By Paolo von Schirach
July 24, 2013
WASHINGTON – Meredith Whitney saw it coming. Back in 2010 she warned about the shaky finances of US municipalities. Her dire forecasts of financial ruin did not come true, but now we have Detroit’s mega bankruptcy that (sort of) vindicates her predictions. Still, going forward there is more than just bankruptcies, as she writes in an insightful op-ed piece in the FT, (Detroit may start a wave of municipal bankruptcies, July 24, 2013).
At issue: generous pensions
Indeed, Meredith points out that the Detroit meltdown is a watershed, because this is the first time in which the interests of taxpayers/citizens are placed on an equal footing as those of retirees and bondholders. In other words, going forward, any attempt to rebalance municipal finances will have to include a renegotiation of pensions benefits foolishly offered in what appeared to be better times to municipal workers.
Indeed Detroit got into this mess largely because of the impossibility to finance its outstanding pension obligations, themselves the legacy of lousy politics. Very briefly, in Detroit and elsewhere municipal administrators bought and still buy the political support of public employees through generous retirement packages. This is relatively easy to do because when the retirement benefits are due the elected officials who agreed to them are long gone.
Cut services, raise taxes in order to pay pensions
Still, as these over generous packages are widespread practice, now more and more US municipalities face huge obligations, without the money to pay for them. As Meredith explains, until now the political pressure has been to do whatever is necessary to pay pensions and bondholders, meanwhile cutting public services ands rasing taxes as a way to stay afloat. However, this is a raw deal for taxpayers and all citizens: lousy services and higher taxes, while retirees still do OK because they keep getting their benefits.
While Detroit is clearly an extreme case, its unhappy citizens went through the same dreadful path: horrible and declining services, (they do not even replace bulbs for street lights anymore), and progressively higher taxes. It is obvious that nobody wants to live in a city that offers less and less, while it taxes residents more. Those who can leave, this way causing the tax base to shrink even more. A truly perverse outcome of a bad policy.
Pensions no longer taboo
So, what has changed after Detroit? What has changed, Meredith argues, is that from now on retirement packages and bondholders interest will no longer be untouchable. And this is not just about extreme cases like Detroit, but about the myriad of municipalities across America that are slowly headed that way.
Indeed, more and more cities cut services and raise taxes in order to pay pensions and bondholders. And it is clear that at the root of this slow moving crisis we usually find over generous and in fact unaffordable retirement packages negotiated by myopic (or cynical) elected officials essentially to buy political support.
While each situation will be different, the Detroit bankruptcy has broken the “pensions protection taboo”. Yes, retirees who felt reassured that, no matter what, their pensions would always be untouchable now will realize that they may have to lose something as a result of any effort aimed at straightening battered municipal finances. Of course, amending or voiding legally binding deals will be extremely complicated; and any such attempt will invite fierce litigation.
Retirees and bondholders will have to share the pain
Still, Detroit’s bankruptcy sets an important precedent. The interests and welfare of municipal tax payers should count at least as much as those of retirees and bondholders. Besides, it is obvious that lower taxes and improved services will make cities more attractive.
As strange as this may sound to myopic local leaders, people and businesses will be inclined to relocate where there is higher quality of life with affordable costs.