NEW YORK – With dozens of U.S. cities struggling to cope with diminishing municipal tax revenues and rising city expenses, Detroit’s bankruptcy ruling sent shock waves through city employees and unions nationwide.
In a dramatic ruling Tuesday, U.S. bankruptcy Judge Stephen Rhodes said Detroit, the largest U.S. city ever to declare bankruptcy, is eligible to proceed with the city’s Chapter 9 filing. The decision clears the way for Detroit’s emergency manager, Kevyn Orr, to negotiate with approximately 100,000 creditors to bring the city out from under $18.5 billion in debt.
Moreover, Rhodes ruled that in reducing Detroit’s obligations to creditors, Orr is not required to give city pensioners a special, protected status under labor contracts with the city. That makes it virtually certain Detroit’s pensioners will receive sharp cuts in the retirement benefits they were promised under their labor contracts.
The Detroit Free Press reported Tuesday that Detroit’s 23,500 retirees were shocked and dismayed Judge Rhodes ruled the U.S. Constitution trumps Michigan’s constitution. The judge rejected an argument advanced by attorneys representing city pensioners that a clause in the Michigan constitution prevented pension benefits from being cut in a Chapter 9 filing.
“Pension benefits are a contractual obligation of a municipality and are not entitled to any heightened protection in bankruptcy,” Rhodes said.
The ruling put on notice cities with unfunded pension liabilities and pension benefits for municipal employees. Unlike corporate pensioners protected from loss by the federal Pension Benefit Guarantee Corporation, no protection from cuts will be afforded by clauses in a state’s constitution that may have been drafted to protect state and municipal employees against federal law in bankruptcy situations.
“I think it’s hugely important,” Robert Novy-Marx, an associate professor of finance at the University of Rochester’s Simon Business School, told the Detroit Free Press.
“In terms of the legal landscape, it clarifies the fact even pension benefits can be impaired. That very much changes the conversation that workers and municipalities are going to have going forward. Up until now, the workers have said we’re going to get paid no matter what. We’re not going to negotiate.”
Michigan Attorney General Bill Schuette joined labor unions representing Detroit municipal employees in vowing to appeal the ruling, the newspaper reported.
Detroit’s city pension funds are short by $3.5 billion, Fox News reported.
Typically, municipal bankruptcy filings are relatively rare, according to Governing.gov, a website devoted to tracking state and local government management. California leads the list with four municipal bankruptcy filings in recent years. The city of Vallejo filed for bankruptcy protection in 2008, followed by Stockton and Mammoth Lakes filing for Chapter 9 last summer. San Bernardino followed suit in August.
Governing.gov suggests many cities are deterred from filing Chapter 9 because of adverse consequences that are difficult to overcome. They include the downgrading of credit ratings, a process that can be both lengthy and costly, and the long-term negative implications impeding an area’s future economic growth.
Only 13 cities, according to Governing.gov, have pursued Chapter 9 filings over the past five years, adding up to only one of every 1,668 eligible localities, or 0.06 percent of all U.S. cities.
Some cities, such as Camden, N.J. – a city of 77,000 adjacent to Philadelphia that is one of the poorest in America after losing several major manufacturing firms – has survived financially without having to file for bankruptcy only because the state of New Jersey has provided hundreds of millions of dollars in loans, grants and direct aid over the past few years.
A study by the Pew Charitable Trusts reported in July found that fewer than half the states have laws allowing them to intervene in municipal finances. Practices vary among the 19 states that have intervention programs, with most intervening in municipal finances only in reaction to a financial crisis.
Occasional success stories can be found.
In August, Michigan Gov. Rick Snyder announced that the financial emergency in the city of Pontiac was over after successful efforts by the city’s emergency manager, Lou Schimmel, to reduce city debt from $115 million in 2011 to $28 million in May 2013. Pontiac reduced the number of city employees from more than 500 six years ago to 20 currently (excluding courthouse workers), reduced annual general fund expenses from $57 million six years ago to $28 million in fiscal year 2012-2013 and sold the city’s golf course to private operators.
In September, Moody’s listed Chicago at the top of a list of U.S. municipalities facing financial insolvency because of unfunded pension liabilities.
Moody’s downgraded Chicago to A3 in July because the city faced pension liabilities that were 678 percent of the city’s operating revenues as of fiscal 2011.
Among the top 10 municipal entities rated by Moody’s as struggling with financial insolvency because of high unfunded pension obligations, along with Chicago, were Jacksonville, Fla.; Houston, Texas; and Dallas, Texas.
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