Detroit Bankruptcy a Wake-up Call for Pensioners

This article from the New York Post is a must read for anyone who has a municipal pension.  State pensions may not be far behind.  All it would take is an amendment to the federal bankruptcy law to allow states to declare bankruptcy.

Get Ready for the Largest Municipal Bankruptcy in U.S. History

In his book The Sun Also Rises, Ernest Hemingway penned a classic exchange regarding bankruptcy.  "How did you go bankrupt?," asked one character.  "Two ways.  Gradually, then suddenly." was the reply.

Well, the same can certainly be said of Detroit, Michigan.  Detroit is getting ever closer to declaring bankruptcy (see here).  If Detroit does declare bankruptcy, it would be the largest municipal bankruptcy in the history of the United States.

What does this have to do with Minooka CCSD 201?  Well, most of us know that the State of Illinois has financial trouble of its own, including the worst underfunded pensions in the nation and pension contributions that are increasingly eating into current services.  Well, if you follow the link above and read the article, you will notice that the Detroit emergency financial manager, Mr. Orr, is contemplating a plan where, among other things, retirees will receive less than 10% of their promised benefits under the current pension plan.  I am quite sure that this is going to cause a great deal of financial hardship for those retirees.  One lesson that we can learn from Detroit's example is that when a municipality (or perhaps a state, in the case of Illinois) gets into serious financial trouble (and by all accounts Illinois is already there), the "promises" that were made pursuant to a pension plan become negotiable.

Now a state is different in at least one important respect: under current law, states cannot file for bankruptcy protection.  They can, however, renegotiate "promises," and you can be sure that they will.  States after all go bankrupt (or become insolvent) just like any other entity . . . "[g]radually, then suddenly."

Ouch! . . . Illinois Makes Forbes' List of "Death Spiral" States

Click here for a recent article which lists Illinois among eleven "death spiral" states.  I must warn you, however, that the article is pretty harsh.

It's Official, Illinois on Road to Ruin

A new report has recently been published by the State Budget Crisis Task Force (apparently you need a task force to tell you what someone who is good in math could tell you).  The State Budget Crisis Task Force is co-chaired by Richard Ravitch (former Lieutenant Governor of New York) and Paul Volcker (former Chairman of the Federal Reserve Board of Governors).  Their new report on Illinois' budget crisis does not paint a pretty picture.  Some highlights from the report summary include the following statements:

"Illinois' budget is not fiscally sustainable." (p. 7)

"Illinois has the worst unfunded pension liability of any state . . . . Illinois will not be able to fund other priorities unless it adopts serious pension reform." (p. 7)

"Illinois' debt is also crowding out the budget." (p. 7)

"It would be better for Illinois to start on a long-run path to a sustainable budget than to live beyond its means for several more years and then face a sudden, painful reckoning." (p. 8)  This could also be said for our school district (in fact, I have been saying this about our school district since I was elected to the board in 2009).  But, it is in the nature of most people to seek to delay the painful reckoning until it can no longer be delayed.  By then it is so large that drastic measures are required.

A couple of other points that are mentioned later in the report:

"Financing deficits, particularly using debt as if it were an element of revenue, is bad financial and budgetary practice." (p.32)

". . .funding pensions, Medicaid, and debt service has diminished Illinois' ability to fund education." (p.37)  In other words, we have starved our future to feed our present.  Can you say "generational theft?"

To read the full report, click here.  To read a discussion of the math involved involved in the problem, click here.

Anothery Canary in the Coal Mine: San Bernardino, CA

Is this the ultimate outcome of the public pension crises?  One day, when the money runs out, when the bond buyers will no longer finance the deficits, and when taxpayers refuse to pay more in taxes, do the pension payments just stop?  While the article is talking about a city (which can file for bankruptcy protection under current law) and not a state (which cannot file for bankruptcy protection under current law), perhaps Illinois politicians should redouble their efforts to reform the state pension systems, for the sake of the pension participants, bond holders (which are, interestingly enough, often pension funds themselves), and taxpayers.  Every day of delay merely makes the problem that much larger (actually, this could also be said of our own school district's deficit spending).

Illinois Debt Downgraded . . . Again

So, after another failure of Illinois politicians to address the ever-growing pension problem, Standard & Poor's (one of the largest credit rating agencies) has downgraded Illinois debt from "A+" to "A."  (see here)  Now an "A" might seem like a good grade, but when it comes to ratings of state debt, it is atrocious.  Only California has a lower debt rating than Illinois (these two states seem to be competing for last place).  Standard & Poor's has also attached a "negative outlook" to the rating, which means another downgrade may come soon.  What does this mean for Illinois?  It means that Illinois is going to have to pay more to borrow money.  For better or worse, bond investors pay a great deal of attention to debt ratings.  When ratings go down, they demand a higher interest rate on the debt of the rated entity.  Which in turn means that Illinois' fiscal problems will grow worse.  Since Illinois is living on borrowed money to fund its spending and pensions, the "hole" just got bigger.  This is a small glimpse of what a "debt-spiral" looks like.  If Illinois politicians continue to ignore the problem, the ratings will continue to drop, the cost of funding will continue to rise, the problem becomes bigger, rinse and repeat.  Once a "debt-spiral" gets started, delay only increases the difficulty and pain of pulling out of the "debt-spiral."  Time works against an easy solution.  As time goes on, the reforms to the pension system will have to be increasingly more drastic in order to fill the "hole."  If one wants an example of a more advanced stage of a "debt-spiral," one merely needs to look to Greece.

