Watch door to bankruptcy slam shut to protect pensions

In the wake of Judge Klein’s ruling last week that Stockton could cut pension debt in bankruptcy, fiscal reformers and conservative commentators were quick to assume, somewhat naively, that this ruling changed everything and would force recalcitrant unions to the negotiating table. The truth, however, is that many states put up numerous roadblocks to municipal bankruptcy and the real import of the ruling was that states where public unions dominate were likely to throw up even more blocks. Now we’ve seen the first indication of this in the remarks yesterday of California Treasurer Bill Lockyer that the state legislature might close down the path to bankruptcy.

The basics of chapter 9 hold that states get to control the process by which their municipalities can file for bankruptcy. Indeed, one of the concerns of the original amendment to bankruptcy law creating chapter 9 was that it interfered with the sovereign powers of states. The law was subsequently overturned and recast by Congress to give states the right to approve of their municipalities going into bankruptcy. As this map makes clear, about half of all states impose some kind of restrictions or necessity of state approval on municipalities before they can file for bankruptcy.

In some cases these restrictions have served to virtually eliminate chapter 9 filings. In NY, for instance, the state opts for local control boards to manage the finances of a municipality. Pennsylvania uses a distressed cities law that’s supposed to help cities recover outside of bankruptcy.

In some cases these laws are pretty ineffective at accomplishing anything except keeping control within state instead of ceding it to federal law. As Nicole Gelinas makes clear in this piece, NY’s control boards have largely been ineffective at helping places get their fiscal house in order. Nassau County, the 13th richest county in the nation, has been insolvent twice within the last 20 years and the control boards have accomplished little in the way of meaningful reform. The county exited from its first control board with worker costs that were still sky-high, and with benefits in place like health-care for life, that were simply unaffordable. The county still spends more than $200,000 annually to employ the average cop.

Similarly, Pennsylvania’s Act 47 for distressed cities was described in this PSI post as a roach motel for cities, which spend decades under the program with little progress.

It wouldn’t be unprecedented for California’s union-friendly legislature to move to restrict bankruptcy. After the Vallejo Chapter 9 case, the legislature, at the behest of unions, slowed down the filing process by forcing cities to go through 90-day arbitration before receiving approval to file. Stockton was able to file anyway because it was such a fiscal mess, and its unions were so predictably recalcitrant about making concessions, that the cooling off period accomplished nothing significant. But now that Klein has struck at the heart of California’s extraordinarily strong protections for pensions, expect further restrictions.

One thing about Lockyer’s speech, however, that’s ironic is his notion that California might act because of “activist” federal judges undermining pension protections. This gets things exactly backwards. There’s nothing activist at all about a bankruptcy judge declaring that contracts can get voided and unsecured debt reduced in bankruptcy.

The real activist judges are the California jurists who over the years have stretched the limits of contract law to provide extraordinary protections to pensions so that it is impossible for places like Vallejo and Stockton to cut their monumental pension costs when they get in trouble–and before they become insolvent.

Legal scholar Amy Monahan unpacks the so-called California rule, which makes it impossible to save money on pensions, and the court decisions over the years that led to this precedent, and she finds them based on leaps of logic and contrary to contract law as the federal courts see it, and well beyond what federal courts have ruled about private pensions. Legal scholar Richard Epstein observes that the California rulings have produced a “financial death spiral” for municipalities caught in the pension trap, for the same reason.

So the real activist judges are those in California who have made it impossible for cities there to reduce their pension costs, even for work that workers have not yet done, and in the process created the financial mess we see in Golden State municipalities, where people get fired and services reduced while taxes go up to protect the pensions of those who remain employed.



Comments (3) Add yours ↓
  1. John Moore

    In the states where Chap 9 is prohibited,, the state, in most cases, buys the insolvency problems of the cities and counties. Most have a program similar to the Ca. program for insolvent school districts where a czar is installed by the state with powers that supercede the school board and administrators. Plus, new money.

    October 10, 2014 Reply
    • Tough Love

      I would be astonished if in (Union-controlled) CA, any such czar would actually do what is NECESSARY and JUST(to Taxpayers) and addresses the ROOT CAUSE of the problem (grossly excessive pension & benefit promises), by materially reducing (by AT LEAST 50%) the future service pension accrual rate of all CURRENT Public Sector workers …. and, END any retiree healthcare subsidies.

      October 10, 2014 Reply
  2. althink81

    Someone with access and the power of the press should ask Gov. Brown and Neel Kashkari whether they would veto any new law trying to further restrict CA’s cities and towns filing for bankruptcy.

    October 10, 2014 Reply

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