Home » Welcome to the Third World » Welcome to the Third World, Part 12: Your Pension is an “Unsecured Obligation”

Welcome to the Third World, Part 12: Your Pension is an “Unsecured Obligation”

by John Rubino on December 8, 2013 · 29 comments

The main difference between well-run and badly-run countries is certainty. In well-run countries, money is worth pretty much the same from one year to the next, the police come when called and protect rather than prey on the caller, and contracts, including pensions and other retirement plans, behave as advertised. In badly-run countries, not so much.

With the contract part of this story, Americans have been living in two different countries, depending on whether they’re in the private or public sectors. Private sector workers discovered years ago that things like pensions and employment contracts are just so much scrap paper. But until recently the public sector had been spared such nasty surprises. Baby boomer teachers, firefighters and college professors have spent lifetimes doing their jobs and watching their pensions accrue. They’ve known for decades that when they retire they’ll get X amount per year for life and have X amount of their health care covered. This certainty makes them perhaps the last segment of US society to retain a belief that the system works.

But that changed earlier this month, when Detroit’s bankruptcy judge declared that pensions can be cut along with everything else:

Pensions Aren’t Sacred and Art Isn’t Priceless: What the Detroit Bankruptcy Ruling Means

A federal judge’s ruling clears the way for Detroit to proceed with the largest municipal bankruptcy in U.S. history
For 90 minutes Tuesday, as snow fell on protesters outside, Judge Steven Rhodes laid out his rationale for allowing Detroit to seek the biggest municipal bankruptcy in American history.

“This is indeed a momentous day,” Rhodes told the hushed courtroom. “We have a finding that this proud and once prosperous city cannot pay its debts.”

By the time the soft-spoken federal judge had finished, it was clear that from worker pensions to the city’s art treasures, nothing in Detroit is completely safe in Chapter 9 bankruptcy.

The effect of his ruling is likely to touch all corners of the city and could serve as a legal precedent for other municipalities reckoning with unsustainable debt. Here are three of the most important takeaways:

Pensions Aren’t Sacred. Lawyers for the city’s 48 organized-labor groups argued strenuously that Michigan law protected state employees’ pensions. Rhodes disagreed, noting that the state’s constitution classified pensions as a contractual obligation on cities’ part, not something requiring special treatment.

That means the city can treat pensions like any other potentially voidable contract. Expect it to do so. On Tuesday afternoon Detroit’s emergency manager, Kevyn Orr, said he couldn’t fix the city’s financial problems simply by restructuring the debt owed to banks. “It can’t be done without impacting pensions,” Orr said.

“For the image of labor, Detroit is a catastrophe,” said Gary Chaison, a professor of industrial relations at Clark University in Worcester, Mass. “The aristocrats of labor have become the paupers of labor. What affected yesterday’s manufacturing workers is now affecting policemen and firefighters. Nobody is safe.”

Detroit is just the first of many. Pension plans across the country have failed to put away enough to cover their obligations while hiding that fact from beneficiaries and bondholders:

Playing Pension Games

Pity the municipal bondholder. Between Detroit’s bankruptcy and the rising concerns over unfunded pensions in Illinois and elsewhere, it has been a rough year for many muni bond investors. While the Standard & Poor’s municipal bond index has recovered from its September lows, it is still off 2.7 percent for the year.

A big problem for investors in this $3.7 trillion municipal market — mostly individuals — is that financial disclosures by states, cities and other issuers of tax-exempt debt can be decidedly inadequate.

Securities laws require issuers of municipal debt to provide the information investors need to make informed decisions when buying or selling these instruments. But lax disclosure practices remain, making it hard to spot signs of problems like those hobbling some states and cities. Disclosures about the soundness of public pensions, for example, can be essential to weighing the health of municipal bond issuers that are responsible for funding them.

Investors aren’t the only ones who need more information. This was on full display last week, when a judge in Detroit suggested in a groundbreaking ruling that the city’s pensioners would not get priority in the city’s bankruptcy, and their retirement pay could be considered an unsecured obligation.

