Municipal bankruptcy is about cutting retiree healthcare

The real crisis in journalism now is reporters being tasked by editors to identify “precedents” in Detroit, Stockton, and other bankrupt cities. Because each case appears unique when scrutinized closely. Only Detroit’s plan had the “border[ing]on miraculous” “grand bargain.” Stockton refused to pursue pension cuts. In Central Falls, the state intervened to protect general obligation bondholders. Stockton had no general obligation debt. Detroit’s most intractable Wall Street creditors were two bond insurance companies one of which was itself broke, and both of which ultimately settled. Stockton faced off against two bond funds that held out to the bitter end. Detroit and Stockton went into bankruptcy with a relatively clear sense of what they wanted to accomplish. What San Bernardino’s trying to do, two years into their Ch. 9, remains one of muniland’s greatest mysteries.

But if we leave aside event-driven bankruptcies that had absolutely nothing to do with retirement obligations (Orange County, CA, Jefferson County, AL), the one constant throughout all these cases is cuts to retiree healthcare (other post-employment benefits; “OPEB”). OPEB has taken shape as a claim both very large and very junior, even more than pensions, arguably, and thus will surely be the first thing targeted in all future municipal bankruptcies.

Vallejo cut OPEBStockton cut OPEBDetroit cut OPEBCentral Falls cut OPEB.

Technically, OPEB sits in a different “class” than pensions in cities’ formal bankruptcy plans. But since the creditors holding OPEB and pension claims are the same people—retirees and workers—recent experience suggests that the municipal debtor will tend to combine these classes, practically speaking, in its pursuit of plan confirmation.

A city goes bankrupt if becomes incapable of negotiating reasonable benefit packages. Bankruptcy enhances leverage with respect to unions, but it’s still, in large measure, a negotiation. The leverage derives from the theoretical possibility that a city, with a court’s assistance, could cram down a debt cut over some creditor class’ objections. But cities seem extremely determined to avoid going nuclear in the case of workers and retirees. They’ll consider a thorough cramdown for Wall Street’s claims, but not Main Street’s. This is partly politics, and partly just the sense that the city has to keep living with these people long after bankruptcy. A city whose credit has already hit rock bottom will see itself as having less to lose from stiffing bondholders than stiffing workers and retirees.

Which brings us back to OPEB. If you can’t cut do both, because bankruptcy is a negotiation, cutting OPEB makes more sense than cutting pensions for a few reasons. First, it’s possible to for a retiree replace healthcare coverage, through a spouse, another job, or the government. There are no equivalents for either Medicare or Obamacare for pensions. Second, while pensions are just as fiscally unsecured as OPEB, and legally unsecured in federal bankruptcy, according to both Judges Klein and Rhodes, OPEB protections are even weaker. Unions and retirees have threatened open-ended litigation over pensions, but not OPEB. Even if they were bluffing in pursuit of a settlement, they had some leverage there. Third, it’s dawning on cities that they should get out of the OPEB business entirely, and might as well do it in bankruptcy. Competitive employers have to offer cash retirement benefits of some form, but not retiree healthcare, because barely no employers offer it outside of the public sector. OPEB becomes even less difficult to justify because the liability is totally unfunded. Even most perfectly solvent cities face a steep climb before they can claim to be managing their long term OPEB commitments as responsibly as they are managing their prefunded pension commitments, which many believe is actually not all that responsible.

Some have succeeded in reducing OPEB obligations outside of bankruptcy; others have tried and failed. Of course, let’s not forget the possibility of adjusting benefits on a going forward basis, which should be more doable given the existence of Obamacare. “Get out while you still can” is good advice for OPEB for non-bankrupt normal states and cities, too.

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