Detroit Bankruptcy Could Affect City Workers Nationwide

If pensions are cut for Detroit's workers, the same could happen to workers in other cities.

Detroit city workers and supporters protest outside the federal courthouse in Detroit while awaiting the bankruptcy decision, Tuesday, Dec. 3, 2013.
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A judge has ruled that the largest municipal bankruptcy in U.S. history can proceed, but the fight is nowhere near over, and not just for Detroit. Detroit workers have vowed to press on, but the ultimate ruling could have a significant impact on the security of pensions for city workers around the country.

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Federal Judge Stephen Rhodes on Tuesday determined that the city is insolvent and eligible for bankruptcy, meaning outstanding pension liabilities could be among the debts the city will be able to discharge. Creditors had claimed the city could not cut accrued pension benefits, as the Michigan constitution expressly says state and city workers' pensions and retirement benefits "shall not be diminished or impaired." However, the judge saw it differently.

"Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy," Rhodes said, as reported by the New York Times.

That means municipal workers in other financially troubled cities – even cities in the seven states with constitutional pension protections – could see their pensions cut in the case of a bankruptcy.

"Anyone who has a city pension where the city has significant financial trouble has to worry about whether or not the city will resort to a bankruptcy filing as a way to adjust or modify an existing pension obligation," says Manny Grillo, chair of the financial restructuring practice at New York-based law firm Goodwin Procter. "I would characterize it as the first really significant opportunity for a major change in outstanding pension obligations."

Detroit's bankruptcy has been long in coming. At the start of 2012, Michigan Gov. Rick Snyder appointed a review team to inspect city finances. That team later found the city to be in "severe financial distress." In early 2013, Snyder appointed Kevyn Orr as Detroit's emergency manager. In June, Orr presented a proposal to creditors, estimating that pension liabilities totalled $3.5 billion, or around one-fifth of the city's debt, which totals more than $18.5 billion. One month later, the city filed for bankruptcy.

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Rhodes found the city did not negotiate in good faith with creditors, meaning in this case it did not give them ample time to object to the proposal.

"They basically didn't really negotiate, only giving 30 days. They basically said, 'Here's what we're going to do, take it or leave it,'" explains Robert Novy-Marx, assistant professor of finance at the Simon Business School at the University of Rochester. However, the court also found that good-faith negotiations with over 100,000 creditors would have been "impracticable."

There is still a chance the ruling could go in unions' favor; Sharon Levine, the attorney representing the American Federation of State, County, and Municipal Employees, told the AP the ruling was "a huge loss for the city of Detroit" and said the union plans to appeal the ruling. (The Michigan AFSCME council has not yet responded to request for comment.)

But if after that and any subsequent appeals the bankruptcy is allowed to proceed, it could mean shifts ahead for how unions and cities approach negotiations.

"I do think it's incredibly important," says Novy-Marx. "I think it's the beginning of the end of the current system, really, because I think it completely changes the incentives of the worker."

He says that rather than ask for more generous pensions in the future, public workers may instead simply ask that cities better fund existing pension systems.

"I envision public sector workers starting to ask for full funding and under a more reasonable accounting regime," says Novy-Marx.

Chicago is one city with large unfunded pension liabilities – in fact, according to Moody's Investor Service, it has the largest liabilities in the nation, at 678 percent of revenue. Jorge Ramirez, president of the Chicago Federation of Labor, an organization of Chicago unions, says the Detroit ruling's implications do not worry him about Chicago workers' future because Chicago is not facing bankruptcy. However, he adds that he believes cities have an obligation to fulfill what they promised to their workers.