John R. Mousseau, executive vice president and director of fixed income at Cumberland Advisers, a money management firm in Sarasota, Fla., said: “Detroit’s pensioners may be as eligible to take a haircut as the city’s bondholders or vendors. This development should demand more disclosure.”

But better disclosure practices among tax-exempt issuers are slow in coming, investors say.

If issuers make material misstatements or omit information, they can face civil or criminal penalties. The Securities and Exchange Commission has brought eight cases contending disclosure failings by municipal issuers this year.

A large case last March involved accusations that the state of Illinois misled investors about its unfunded pension. From 2005 to 2009, a period when the state issued $2.2 billion in bonds, the S.E.C. said Illinois failed to warn investors about the pension system’s woes and “the resulting risks to the state’s financial condition.”

Among the details missing from the state’s offering statements and filings, the commission said, were those relating to the contributions made by the state to its various pension funds. The commission said investors were not told that the state was contributing far less to the pensions than was required each year. Last week, the Illinois Legislature voted to shore up the pensions by raising the retirement age for some workers and lowering cost-of-living adjustments. The state is facing a pension shortfall of $97 billion.

Illinois settled with the S.E.C., but the agency did not impose fines or penalties. The S.E.C. doesn’t typically exact penalties in such cases, its officials said, because the money would come out of a state or city budget, making matters worse.

A crucial metric that should be found in issuers’ offering statements and filings is one cited by the S.E.C. in the Illinois case: the shortfall in annual contributions that are needed to keep a pension fully funded. Known as annual required contributions, or ARC, many states fail to meet them.

This has the effect of masking an issuer’s financial troubles, Mr. Tobe said. “There almost needs to be a bold statement saying the state is not paying 100 percent of its ARC payments,” he said.

He cites a December 2011 offering statement for $72 million of bonds issued by the University of Illinois. Nowhere does it detail the shortfalls in state contributions to the university system’s pension fund in recent years. Investors seeking this information must go to the Illinois State Universities Retirement System website.

Some thoughts
It has been generally understood for a while that pension plans use unrealistic return assumptions to hide the fact that their governments aren’t contributing enough each year. But it’s interesting that even with a raging bull market in equities – which have of late returned a lot more than the typical pension target of 8% – many plans are becoming even more underfunded. Part of this is due to the fact that the bonds in pension fund portfolios have gone down in the past year, offsetting gains in equities. And part is due to governments failing to contribute as much as they’ve promised they would.

Stocks, based on most historical measures, are ripe for a correction, and bonds, even after a recent uptick in rates, yield next-to-nothing. So the average pension fund, instead of making its optimistic 8% return target, might actually lose money in the next couple of years. In that case, their underfunding would be too horrendous to hide.

With a growing number of cities (and some states) devoting unsustainable portions of their operating budgets to paying former rather than current workers, Detroit might become the template for dozens of other cities in 2014 and beyond. And millions of people who thought they’d nailed down a middle class retirement in a well-run country will find out they’re not in that country any more.

  • silverbug

    An endangered specie for sure. Glad I took my pension in a lump sum from Verizon. Who hands you over a half million all at once in this day and age?

    • TyroneB

      How right you are, silverbug.
      Go to the bank these days and ask for a large amount of YOUR money and get asked, “Why?”

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  • Robert Happek

    A few centuries ago, pensions were uncommon. In a few centuries from today, it will be back to normal. People will work until they die.

    • pipefit9

      “In a few centuries…”? What the heck are you talking about? Are you predicting the social security system will be solvent for more that few years? That is a mighty bold prediction.

      The USA federal govt. has over $100 trillion in unfunded liabilities(present worth). Since there is no one big enough to bail them out, bail-ins it shall be.

  • northwind

    no need to work ’till you die if you make your own retirement fund. I cashed out my IRA fifteen years ago and made my own investments and set aside my own nest egg.

    • PaperIsPoverty

      That’s true but not always possible. If you work at a university there’s a good chance you can’t get any of the money out — not as a loan, not for hardship reasons, just not at all — until you’re 59 1/2. You can’t even roll it over into a regular account where you can buy stocks or ETFs… you’re locked into choosing between “approved” mutual funds. Some poor saps who have TIAA-CREF through university retirement plans may only have 4 or 5 fund choices which vary mostly in the percentage in bonds vs. stocks. University faculty don’t know enough about finance to know how badly they’re being screwed on this.

