The economy was much better when employment was provided by leading private concerns; alas, that is no longer the case.

    6. Bobbie says:

      Bummer, isn't it John? How people can be in position of gpvernment to steal from an area invested to be there for them? Take away from those that took from.

      I never thought to think about social security. You mean that program government manipulated people to pay into to be there for them that now the government is compromising the health and well being of the elderly, that is also bankrupt under government control?

      But seriously, I am sympathetic with the noble positions and the unfortunate circumstances under the control of government and beyond the control of the taxpayers, but id somebody has to pay for it, it shouldn't be the innocent but the accountable.

    7. Jane says:

      Its all about the Unions! And their desire for control of our country.

    8. Michael Donofrio says:

      At some point along the way the public servants became our masters. If the new crop of Democratic Govs (like Brown and Cuomo) have the courage to stand up to their power bases (the unions) we will see Democrats becoming fiscal conservatives. They have to—not only to get votes in 2012–but to undo the mess they allowed their beloved unions to create. If they can't muster the courage, the GOP will take care of it–wholesale currettage of the governments will be in order and the Dems will be banished for years. Of course, since the original pension obligations used financial trickery to ransack the taxpayers and created bad faith contracts; a legal challenge in a favorable court is all that will be needed to undo the whole damn mess. If unions are smart, they would play ball now. They can pick their poison: negotiate with a guy like Cuomo now or a guy like Christie later. Either way, things will change and people are realized that the unions broke their social contract. Yet, our property taxes just keep going up and up…

    9. Roger, Long Beach says:

      Perhaps the Fed should guarentee that no local government will need to file bankruptcy, as long as they use generally accepted accounting practices (i.e. not New York City), the Fed will make emergency low interest loans available to them. Governments should easily be able to pay it back when times get better and it would help keep people employeed during these tough economic times.

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