Puerto Rico’s Impending “Bankruptcy”

Puerto Rico has been struggling financially for years.  Yesterday the U.S. territory  decided to invoke a new federal statute that will allow the island to go through a process something like bankruptcy, in hopes that it will be able to shed its crushing debt load and get a “fresh start.”  Puerto Rico owes $74 billion to bondholders and has another $49 billion in unfunded pension obligations and has been unsuccessful in convincing Congress to bail it out or cajoling creditors into making concessions.  Making timely principal and interest payments on its debt requires $3.5 billion in payments a year, but Puerto Rico has only $800 million to spare.  The inexorable results of that math made the quasi-bankruptcy inevitable, triggering what will be the largest government “bankruptcy” process in U.S. history.

no-bailout-puerto-ricoThe process will be something like a bankruptcy because Puerto Rico — like every U.S. state and territory — technically cannot go through the traditional federal bankruptcy process.  Instead, Puerto Rico has invoked the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”), enacted during the Obama Administration, which contains some elements of the bankruptcy laws but also includes special provisions providing that, in some ways, Puerto Rico must be treated as a sovereign.  Under the PROMESA law, the process of dealing with Puerto Rico’s debt will be supervised by a federal bankruptcy judge.  Chief Justice John Roberts will appoint the judge, who will then start deciding what to do with Puerto Rico’s appalling financial problems.

Puerto Rico invoked PROMESA because a stay that had prevented creditors from suing ended and a series of creditors immediately filed suit, hoping to be first in line to be paid.  The PROMESA law stops those lawsuits and, Puerto Rico hopes, will give it substantial leverage to negotiate with creditors and try to convince them to take pennies on the dollar for the debt — with the threat that, if creditors don’t agree, the federal judge could impose an even more draconian result.  Creditors are furious.  Republicans in Congress aren’t willing to go with a bailout option, arguing that Puerto Rico has already received big federal subsidies and should explain why it got into this predicament.

It’s an entirely reasonable request that, frankly, could also be made to many U.S. cities and states that face similar debt issues.  Puerto Rico’s economy has struggled for years, and Puerto Rico officials decided, year after year, to borrow to pay their operating expenses rather than doing the responsible thing:  cutting costs, pruning government employee pensions, trimming payrolls, and forsaking pet projects in favor of fiscal prudence.  Now creditors and employees who have pension obligations will have to take pennies on the dollar, and according to a federal board Puerto Rico is “unable to provide its citizens effective services” — all because Puerto Rico’s politicians were unable to make the tough decisions and kept borrowing to put off doing so until some point in the future.  Now that time has come.

Investors who may have bought Puerto Rico bonds at a discount, after the difficulties became obvious, might not be sympathetic characters, but many of its bonds likely are held by individuals who viewed bonds issued by a U.S. territory to be a pretty safe investment that would help fund their retirement years.  And employees who have earned pensions will receive less than they were promised, meaning they’ll have to tighten their belts even though Puerto Rico’s successive governments didn’t do so.  And a default of sorts on Puerto Rico’s governmental debt isn’t going to be helpful for other governmental entities that want to borrow through issuance of bonds, either.

Interesting, isn’t it, that the federal statute that allows Puerto Rico to go through the quasi-bankruptcy process — PROMESA — sounds a lot like “promise”?  Thanks to its governmental mismanagement, for Puerto Rico the PROMESA process it will be more like promises broken.  I only hope that the successive administrations who put their heads in the sand and borrowed, borrowed, and borrowed are in some way held accountable for their gross irresponsibility.

Avoiding The Squirrel Distraction

Sometimes it’s hard to really figure out what is happening in the country.  During the glitz and glimmer of a presidential campaign, the American public, and most of the news media, is like a dog in a yard, sniffing this and that and always ready to be distracted when a squirrel goes capering by.  That’s why we focus, briefly, on stories that appear for a day and then vanish into the mists of time.

imageUnderneath that surface glitz and glimmer and the ginned-up controversies it produces, however, is the serious stuff.  It’s the stuff that harder to follow, and more boring to read.  It’s the stuff that the talking head pundits on the “news” shows don’t want to address, because they probably don’t understand it themselves and because it can’t be reduced to a funny one-liner or a clever tweet.  From time to time, though, a real journalist will tackle the serious stuff and produce an article that serious people really should read if they want to get even a glimpse of the challenges that our country is facing.

Mary Williams Walsh of the New York Times wrote one such article recently, about the American public pension system — and how its liabilities are legally, but chronically, underreported.  Told in the context of one tiny pension plan, for California’s Citrus Pest Control District No. 2, the article relates how public pension funds keep two sets of books — one that is officially reported, and one that reflects the “market value” of the pensions and that is kept hidden from the public eye.  The officially reported numbers paint a much rosier picture than the latter.

And that’s where the real problem lurks.  For California’s Citrus Pest Control District No. 2, which covers only six people, the official books showed a large surplus.  The market value books, however, showed that the pension plan in fact had a deficit — and when the plan decided to convert itself to a 401(k) plan, Calpers, the giant California public employee retirement system, required the pension to make a totally unexpected, and large, payment to satisfy the market value of its liabilities.