    • Dan

      If you are investing in the market then you are gambling that another crash isn’t going to happen as the debt incurred by too big to fail is increasing those odds everyday. If you are in real estate your are investing in another bubble created by the same. Any way you turn if you aren’t in the 1% you will feel the pain again because the banks are still committing fraud and the government is still looking the other way. That nest egg, if in the bank, is collection 0% interests………so your feelings if superiority is really sitting on moiunds of insecurity that you think you know, but you really don’t.

      • PaperIsPoverty

        So there are these things called gold and silver coins….

        • Dan

          But, and there is always a but in the crowd, you can’t pay your taxes with gold and there is no way to pay your bills in gold. They have us by the you you know whats and are squeezing everything they can until the Fed stops pumping dollars into the well without a bottom. End too big to fail and problem solved, movetoamend.org

          • makeupdiva

            you can sell gold to buy and pay whatever you need and then your money is not all in the dollar – just as you need it. Gold will always have value – the dollar will not – it is a ponzi scheme and as soon as China and Russia decide they no longer want to play – we are done – sooner than you think

  • Ozzy Osgood


    • Ozzy Osgood

      Two things were at work here: A culture of mediocrity and a culture of largesse. Turns out the first culture cannot support the second.

  • hellbentgerbils

    what ever happened to that financial analyst lady who a few years ago was warning of the coming muni-bondpocolypse ? seems she was right….kudos to her, just wish i could remember her name…….lots of people said she was wrong……well…she wasnt.

  • Dan

    I remember years ago when the discussion of the 501K’s and pensions were going around there was a study done proving that pensions were better and that 501Ks were created for people who had high incomes to stash some extra savings in. When the banks realized they could use them as retirement funds and people like Mit Romney could actually rob pensions, pensions began to be liquidated and the 501K got promoted by corporate America and the banks as investments that they could rent seek off of. Pensions began to be used as collateral by corporate radars to borrow money to bankrupt the company to either offshore it,or shut it down. By the way the money borrowed to ship jobs to China was borrowed from them as their banks filled up with American dollars, leading to a huge trade deficit and loss of middle class income.

    • PaperIsPoverty

      I don’t disagree with much of this stuff you’re getting from (I’d guess) Daily Kos et al — mutual fund fees are definitely a rip-off since they don’t outperform general markets, and vulture capitalists definitely stole from workers to help offshore their own companies — but you might also have something to learn from finance-savvy folks. Many pensions are in horrific shape but have managed to avoid admitting it so far, and colloquially, pension funds are known as “where bad debts go to die.” Or maybe that’s just Calpers. Not because they’ve been looted (perhaps some have) but because they do stupid things like buy real estate in the southwest in 2005-6 using “innovative” financing.

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  • Goldman

    There is a bridge near my home with a full-time watchman. This bridge is not a draw bridge or really require any minute by minute observation. But, the watchman drives an Infiniti i37 and I’ll bet he is in line for a very nice pension from the Bridge Authority that he works for. In many ways we are Greece, except we have a lot more wealthy and a lot of many more political patronage jobs.

    • Dan

      Greece, isn’t us and we aren’t them. If all our wages were tied to the economy our wages would have inflated along with the increase in prices. But capitalism is failing the American people, not the people failing it, as you would have us believe. When capital can leave the state of origin the people are left with Detroits. I believe Ricardo had it right, but he was in a quandary, or didn’t believe that the state of origin would become corporate owned and the laws would be bent to offshore and outsource the basis of it’s means of production, the wealth of the nation. Either you are for the mother country or you are a corporatist, only interested in your personal wealth at the expense of the workers who provided you the capital in the first place as their wages stagnated for the last 30 years.

      • pipefit9

        There is nothing wrong with free trade and the outsourcing of labor, as long as there is a mechanism to balance the account automatically, once a certain trigger is passed. Even the watered down gold standard know as Breton Woods had such a mechanism. It was the foreign gold window, which Nixon closed in August of 1971.

