Why Detroit cut pensions, and Stockton didn't

On June 28, 2012, the city of Stockton, California filed for bankruptcy, $1.1 billion in debt, and on July 18, 2013, the city of Detroit, Michigan filed for bankruptcy, $18 billion in debt. The difference between the two cities’ fiscal crises amounts to more than $16.9 billion difference in debt burden. In Detroit’s plan of adjustment, the pathway out of debt, it cuts pension benefits for retirees, but in Stockton’s plan of adjustment they didn’t.

Here’s why.

First, Stockton was financially distressed, but not to the extent of Detroit. Stockton’s woes came from a dramatic decrease in revenue from the financial crisis of 2007 and subsequent recession. Property tax collection in the city fell from $61.1 million in fiscal year 2007, to $43.6 million in fiscal year 2012. Prior to 2007, Stockton’s balance sheet would have looked healthy. By comparison, Detroit ran deficits each year since 2004.

Detroit’s been in decline since the 1950’s. The city’s population once was 1.85 million show census data from 1950. At the time Detroit filed for bankruptcy, its population was 688,701. By comparison, Stockton’s population increased, despite the fact that the city’s crime rate increased with its indebtedness. Between 2000 and 2013, Stockton’s population increased from 243,000 to 298,118.

Moreover, the basic math of it all meant Detroit had much harder choices to make than Stockton. Stockton filed with $1.1 billion in debt and liabilities, Detroit filed with $18 billion in debt and liabilities. Quite the difference.

Now, both California and Michigan have clauses in their constitutions’ which prohibit the impairment of municipal contracts. Impairment means to alter, and or reduce the benefits provided to municipal employees once they’ve been contracted. The point of contention has been that in both the bankruptcies of Detroit and Stockton, the cities’ have been able to impair pension obligations.

Chapter 9 bankruptcy, the chapter in the U.S. Bankruptcy Code under which municipalities file is federal law, and the case is carried out in federal bankruptcy courts. Federal law supersedes state law. But an even simpler answer is that which was provided by Judge Christopher Klein who presides in Stockton’s bankruptcy case: “Bankruptcy is all about the impairment of contracts….That’s what we do.”

It’s true, the most basic purpose of bankruptcy law is to allow debtors’ to alter or break contracts – reduce debt – which they otherwise couldn’t satisfy. Municipal retirees deserve sympathy, but their pensions are but another contract, another debt. They’re even more vulnerable because they’re unsecured debts or debts that weren’t backed by collateral at the time money was borrowed or the liability incurred.

Secured debt has more protection in bankruptcy, because the lender was provided with collateral by the debtor, or further assurance of payment. Debt that is secured can only be undone if the collateral is surrendered to the lender, or the fair market value of the collateral is provided.

Both Judge Klein, and Judge Steven Rhodes, who presides over Detroit’s bankruptcy case, ruled that pension obligations can be impaired in bankruptcy.

Reported by the New York Times’ Mary Williams Walsh last week, Judge Klein has decided to approve Stockton’s plan of adjustment – the plans which outlines who will be paid, and who won’t, and how much.

Stockton didn’t impair pension obligations, while it was fully empowered to do so. Detroit’s bankruptcy case is likely to come to a close soon, and it does impair pension obligations. Detroit retirees will likely see four percent less in their monthly payments.

“The City is unwilling to further reduce or eliminate pensions thereby defaulting on its contract with nine labor organizations, and, in effect roll the dice to see if employees flee,” said Stockton in a financial disclosure.

If only Detroit can do the same, but to be clear, it can’t. At the time Stockton filed for bankruptcy, its pension fund was 85 percent to 90 percent funded. There wasn’t much the city owed with respect to that liability to keep it fully funded. Detroit has two pension funds, one for a majority of municipal employees and a second for the Police and Fire Departments. The General Retirement System, the fund for municipal retirees, was only 70 percent funded, while the Police and Fire Retirement System was 89 percent funded. Combined, both the pension funds overseen by Detroit, had an unfunded liability of $3.5 billion.

Retiree health care benefits went unfunded for years in Detroit, and that liability was $5.7 billion. So, combined, Detroit had $9.2 in liabilities related to retiree costs. A much heftier debt burden than Stockton. Retiree cost represented more than half of the overall $18 billion in debt and liabilities Detroit owed.

Furthermore, the $9.2 billion in retiree costs is a part of the city’s $12 billion in unsecured debt or in other words, the debt that can actually be cut in bankruptcy. The other $6 billion in debt that Detroit filed with was secured debt related to its Water and Sewerage Department – which can’t be cut in bankruptcy. There was little else that Detroit could do.

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