The different bookkeeping is all about how the pension funds discount their future payments to present value.  It’s the concept of the time value of money — that a dollar today, which can be invested and earn a rate of return, is worth more than a dollar 10 years from now.  Future payments, like those made by pension plans, always get discounted to their present value.  The key issue, though, is what interest rate you use to do the discounting.  Using smaller, more conservative rates will show a higher present value of future payments, whereas using a higher, more aggressive rate will produce a much lower present value — and perhaps even show a surplus.

In the case of the Citrus Pest Control District, the officially reported present value was calculated using the assumed annual rate of return on investments — which is 7.5 percent.  Using that discount rate showed the little pension had a large surplus.  Of course, anybody who does any investing knows that a constant, 7.5 annual percent rate of return achieved over the course of decades of pension payments would be a fantastic rate of return.  Anybody who lives through the down markets of 2008 and 2009 also knows that it’s just not a realistic, long-term assumption.

The upshot is that we’ve got a serious problem in this country with public pension funds that are terribly underfunded.  One of these days, someone is going to have to pay the piper, as Citrus Pest Control District No. 2 did.  But at the presidential debate next week, will anyone ask Hillary Clinton or Donald Trump about this important issue, which could bankrupt many of our local government entities — or will we get questions about pneumonia, hydration or whether it was wise to use the word “bomb” before knowing that a bomb was in fact used in the New York City dumpster bombings?

Look, a squirrel!

Will Detroit Once More Lead The Way?

At one time in American history Detroit was a leader in commerce, capitalism, and civic development.  As the home of the American auto industry, Detroit experienced the boom.  More recently, Detroit has experienced the bust.  Now the question is whether Detroit will become a leader in a different way — by showing how local governments can use the federal bankruptcy laws to try to free themselves from the product of decades of financial mismanagement and shortsightedness.

IMG_5164Yesterday, federal bankruptcy judge Steven Rhodes ruled that Detroit’s pension obligations are not immune from scrutiny in a federal bankruptcy proceeding, notwithstanding a Michigan constitutional provision that specifically protects public employee pensions.  In effect, the judge said, contractual obligations that require cities to pay public pensions are like any other contracts and thus may be modified and restructured by a bankruptcy judge after all sides present evidence and argument.  It is the first clear ruling on this issue — one that is of enormous interest to other local and state governments that are dealing with the fiscal consequences of overly generous public employee benefit and pension arrangements that were reached when times were flush but that now threaten to crush the governments’ ability to provide basic services to citizens.

The bankruptcy judge’s ruling will be appealed, and the judge also has promised to be careful and thoughtful before changing any monthly pension payments.  Neither of those circumstances may provide much comfort to former Detroit employees who have retired in reliance on their monthly pension payment from the city and who now must wonder how they personally will be affected.  At the same time, Detroit’s financial challenges are so staggering that city administrators have few options.  The bankruptcy process will work for Detroit only if the city emerges from the bankruptcy with a balanced budget and financial obligations that it can realistically carry given its current, shrunken state — and employee and retiree benefit programs have to be considered as part of that process.

When we visited Detroit earlier this year we stopped to look at a famous downtown statue called the Spirit of Detroit, of a seated man holding the sun in one hand and a family in the other, with a quote from the Bible about liberty behind him.  Viewed in the context of Detroit’s current, crippling financial problems, the figure looks like he is trying to decide which way to turn.  A bankruptcy judge will now help him make that decision.

The Detroit Dilemma

Detroit is a mess — financially, socially, and otherwise.  It has filed for bankruptcy in what is the biggest municipal bankruptcy in history.

Detroit owes billions of dollars.  Its listing of creditors in its bankruptcy case is more 3,500 pages long.  Among other debts, it has huge, unfunded pension obligations to active and retired public workers.  In its bankruptcy Detroit will attempt to obtain significant cuts in those obligations.  Today, in an effort to forestall such cuts, Detroit’s two public employee pension funds are expected to file objections to the bankruptcy, arguing that the bankruptcy proceedings and the attempts to cut pension obligations violate the Michigan Constitution.  The city’s condition is so dire that it has hired Christie’s, the auction house, to value the city-owned items in the Detroit Institute of Art and advise the city on how it could “realize value” from those items.

Much of the focus has been on how Detroit got to its current state.  There is value in that process, because understanding the bad decisions and mismanagement — as well as the failure to recognize the impact of broad economic trends such as the departure of manufacturing jobs — may help other cities to avoid Detroit’s fate.  But it is equally important to think carefully about what happens now, and how America should handle the Detroits of the future.

At present, there doesn’t seem to be any appetite in Congress or in the Obama Administration for using federal money to bail out Detroit.  That’s a relief.  The prevailing view about Detroit may mean that we have moved beyond the notion of bailing out mismanaged entities, be they private or public.  (Speaking of prevailing views, advocates of governmental thrift will grind their teeth when they read the article linked in this paragraph, in which a spokesman for Detroit laments the city’s prior failure to take advantage of federal funds, which he describes as “free money.”  It wasn’t “free” to taxpayers, but local and state governments have long looked at the federal government as an endless source of money.)

