Municipal market ghosts of past, present and yet to come

James Dearborn, Head of Municipal Bonds | December 9, 2013

  • December 3, 2013 — a seminal day in muni pension discussion.
  • Ghost of Christmas Past – good times were had by all.
  • Ghost of Christmas Present – sobering reality as negotiations continue to go nowhere.
  • Ghost of Christmas Yet to Come – rising above the Detroit debacle.

In the annals of public finance history, December 3, 2013, will likely be remembered as a seminal day in which the nature and direction of debate about large unfunded pension liabilities changed dramatically. It was an odd coincidence that Illinois legislators finally decide to confront a large and growing unfunded pension liability on the same day that a U.S. bankruptcy court judge in Detroit ruled that the state constitution provides no protection for pension benefits of the city’s current and future retirees. These two seemingly independent events will have long lasting implications and repercussions for state and local finances. As we enter this Christmas season, the events of December 3 bring to mind the Charles Dickens classic tale “A Christmas Carol”, with the ghosts of Christmas past, present and future playing out right before us.

Ghost of Christmas Past: These were the good old days when state and local governments offered generous pension benefits in return for wage and benefit concessions in labor contracts. The cost of these future benefits was not immediately felt and labor peace was maintained. It was also the day of the pension funding holiday where, when budget stress hit, state and local governments readily reduced pension contributions as a quick, easy and, supposedly, painless way to achieve balance in lean years. Finally, this was the era of the pension obligation bond, a wonderful instrument that was supposedly a win, win, win for everyone. But, in the end, when invested bond proceeds were squandered in equity market crashes, issuing governments were left with still large unfunded pension liabilities plus the debt service on the newly issued POBs – indeed a lose, lose, lose proposition if there ever was one.

Ghost of Christmas Present: In so many places, this is where public sector unions and state and local politicians continue to stake out untenable positions regarding the fixes for dealing with looming unaffordable annual contributions to severely underfunded systems. These annual contributions appear poised to swamp budgets, likely resulting in large cuts in public safety, education or other vital public services. Yet, politicians and unions seem to exude a “bah humbug” spirit, as they resist needed compromise and concessions that will alleviate the coming crises.

Ghost of Christmas Yet to Come: Unfortunately, this vision of Christmas has already arrived in the form of downtrodden and bankrupt Detroit, with acres of abandon buildings, near non-existent public services and economic despair on every corner. Indeed, Christmas in Detroit looks bleak, and for employees and retirees the future looks bleaker as Judge Rhodes ruled that state guarantees of pension benefits could be trumped by U.S. bankruptcy court law. Surely, there is little joy in Motown this Christmas season.

However, like Scrooge awaking from his fitful slumber on Christmas morning, Illinois has offered the prospect of turning over a new leaf. On Tuesday, legislators and the Governor agreed to a package of significant reforms that will reduce unfunded pension liabilities by about 20%. The package also lays out a binding plan to return the state to near full funding over the next 30 years. Although “The Christmas Carol” allusion is not perfect, as state unions have promised legal challenges to the agreement, we can hope in this holiday season that union leaders will look to Detroit as a sobering vision of their future and realize that compromise and constructive engagement are crucial to avoiding the fate of the Motor City. In fact, we remain optimistic that Detroit offers a vision of the future that will change the tone and urgency of debates across the country, in places like California, Chicago, Pennsylvania and New Jersey.