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Home Publications Blogs Beat the Press The Constitutional Issue With Detroit Pensions Shouldn't Be a Joke

The Constitutional Issue With Detroit Pensions Shouldn't Be a Joke

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Wednesday, 23 October 2013 07:36

The coverage of the legal battles surrounding how Detroit's pensions would be treated in bankruptcy have generally treated the guarantee of public employee pensions in the Michigan state constitution as somewhat of a joke that needs to be cast aside given Detroit's dire circumstances. The basis for the humor is less than obvious.

When the state of Michigan put a guarantee into its constitution it was presumably sending a message to both its public sector workers and its potential creditors. The pensions would have a prior claim on state and local government assets before other creditors. Workers put in their time with this understanding and presumably creditors made loans to Detroit's city government with the same understanding. 

The question now is often posed as to whether this priority can carry over into federal bankruptcy court, which does not award pensions complete priority over other creditors. (In other words, bondholders do not have to allow pensions to be paid in full before they can get partial collection.) The argument presented in the media is that federal law trumps state law or a state constitution, therefore the bankruptcy judge is free to cut pensions to partially payoff other creditors.

However, there is a prior issue. If public employee pensions cannot be guaranteed protection in federal bankruptcy court, can the city of Detroit declare bankruptcy? The city is a creation of the state. (This is especially true at present with Detroit being run by a city manager appointed by the governor.) Certainly the state of Michigan can't embark on a course of action that would lead it to violate its own constitution, so how can a city within the state?

There are entities that do not have the option of filing for bankruptcy in federal court, like state governments. It is possible that Detroit may also not have this option if it could result in a violation of the state's constitution.

Okay, that's enough playing at lawyer for the day. It just doesn't seem like the issue of protecting pensions is so obviously crazy and informed investors should have known about this clause in the Michigan constitution when they decided to lend the city money.

 

Comments (12)Add Comment
Bankruptcy
written by JayR, October 23, 2013 8:24
There is another possibility which is the state government could be held liable for any bankruptcy shortfall the pension encounters. Actually if you read the Michigan constitution the next sentence says "...Financial benefits arising on account of service rendered in each fiscal year shall be funded during that year and such funding shall not be used for financing unfunded accrued liabilities." Not a lawyer here as well but it seems like this puts the liability onto the state. I am sure the state would rather not pay and instead have the creditors take a hit, but the federal or state courts may see it differently.
You may be overstating the case
written by wkj, October 23, 2013 9:14
I think you may be overrating the importance of the Michigan constitutional provisions on pensions. Prior to about 1930, pensions were often viewed as an employers voluntary reward to loyal employees and not as a contractual right. http://articles.chicagotribune...sion-plans

I think a fair reading of the Michigan provision is that it merely gives state employee pension rights contractual status. Bear in mind that the bondholders' claims also have contractual status (under the terms of the bond documents) and that US Const. Art 1, sec 10, clause 1 says that "No State...shall pass any...Law impairing the Obligation of Contracts." (In light of this language, the part of the Michigan constitutional provision may be redundant.)

When all of this is ultimately sorted out, I think a possible result is a conclusion: (i) that both bond indebtedness and pension rights are contractual obligations of the City, (ii) that neither may be unilaterally reduced by the City, but (iii) that both may be adjusted in bankruptcy.
The Democratic Party and Pension Rights
written by Ellis, October 23, 2013 9:30
The sharks smell blood. The private sector has already gutted the pension rights of their employees. It was only a matter before the same thing would happen in the public sector. And it's not just about the Rust Belt. The city of San Jose, which is in the heart of Silicon Valley, is also cutting the pensions of their employees. So, is the city of Chicago and the state of Illinois.

Because municipal governments have a pressing need to give more money away to enrich the banks and big business, like the auto companies in Detroit.

And the great thing is that the Democrats are the ones doing all the cutting.