It’s important that we set the right precedent with Detroit — because there will be other municipal bankruptcies, and with the massive unfunded public pension and health care obligations in states like California and Illinois, there could well be state bankruptcies, too.  I think the President and Congress are right to resist calls to bail out Detroit, and should similarly resist the the temptation to assume the obligations of badly managed states.  In the meantime, we can hope that the failure to bail out Detroit will cause mayors and governors of other troubled governmental bodies to get serious about getting their fiscal houses in order.

The Public Employee Pension Problem, From Sea To Shining Sea

It seems like every day brings a new story about how states across the country are struggling with public employee pension and health care benefit costs.  In Ohio the issue is at the forefront due to the upcoming vote on Issue 2, and I’ve written about the huge challenges confronting Rhode Island and Illinois.

Now California — which may have the biggest problem of all — is trying to work through the issues.  On Thursday Governor Jerry Brown declared California’s current system unsustainable and unveiled an approach that tries to deal with the inevitable effects of demographics.  Brown, a Democrat, proposes raising the retirement age for most government workers from 55 to 67, increasing employee contributions to 50 percent of pension costs, and moving the state’s system from a complete defined benefits program to one that includes a 401(k) component, where employee benefits depend on their contributions and the performance of investments they have selected.  He also proposes reforms to ensure that pensions are based on regular salaries, not on bonuses or overtime.  Public employee unions have been critical, arguing that they have recently given concessions and that any changes to benefits should be the product of collective bargaining.

From sea to shining sea, the handwriting is on the wall:  states and local governments eventually must grapple with meaningful reforms to budget-busting public employee pension and benefit costs.  The Ohio General Assembly attempted to do that with the legislation that is the subject of Issue 2.  If Ohio voters reject Issue 2 come Election Day, the issue is not going to go away.  Why not tackle it now?

The Rhode Island Lesson

Supreme Court Justice Louis Brandeis once described the states as “laboratories of democacy” — that is, in our federalist system, individual states were free to experiment with different policies and diverse approaches to common problems.  The idea was that, from the results of those experiments and the testing in state “laboratories,” sound policies could be distinguished from unsound.

Brandeis’ concept is playing out in Rhode Island, and in this case, the experiment has produced results that should give every other state pause.  As this New York Times article explains, Rhode Island and its cities are in desperate financial straits because the pension obligations owed to public employees have become crippling and are consuming ever-larger shares of governmental budgets.  A combination of rank politicking, ridiculously over-optimistic investment return projections, shrinking tax revenues, and longer-lived retirees have forced Rhode Island and its municipalities to choose between meeting its pension obligations and providing essential government services.  One city, Central Falls, has already declared bankruptcy, and the state itself has had to take special measures to try to protect its bond rating.

I mention this unfortunate story because it seems pertinent to Ohio’s impending vote on Issue 2, which relates to how compensation, health care benefits, and pension benefits should be decided for public employees.  As we consider Issue 2, it is important to keep in mind that government does not exist simply to provide benefits for public employees.  I don’t want to see Ohio become another Rhode Island, where pension and health care benefit costs are bringing down local governments or are imposing such all-consuming obligations that roads and bridges may go unrepaired.

I’ve Made Up My Mind On Issue 2

Early voting has has been underway for more than a week now on Issue 2, the issue dealing with public employee issues.  Today I got an email from Ohio’s Democratic Senator, Sherrod Brown, urging me to vote early against the issue.  I’ve going to wait until the election to vote, but the email got me to thinking about Issue 2.

After some reflection, I’ve decided I’m going to vote in favor of Issue 2.  I recognize that there are arguments the other way, but I’ve made up my mind.  Here’s why:  I don’t think the collective bargaining model works with public employees.  In the classic case, workers collectively bargain with bosses who own the business.  The bosses have skin in the game and an incentive to vigorously bargain with the employee’s union.  Our political leaders don’t have the same kind of skin in the game, however.  To the contrary, they may have been elected with the active support and contributions of public employee unions.  I also think that it is not unreasonable to ask public employees to contribute more toward their health insurance and pensions.  Many in the private sector pay 100% of the cost of both of those benefits, without any employer contribution.  Add to that the fact that there is a lot more job security in the public employee world, and I think that public employees have a pretty good deal.

I don’t believe that Issue 2 would solve our governmental budget problems by itself, and I defer to no one in my admiration for police officers and firefighters, but I also think we simply cannot afford to continue to expand the size, scope, and cost of our state and local governments.  Every police officer and every firefighter may be essential — but not every teacher is, and not every clerical worker at the BMV is, either.

If Issue 2 gives our leaders more flexibility to deal with bloated public employee payrolls and to avoid the kind of crippling, long-term pension obligations that are such a problem in states like California — or, for that matter, in countries like Greece — I think that is a good idea.  I’m going to vote for Issue 2 because I think it is the prudent thing to do.