The American Interest
Analysis by Walter Russell Mead & Staff
Detroit's Pension Funds Get Delusional

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]

Published on August 23, 2013 8:48 am
  • cubanbob

    It’s obvious the unions are desperate to avoid the bankruptcy. If it goes through how are they going to explain to the membership their colossal incompetence in allowing the underfunding over the decades? CYA at its finest.

  • f1b0nacc1

    Bankruptcy (and the attentendant reorganization) will not only be embarassing, but it will potentially open up the option of doing away with public sector unions in the first place, and that is what is really at stake here. Just as advocates of Affirmative Action have been loathe to see cases go to the SCOTUS (where the whole edifice of AA is being slowly whittled away), preferring to settle out of court where there are no precedents established, the public sector unions are terrified that a successful trip through the bankruptcy path will open the doors for municipalities and states to escape the straightjacket that the unions have fashioned for them.

    • Jim__L

      Now we need to extend the potential to discharge student loans in bankruptcy, and another unsustainable practice can start rebalancing itself.

      • f1b0nacc1

        The moment such a thing occurs (and given this administration, I rule nothing out), you will see the end of student loans. After all, what would stop students (who have no real assets to lose in a bankruptcy) to simply go to school, then declare bankruptcy to avoid repaying their loans? Certainly the recovery from bankruptcy isn’t pleasant, but it is far, far better than coping with student loan payments.
        If on the other hand, you were being facetious, I apologize for being dense…(grin)

        • Jim__L

          Not facetious, just highly skeptical of whether student loans do more good than harm. They’re the root cause of the ballooning cost of higher education, a huge boost to the debt burden on Americans today, and a major cause of the declining purchasing power of the middle class.

          • f1b0nacc1

            I couldn’t agree with you more, and I say this as someone who spent some time as a university administrator. The core of the problem, however, is not the loans, but the idiocy of the assumption that everyone (or even a very large portion of everyone) should be going to college. Depending upon how you cook the numbers, anywhere between 35 and 60 percent of the population sees the inside of some sort of institution of higher learning, compared with the low-to-mid single digits of a century ago. Obviously times have changed, but returning to a time where 10% of the population went to college strikes me as a very positive goal…

    • Rich K

      We can only hope.

  • freeinaz

    These crooks in Detroit have been delusional for the last 50 years what makes you think they will change now?

    • Pete

      Exactly right.

      And it comes down to this.

      The public sector employees reason that they got their ill gotten pensions fair-and-square by corrupting city politicians, and so they deserve to keep their pensions unaltered regardless of the cost to society.

      The sooner public sector unions are gone, the better society will be.

  • Jim__L

    “Arrears with vendors”… and soon, the vendors will stop vending.

    That’s what’s going to bring this all to a screeching halt. Doctors will leave their profession, drug companies will stop supplying their products, and vendors that supply government contracts will either get out of the public sector or stop existing altogether.

    The economy will rebalance itself along sustainable lines.

    That’s inevitable. No policy short of coercion can prevent it, and even coercion will not be able to realize its goals.

    • Rich K

      Who is John Galt?

  • avery12

    Genuine questions: what is the likelihood that these pension funds are also heavy Detroit bondholders and, if it proves to be so, then what would be the pension funds’ calculus of their interests in the lead up to bankruptcy?

  • Corlyss

    “why are pension funds even fighting this battle in the first place?”

    Geeez Louise! I thought it was fairly obvious. Unions are not about the union members. They are about the leadership and the political deals the leadership can wangle with and thru corrupt politicians whom they and their organized crime bosses control. Of keenest interest to them is the inviolability of collective bargaining, a recent addition to the tools by which the two sinister factions connive to steal from the taxpayers. It has been a cozy set up for the last 50 years without close examination by anyone whose opinion mattered, all hidden from view by a lot of rhetorical non-sense about a “constitutional right” to collective bargaining. Bankruptcy, investigation, court-oversight, and, above all, the harsh light of heretofore neglectful media exposure threaten the vermin and their arrangements to protect each other. Once the court-appointed master gets his hands on the actual books, gets into the private correspondences via discovery, the players are all at extreme risk of criminal prosecution.

  • John Morris

    The unions are behaving rationally. They understand there is zero chance of their being forced into taking a haircut in any potential bankruptcy. But it is still best for their interests if there isn’t one so that is the fight they are having.

    After seeing how the bondholders fared in the GM takeover by the unions, raise your hand if you can imagine government workers & retirees faring any worse in this case. Is what is going to happen legal? No. Is it moral? No. Is it going to have terrible consequences? Yup. But as certain as the sun rising in the morning it is going to happen. Everybody knows it. The bondholders are going to be ruined, the citizens of Detroit will be taxed ever harder and the union will keep their benefits even if the US taxpayer gets the bill, which is of course the only entity that can even still pretend to have that sort of money… because it can print it.

  • http://www.picsofcelebrities.net/blog/2012/05/08/voice-season-finale Cromulent

    California sells illusions, Detroit wallows in delusions. Its what we do.