Detroit To Axe Public Pension Fund

June 25, 2013

By Richard Danker

Detroit emergency manager Kevyn Orr met Thursday with
labor groups to tell them what they already know: He won’t spare public
employees in his mission to make the city solvent. Orr’s preliminary report to
creditors, released last Friday, says “there must be significant cuts in
accrued, vested pension amounts for both active and currently retired persons.”
That would be a game-changer.

If it takes effect, Orr’s proposal would
mark the first time a large government pension plan sponsor has rescinded
benefits for both active and retired employees. It could set a precedent for
cities — as well as states — in financial emergency to restructure pensions the
same way as other debts by paying out cents on the dollar instead of making them
whole. The emergency manager also announced he has ordered a probe into the city
pension funds and employee benefit programs to investigate possible waste, fraud
and abuse.

Orr has his vision for staked Detroit’s financial
reorganization on fairness. “We want to put everyone on notice that we're going
to treat them equally,” Orr’s spokesman Bill Nowling said. “We’re not going to
pit union stakeholders against creditors.”

But while the two main Detroit
funds say they have $5 million stashed to wage a legal battle, that isn’t likely
to deter Orr from having his way. Even if he can’t get an out-of-court
agreement, Orr’s work will likely be the blueprint for reorganization. A judge
would be hard-pressed to reject a pre-packaged bankruptcy plan to which 80 to 90
percent of Detroit’s creditors agree.

As Detroit’s tax base hollowed out
over the last decade, it failed to rein in its retirement system accordingly.
Legacy costs involving pension and healthcare benefits consumed 39 percent of
city revenue last year and are on pace to absorb more than half of revenue in
2014. This is the essential problem of the defined benefit pension model — the
automatic contractual increase in benefits make them almost impossible to
restrain.

No major city wants to be first in repudiating the retirement
benefits of its workers, yet the emergency circumstances warrant it. Detroit is
on track for nearly $200 million in negative cash flow next fiscal year. One
snippet from Orr’s report — “City urgently needs to upgrade or replace the
following IT systems, among others: payroll; financial, budget development;
property information and assessment; income tax; and [the police] operating
system.”

Most of Detroit’s problems — municipal mismanagement, civic
neglect —are its own. But the public pension crisis is plaguing state and local
governments coast to coast. Detroit is about to show them the most drastic way
out.

Rich Danker is economics director at American Principles
Project.