When former Los Angeles Mayor Richard Riordan gazed into his crystal ball in 2010, he told the Wall Street Journal, “Los Angeles is facing a terminal fiscal crisis: Between now and 2014 the city will likely declare bankruptcy.”
The tremendous growth in payouts for retirement benefits over the years certainly lends merit to his prophecy. According to Stanford Institute for Economic Policy Research, pension costs in L.A. increased from 8.5% of total city expenditures in 1999 to 15.4% for fiscal 2012.
Stanford’s study also estimated that each of the city’s three independent pension funds is unfunded by billions of dollars: the city of Los Angeles Fire and Police Pension System is $9.25 billion unfunded; the Los Angeles City Employees’ Retirement System is $11.32 billion unfunded; and the city of Los Angeles Water and Power Employees’ Retirement System is $6.59 billion unfunded.
Many cities have begun to make reforms like trimming benefits, upping the retirement age, increasing employees’ contributions, shifting retirees into Medicare, or reexamining the meaning of “defined benefit” pension plans.
It’s likely, though, that reform can’t come fast enough for some cities and bankruptcy may be imminent.
One good bit of news in all of this is that municipal bonds are very resilient even when a city files for bankruptcy. For instance, in the well- known and large municipal bond default of Orange County, California, the recovery rate was 100 cents on the dollar. Bondholders that held on to maturity did not lose any money because Orange County did not miss a single interest payment or principal payment.
Just be sure to pay attention to a municipal bond’s rating. If it falls to junk, you might want to bail out.