Detroit’s looming bankruptcy is making news again, this time focusing on current restructuring plans aimed to wipe out $18 billion in debt by axing pension checks of city retirees, including police and fire.
Massive long-term retirement and healthcare promises were by no means solely responsible for the city’s fall, but these massive pensions coupled with a tax base weakened by high unemployment and housing vacancies caused the budget to bleed out quicker.
The Michigan city may be the most recent victim of bankruptcy, but many of the 61 largest U.S. cities have adopted the same retirement legacy leading to $118 billion in unfunded healthcare debts. Retired city workers stop contributing to the system; the system keeps paying them; and before you know, a fiscal crisis has begun.
If you think the three cities below are too big to fail, think again.
The solid performance in the stock market in 2013 may have allowed some of their investments within pensions to grow and cover costs.
However, when the growth rate of investments slow, and the payout rate speeds up, expect to see any one of these cities next in line at bankruptcy court:
New York City
When adjusted for population, New York owes $20 billion more for retiree health care than Detroit, or a total of $88.2 billion.
On top of those obligations, the Big Apple owed pensioners $69.9 billion more than it set aside as of last year’s annual report. Again, adjusted for population, that’s $28 billion more than Detroit owes.
One of the reasons New York City can’t balance its annual budget is because it has to spend one-third of its revenues on health, retirement benefits, and debt. New York’s budget has run an operating deficit six of the past seven years (with the shortfalls covered by pre-2008 surpluses).
The Windy City may be closer to bankruptcy than New York. Fitch Ratings recently downgraded the city three notches because of pension liabilities for its 30,000 retired workers and a struggling economy.
Makes perfect sense when you consider that Chicago’s four pension systems—for police, firefighters, laborers and municipal workers—were short by $19.5 billion at the end of 2012. That does not include the ailing pension fund for Chicago teachers, which had its own $8 billion shortfall at the end of the last fiscal year.
The option to raise property taxes to cover the annual required pension contribution is simply out of the question considering homeowners would be looking at a 35% tax increase.
Next year, Chicago must come up with a state-mandated $590 million increase in its contribution to police and fire pension funds, so it’s going to get worse before it gets better.
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.