One other note: the Detroit pension funds are actually in better shape than those of a lot of other big cities. So, that's not the real issue here.
yes yes, the issue is guaranteeing everything to everyone
written by pete, October 23, 2013 9:46
And Christmas is coming soon...the moral hazard problem here is immense. Guarantee a bunch of stuff that cannot be delivered, and then run like hell. Cool strategy. Sounds like the toobigtoofail banks in the 2000s. Guarantee a bunch of stuff, let the government launder the money through AIG to pay off Goldman Sachs etc. Ugly ugly ugly, and no one is in jail. Clearly some advocates, like Dean, will lobby for the pensions, while others will lobby for the bond holders. That's why we have courts. Of course, in the case of GM, the government whiped out the bondholders in favor of the unions. Same might happen here.
...
written by skeptonomist, October 23, 2013 10:28
There is no moral or economic reason why pension benefits should be at hazard. Employees should not usually be in the position of gambling with their retirement when they take a job, especially with a government entity. People who buy stocks or bonds take a risk by choice, for benefits that are usually larger the greater the risk.

If population has fled from Detroit, leading to bankruptcy, it has settled elsewhere in or out of the state leading to increased tax revenue there. The state and/or nation have the means and the obligation to guarantee Detroit's pensions.
simply untru skepto
written by pete, October 23, 2013 10:45
The feds took away a good portion of my social security benefits in the 1980s, simply stole them, increasing my contribution and reducing my benefits. If they can do this to social security (which they are apparently going to do again), why not Detroit pensions? Logic is very similar.
a suggestion
written by john farmer, October 23, 2013 1:29
Detroit has filed for bankruptcy with $18 billion in liabilities. JPMorgan Chase is negotiating a $13 billion settlement with the government. I think there may be a solution that doesn't require pension cuts for public employees.
interesting argument
written by tew, October 23, 2013 8:26
That's an interesting argument. It will be interesting to see how things play out.

The creditors indeed would have known about the pension protection in the state constitution. Indeed, one would think that Detroit paid a slightly higher interest rate for a long time due to this protection.

Then again, Fannie & Freddie paid higher interest rates than Treasuries for decades and then the taxpayers bailed the bondholders out when they came crashing down. In other words there is precedent for this kind of bait and switch, except that it's been done in favor of bondholders rather than against them.

[Note: I'm not a fan of the public sector unions. I think it was a mistake to allow them in many cases.

This makes it hard on you to decide whether to thumbs down or up :)]
getting it from both ends
written by tew, October 23, 2013 8:31
Everytime issues with public sector pensions (and overall compensation) are discussed, a bunch of people start screaming "Bank(st)ers!"

Well, for the ordinary citizen both of these hugely influential and corrupting segments are damaging. Just like you'll find honest banks and financial services people, you'll find plenty of good, hard-working public sector employees. But that doesn't mean they're not extracting us due to their enormous lobbying power. They intimidate our elected representatives to get what they want.

So, yes, when you scream about bankers whenever the public sector is brought up, you're right, but not for the reasons you mean.
So What
written by Hopley Yeaton, October 24, 2013 2:13
When the money runs out, it doesn't matter whose claim takes precedence. Maybe you think someone someplace else can be taxed for it. I have a suggestion. Come here to Cleveland and have a rally in Public Square. Suggest we vote to raise our taxes and then send the money to Detroit's retirees. rotflol
Pension status
written by SMIA, October 24, 2013 3:04
This issue is much simpler, and more limited, than you seem to understand. The U.S. Constitution says that States cannot "impair the obligation of contracts". All the Michigan constitution is saying is that pension benefits have the status of contractual obligations. The basic job of a bankruptcy court is to impair the obligation of contracts when all such obligations cannot be met. Bonds are also contracts, and therefore have the same status as pensions.
Federal Law trumps Michigan's Constitution
written by Dave Thomas, October 24, 2013 5:28
Federal bankruptcy law takes precedence over a state constitution. Is the author unfamiliar with the Supremacy Clause?

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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