One major issue in the Detroit bankruptcy is whether retired city workers will take a hit to their pensions. Pension and health benefits for city employees cost the government roughly one-third of its total revenues, and so some argue that retirees — along with bondholders — are likely to get a haircut. Others, including a Michigan judge, counter that public employee pension benefits are protected by the Michigan state constitution and thus are off limits.
Here’s what the Michigan state constitution says with regard to pensions:
Sec. 24. The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.
As a non-lawyer, here’s how I read this passage: it pretty clearly prohibits an arbitrary reduction in public pension benefits. Congress, for instance, could pass a law tomorrow reducing Americans’ Social Security benefits and individuals would have no legal recourse because those benefits are non-contractual. The Michigan state constitution appears to outlaw such changes.
But does it outlaw pension cuts taking place during bankruptcy? The key issue is that, contractual obligation or not, bankruptcy is defined as a period in which a debtor may break its contractual obligations due to an inability to meet them. The Michigan state constitution, at least on my crude reading, doesn’t afford public employees any additional protections to those granted to others, such as municipal bond holders who have contractual obligations with the city. So at least some benefit cuts might be on the table.
But does this mean that retired city workers should take the same haircut as municipal bond holders? I really don’t think so. Anyone loaning money to the city of Detroit was knowingly taking the risk that the city might not repay; that’s why bonds issued by Detroit paid a higher yield than Treasury securities, which are assumed to be riskless. As with any risk investment, sometimes it pays off, sometimes it doesn’t.
City employees, on the other hand, exchanged services today — along with employee contributions to their pension plan — for benefits to be delivered in the future. Sure, employees should consider the financial stability of their employer in its ability to deliver what is promised, but city employees seem to be a qualitatively different group than municipal bond holders. And, as much as I believe that public employee pensions may be overgenerous and that the costs of such plans are a burden to city and state governments, a promise once made should be kept, at least insofar as is possible. Does this mean no cuts for retired Detroit city workers? Probably not. But should they be paid the same pennies on the dollar that is being offered to municipal bond holders? I really don’t think so.