        That closure opened the door for open ended trade deficits and the wholesale hollowing out of our economy. Many of those jobs that cannot be exported still have pension benefits, but there is no way to pay those benefits from the present tax base. Ditto Social Security benefits.

        Sometimes you just have to throw the monopoly money back in the box and start a new game. Unfortunately, the new game starts with everyone having the shirt on their back and not much else, so no one is shoving for possession of the megaphone to announce that bit of unpleasant news.

  • Just Justin

    What really concerns me about this Detroit bankruptcy and the “haircut” that the pensioners will be subjected to is that it seems that more cities and town will do this just because they can! They will say “Detroit did it. We can do it too!” And they will rip off the workers’ retirement monies. I wonder how many hundreds of billions of dollars will be ripped off this way, and pocketed by private interests. Goodbye American Dream….Hello Third World.

  • Motorbike Mike

    What really astounds me is the mass ignorance of the people that I work with. I work in a hospital, which is highly dependent on government funding. Many of my coworkers are of the mentality that as long as they are recieving a paycheck, things are A-OK. I see disaster coming. Yesterday, I saw a list of patients – many of them quite elderly, no insurance (except goverment welfare insurance), and with severe health problems. Sadly, many of the patients were immigrants who our government has let come to our country and overwhelm the system. One of my grandfather’s famous expressions is “There is no such thing as a free lunch.” I strongly believe that healthcare is headed for a crisis that will be an absolute nightmare. It will be just like Detroit – “Sorry folks, there is no money!” Sadly, America’s economy is in shambles. It is a mirage, an illusion.

  • Anthony J. Alfidi

    Government employee unions discovered that their numbers and dues translated into political power. They used this power to negotiate for generous benefits that any actuary could have told them were financially unsustainable. No one listened.

  • Bruce C

    Were growth expectations some 4 decades ago overly ambitious or were they “realistic” within the culture?

    That is my question. I remember discussions with my father, who was a stock broker and died in 1972, about the ability of corporations to ultimately afford the pensions that they offered. He didn’t think they could but, like politicians, the boards kept extending them because there was no immediate cost in doing so and there would have been if they didn’t. Corporations have already begun hitting their walls and now municipalities and states are too. It’s just a matter of time for the Federal government.

    But that doesn’t answer my question: Were the expectations of growth unrealistic? In my most enlightened and magnanimous moments I think not. It’s possible that the previous generation was not deluded, that they had healthy and realistic expectations based upon greater beliefs and aspirations, and that they could have continued “unlimited” growth.

    The various aspects of this terrible quagmire that we’re all debating each week seemed to start with the assassination of President Kennedy followed by Lyndon Johnson’s “Great Society” and the Vietnam War and then Nixon’s decoupling of the US dollar from gold.

    I could be wrong, but “we” really seemed to have “it” for a while. I really feel humbled by it all.

    • Nexusfast123

      Mate…it has all come about because of free trade agreements and a cost reductionist mentality that reduces all business decisions to off-shoring, out-sourcing, etc.

      The end result has been the massive deindustrialisation of the US with eight to nine million jobs and sixty thousand manufacturing facilities being lost – mainly to China.

      The US will never recover unless Washington changes – they will not. The working class and middle class in the US have been sold out so that a few executives, bankers and shareholders can make a few cents in the Dollar more profit.

  • Chris Howell

    This is actually quite funny if you step back and look at the bigger picture. Many of these people are big government Democrats (note: I did not call them liberals b/c they are not liberal) and as such will continue to vote for candidates that espouse how great government is, Republicans included; ex. the republicans’ nominees for POTUS in the last 2 elections:Romney (Romney Care) and McCain (Surveillance state). They will get exactly the kind of government they deserve; unrestricted and unafraid of them b/c they too want a “free lunch”. Enjoy your Corporate economy (note: not Capitalist economy or Free Market economy) and Fascist government. Oh yeah, one more thing peasants; there is no such thing as Corporate Capitalism; it is called Fascism, a Fascist economy, or Corporate economy. Read a book. Redeo ad fontes.
    With a hearty laugh and a big middle finger,

  • Nexusfast123

    They will be coming for your savings as well with the ‘bail in’ provisions that are being put in place – no job, no pensions and no savings.

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