Public Pensions On The Chopping Block, Ctd

A reader writes:

I have mixed feelings on the bankruptcy situation in Detroit. On the one hand, I don’t want retired public workers to be thrust into poverty because their pension vanished or was severely cut. On the other hand, it has always bothered me when some retiring public employees were able to game the system by working tons of overtime the last three years on the job to up the salary on which their pension was then based. I also feel for the current residents of Detroit who are currently paying the pensions for a pool of retired public works that is vastly disproportional to the current size of the city.

In the end, it will all depend on how humanely and rationally the cuts to the pensions are made. Go back and recalculate the pensions based on non-overtime and bonus pay. Figure out a minimum pension amount for everybody and then apply a percentage cut on pension amounts over the newly set minimum. I’d even say they should reduce the pension amounts less than other kinds of debt, but there will have to be some cuts, especially for those who are living well on the defaulting city’s dime.

A critic of the cuts points out:

Your post didn’t mention the big, glaring issue behind these pension cuts:

1.  Public school teachers weren’t covered by Social Security until the late ’60s.

2.  Firemen and policemen still aren’t covered by Social Security.

Which means that these former municipal employees aren’t getting a pension in addition to Social Security and living the high life – the pension, for many of them, is all they have.

Another elaborates on the Social Security factor:

Those who want to cut pensions should consider a few things. First, pension plans are usually presented in the recruitment phase as an incentive to work for an employer. Pension benefits are part of an employee’s compensation. Many who earn pensions are not paid especially well, despite the whopping, headline-catching pensions of former fire and police chiefs and other top city, county, and state officials. The average worker gets something like half their average salary at full vesting after 25 to 30 years, with the benefit pro-rated based on their years of service and typically a three-year average of their top salary. Pension benefits are taxable like any other income.

At the same time, the Social Security Administration imposes on pensioners the Windfall Elimination Provision, which reduces Social Security benefits by 60 percent if a person has a pension. This is probably fair if a pensioner has worked many years for the pension, but in many systems you can vest in the pension plan for partial benefits at, say 10 years. By doing so, you forfeit 60 percent of your Social Security benefits even if you worked much longer at a Social Security-eligible job.

Cutting benefits across the board punishes people who had no say in how municipal or county or state budgets were planned and executed. Many pensioners will be reduced to penury if broad cuts in pensions are permitted by the courts when local governments are so badly managed that they wind up declaring bankruptcy. Better to cap pension benefits at the higher end while leaving lower-end pensions minimally impacted. Penalizing pensioners for the incompetence or misbehavior of others is the height of unfairness.

An expert on the subject sounds off in detail:

As a law student currently staring down the barrel of a bankruptcy exam, I have to take issue with Heather Long’s characterization of the “best interest of creditors” test. Although Section 943(b)(7) says that the plan must be in the best interest of creditors, this test isn’t as rigorous as it sounds. In other sections of the Bankruptcy Code (the sections applying to private parties) the “best interest of creditors” is determined by reference to what the creditors would get in a Chapter 7 liquidation proceeding – that is, if all the debtor’s assets were sold, how much would the creditors get? Usually this isn’t much – if it’s anything at all – since secured creditors are allowed to take the full value of their secured claim, and very often so much of the debtor’s property is used as collateral for secured debt (by security agreements placing a lien on all the debtor’s unencumbered property, or on the debtor’s inventory or equipment) that there’s virtually nothing left to sell. Even then, there are priority claims – listed in Section 507(a) – that must be paid in full to the extent possible before any general unsecured creditors get paid. Except for benefit-plan contributions to be paid out for services rendered in the 180 days before filing [under Section 507(a)(5)], pensions are not priority unsecured debts and can only be paid after priority debtors are fully satisfied.

What this means is that the “best interests of creditors” in most private bankruptcy plans is “the creditors receive more than nothing.”

Now, I could be wrong – the part of Chapter 9 incorporating provisions of Chapter 11 by reference specifically excludes Section 1129(a)(7), which specifically states that the plan must be better than Chapter 7 for each particular creditor, and replaces it with the much vaguer 943(b)(7), so there is room for the court to improvise there. On the other hand, the idea that “the best interests of creditors” test requires a comparison with a hypothetical liquidation is firmly entrenched in the precedent of the Bankruptcy Courts.

Bottom line: “Best interest of creditors” may prove to be of much less value to Detroit’s pensioners than it sounds.