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Finally, Hope for Pensioners in the Detroit Bankruptcy

It is indeed remarkable that the Detroit’s Emergency Manager Kevyn Orr has agreed that existing pensioners can receive virtually all of their retirement benefits in a startling settlement proposal. Police and fire will receive their entire amounts (minus a portion of cost of living adjustment) while other former employees will receive 96 percent (minus all cost of living). This is quite a distance from the 5 percent and 26 percent haircuts previously threatened.

It is remarkable not just because of the improvement in terms offered the pensioners. It is remarkable because it makes clear that the emergency manager appointed by the governor as a virtual dictator of the city conducted the bankruptcy like a political operation, public relations and all.

The question is: how did he plug the pension funding gap that he claimed existed so that he could offer this deal? At the outset, he claimed that the holdings in the funds, including investment earnings over time, were insufficient to pay promised benefits over the next decades by the amount of $3.5 billion. The new deal assumes that the city will receive around $800 million from private charitable funds and the state over the next few years to mitigate this deficit. But that is a far cry from $3.5 billion. Where did the extra $2.7 billion come from?

Is it possible that the original unfunded pension obligation was a manufactured number to make matters seem worse?

The latter is what we have suggested in a major report on the Detroit bankruptcy. The pension fund boards had calculated that the unfunded liability was $800 million, interestingly the same figure as the $800 million promised by the charities and the state of Michigan. The emergency manager's number was the result of using some extraordinary assumptions, far afield from common practices, that ballooned the figure because of compounding of interest.

The entire episode leads inexorably to the conclusion that the emergency manager used mathematical tricks to demonize the pensioners (and city workers in general) so that he could pursue a plan to structurally change the politics of the city and the state, favoring his boss, the governor. The people of Detroit, and especially the pensioners, with the help of a few progressive advocates, seem to have successfully called the emergency manager (and thus the governor) on this arithmetical deception.

This should be a lesson to us all as the debate over unfunded public employee pension liabilities spreads across the country. There are those who are fundamentally hostile to public employees and to government generally who will claim that public employees have pillaged government budgets with voracious demands. They will cite individual instances of mistakes and even bad judgment by pension trustees, but in the end these are meaningless. They will also fiddle the numbers to scare the public.

But the real problem is not the benefits earned by public employees as part of their overall compensation, which is overwhelmingly too meager, rather than excessive as those hostile to government as a matter of principle claim. The problem is that the Great Recession devastated the tax base of state and local governments, and municipalities most of all. The real estate crash, triggered by the big banks, was a tremendous blow to local governments, which are so dependent on real estate taxes. The public’s loss of income was nearly as damaging, as income and sales taxes dried up. Unfunded pension amounts, already inflated because of investment losses in the crash, grew because the local governments could not make ends meet and the most obvious temporary fix was to defer contributions. The cities were the lowest in the budgetary food chain, and austerity measures at the federal level triggered cash flow squeezes through all levels of government compounding the problem rather than providing remedies that would have eased the effects of the recession.

This is a form of trickle down economics that actually has an effect.

The tragedy of Detroit now enters another phase. It appears that the bankruptcy will be finalized in a series of mid-summer hearings. So far, the emergency manager has spent $95 million in legal and consulting fees and this figure is bound to grow. It makes one wonder how it would have worked out if the city had not been taken over by a state appointed “Czar” and Lansing had instead worked collaboratively with elected officials rather than in opposition. The pensioners may have ended up in the same place, without law firms and consultants bleeding the city.

Even if an elected government had gone through a bankruptcy, the outcome would probably have been far better since it would not have been considered a outsider like the emergency manager. Democracy should never have been subverted.