Update:  Since I mentioned California, here is the latest news on pension reform out of California.   

A "Date with Destiny" or Another Opportunity to Kick the Can Down the Road?

So, Governor Quinn has called a special session of the Illinois General Assembly and set a vote on pension reform for August 17th.  Governor Quinn has called this a "date with destiny" (see here).  Depending on whose figures you believe, Illinois has anywhere from an $83 billion to $203 billion unfunded pension liability (see here).  It is getting to the point where Illinois will soon be spending more on pensions than on education (see here).  Increasingly, pension payments are "crowding out" spending on other state services (see here).  This fiscal calamity that is staring the Governor and the General Assembly in the face, however, may not be enough (at least, not yet) to prod politicians to actually do anything about pension reform, however.  The politicians already seem to be lining up their excuses for kicking the can down the road one more time (see here).  Unfortunately, every time that Illinois politicians kick the can further down the road, the problem continues to grow, and the pain necessary to alleviate the problem (including the pain for those who depend on state pensions) continues to grow.  Not only does the unfunded liability continue to grow, but the cost of financing state deficits will grow as bond rating agencies downgrade Illinois debt (see here).

You may not be able to depend on Illinois politicians to tackle the problem of pension reform any time soon, but you can depend on at least one thing in this mess: pension liabilities that are not sustainable (and every rational person on both sides of the aisle from the Governor's office to the General Assembly agrees that the pension liabilities are not sustainable) will not be paid in full.  Kicking the can down the road does not help anyone (except maybe the politicians, who seem to care only about their next election).  It does not help the taxpayers, who can only look forward to their taxes being raised yet again.  It certainly does not help the people that depend on the pension liabilities being paid, who may wake up one day to only to find out that the pension they relied upon is being cut drastically (one town in Alabama stopped paying pensions entirely, see here).  And it most certainly does not help the younger public sector workers (teachers, firefighters, policemen, etc.) whose positions are being cut because pension obligations are taking a larger and larger share of state and local budgets (see here). 

Is Rhode Island the "Canary in the Coal Mine"?

The problem of state and municipal pensions is something that has been building for decades. Years of over-promising and under-funding created the problem. But the burst of the housing bubble, the financial crisis of 2008 and the subsequent three years of little to no growth and high unemployment have brought the problem into sharp focus. When the economic tide was rising, many of the problems could be hidden and politicians and the public could engage in the ever popular game of denial called "kicking the can down the road." Now that the tide has gone out, it is becoming clear who was swimming without any pants. This crisis will lead many municipalities to declare bankruptcy in order to get out from under the crushing burden of their pensions. States will face a similar crisis, but since they currently can not declare bankruptcy, they will deal with the problem in other ways. Rhode Island seems to be further along in the process than some other states. However, many other states, including Illinois will face similar problems (to understand the scope of the problem, click here). Illinois has already enagaged in one round of pension reform. It is likely many other rounds will follow.

What does this have to do with schools you may ask? Plenty. You see, many states, such as Illinois, will be forced with the choice of cutting back on its pension promises or cutting back on funding for current services such as education. The reason is simple. The state legislature will realize (hopefully soon) that raising taxes is not the answer, since it will lead to capital and human flight from the state to "greener pastures." The most recent Illinois state income tax increase has already contributed to this process. Such capital and human flight reduces the tax base in Illinois thereby leading to lower tax revenues than anticipated (indeed it is possible that such rate increases could lead to lower tax revenues than previously collected under the lower rate). Further tax rate increases have a similar effect, leading into a self-reinforcing cycle of economic destruction. Many states and municipalities have already learned this lesson the hard way (see here and here). (Economics teaches that human beings respond more or less rationally to incentives and change their behavior in response. Even journalists understand it.)

How will this affect Minooka 201 taxpayers? Well, I expect that more of the burden of funding education will be shifted from the state to the local taxpayer. Currently, the state of Illinois provides 15% of our education fund revenue (approximately $4 million) and 67% of our transportation fund revenue (approximately $1.7 million). If the state decreases its contribution, then we will be faced with the following dilemma: the school board with either have to increase the tax levy on local taxpayers or cut expenditures to offset the decreased state funding (or some combination of the two). Bear in mind that if the school board seeks to raise the levy on the local taxpayers, a similar process to the one described at the state level is likely to occur at the local level. As the levy is raised, this will tend to induce capital and human flight out of the school district (businesses and people, after all, have a choice in terms of where to locate, and some will not be able to afford the increased taxes). In essence, the state will have kicked some of their problem "downstairs" to the school district. (They may, of course, kick some of their problem to the municipalities as well.) Another option, and the one that I recommend, will be to do what many private businesses have done in this economic crisis . . . find ways to deliver the same quality product or service at lower cost. This, of course, is easier to say than to implement.

These budget problems at the state and local (and federal) level are not going away any time soon. These issues are going to be with us for many years to come. The game of "kicking the can down the road" is no longer an option.