A Detroit judge's ruling may open a path for cash-strapped California communities to fill potholes, illuminate streets and restore other public services.
Judge Steven W. Rhodes, who is presiding over the Motor City's bankruptcy, rejected claims that public employee pensions are untouchable. If the ruling is upheld on appeal, it will be a game-changer.
Public employees and pension funds, including the California Public Employee Pension System, contend that retirement benefits, including prospective benefits, are constitutionally guaranteed and cannot be reduced, even in a bankruptcy proceeding.
To cover soaring retirement costs, which in some places are approaching 50 cents on every payroll dollar, cities and counties in California and across the country have laid off workers and slashed spending on parks, street maintenance and other public services. A handful have filed under Chapter 9 of the federal bankruptcy code; others are weighing the possibility.
While collective bargaining has produced lower benefits for new employees, these cuts offer little in near-term savings. In past cases, local governments, including Vallejo, have elected to leave retirement benefits for existing employees untouched in bankruptcy proceedings.
Detroit took a different approach, seeking full flexibility in its "plan of adjustment," the formal plan to restore some public services — and solvency — by writing off a portion of the city's crushing $18 billion debt.
Retirement benefits also are the subject of court proceedings in San Bernardino, where CalPERS is seeking to block the city's bankruptcy filing because it could result in pension cuts.
California and Michigan have similar contract clauses in their state constitutions, and they are the source of claims that pensions can't be cut. Rhodes ruled to the contrary. He said the constitutional protections are outweighed by federal law, which allows debts to be reduced or abandoned with court approval.
"Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy," Rhodes said.
With that ruling, leverage shifts from public employees to public employers.
To be clear, we aren't suggesting that Santa Rosa or any other community head for bankruptcy court. That's not only an admission of failure, but it surrenders control to the court with unknown ramifications, potentially including pension reductions for current retirees. It must be used only as a last resort.
Nor are we suggesting that retirement costs are the sole source of financial troubles for state and local government. But a retirement promise depends on solvency, which in turn depends on sustainable finances. It's time to start fixing financial models before more communities follow the path of Detroit, Stockton and San Bernardino.
Until now, it has been assumed that retirement benefits can only be increased, never cut, from the time someone is hired by a public agency.
On Day 1, by this interpretation, an employee is entitled to earn retirement benefits at the same rate, or higher, in their 20th, 30th, even 40th year of employment. Pensions effectively were off the table during collective bargaining.
In contrast, retirement benefits for most private sector workers can be frozen at any time and eliminated or earned at a lower rate going forward. It's often among the first steps in bankruptcy.
Rhode Island and Illinois have pursed legislative fixes. In California, San Jose Mayor Chuck Reed is exploring an initiative that would give public agencies flexibility to negotiate prospective reductions in retirement benefits.