Now that Detroit’s bankruptcy filing is official, the battle between Emergency Manager Kevyn Orr and union leaders over the health of the city’s pensions has taken center stage. The key question is: How healthy are the city’s pensions, exactly? As we’ve seen before, it’s a difficult question to answer, as relatively minor-seeming changes in the estimates of the rate of return and discount rate can lead to radically different assessments of the true state of the plans. As a result both sides gearing up for a battle of words (and actuaries) over how best to calculate the amount of the unfunded liabilities; with the funds arguing that they are healthier than they appear, and the city claiming the opposite.But in a new column at Bloomberg, Megan McArdle asks a slightly different and altogether more trenchant question: why are pension funds even fighting this battle in the first place? As she notes, pension funds would actually stand to gain if it looked like they are as insolvent as possible during bankruptcy:
Heading into the bankruptcy, a pension fund would normally try to inflate the underfunding estimates as high as possible, not minimize them. That’s because the unfunded pension liability is treated as an unsecured debt; it has to assemble with other unsecured creditors to collect whatever’s left over after the secured creditors have been paid. The bigger the claim, the larger the amount you’re likely to collect.
The fact that the funds are still fighting to prove that they are healthy suggests that they may not actually be jockeying for position with other creditors, but instead think that the city can actually stay out of bankruptcy altogether. If so, they are seriously ignorant of the true state of play:
The city is running out of cash — in fact, it already has run out of cash, which is why it is borrowing to pay pension contributions and running in arrears with vendors. Even the judge who stayed the bankruptcy didn’t try to argue that the city had the money to pay its obligations; she was reduced to the wistful hope that President Barack Obama would step in and use his healing powers, which is to say, taxpayer funds, to keep the pensions solvent.
Indeed. Detroit’s finances are a shambles, pure and simple, and have been getting worse for years. The chances of things turning around anytime soon appear to be slim-to-none. If the pension funds are actually staking their future on a fight against bankruptcy, there’s a strong element of delusion mixed in with their desperation.[Detroit image courtesy of Shutterstock]