The Canary in the Coal Mine.

The New Capitalism in Government: Bankrupting Cities.

Capitalism is a system that has a legal foundation in the sanctity of the written contract. When you negotiate a pension with an employee, you make certain promises in exchange for certain considerations, and then you both signify your agreement to the terms by signing a legal contract. When you do so, you expect that your employer will honor the terms of that contract for the next 20 years or so, otherwise you may as well be working for the KGB, or some other government agency in a country that makes up its own rules to match the circumstances as they see fit at the time. This sort of thing would never happen in America, the birth place of modern capitalism, would it?

On March 3, Providence Mayor Angel Taveras stood before hundreds of retired city workers—former teachers, firefighters, police officers and many others—who had gathered for a town hall meeting in a ballroom overlooking the Pawtuxet River. Having warned that the city could face bankruptcy, he said, “I’m here because I want to make sure that we save your pensions.” You know, those pensions, uh-mm, the ones you have contracts for?

As his chief of staff explained soon thereafter, retirees could see their pensions cut by 73 percent if the city files for Chapter 9 bankruptcy. To avoid that outcome, Mayor Taveras has asked tax-exempt institutions—hospitals and universities—for an additional $7.1 million in voluntary payments to the city and proposed that retirees pay more for healthcare and accept an estimated twenty-year freeze in cost of living adjustments (COLAs) on their pensions. If nothing changes, said the mayor’s chief of staff, the city “will literally have no money to make payroll, make debt payments [or] pay our vendors” come July.

That may sound dire, but the city’s finances were in worse condition this time last year, when Mayor Taveras announced a $110 million structural deficit. Since then, he has reduced the deficit to $22.1 million by, among other things, increasing taxes, closing schools, trimming police and fire department budgets and negotiating new labor contracts with teachers, firefighters, police and others.

If the city implements the proposals delivered before retirees at the town hall meeting—suspending COLAs, moving retirees over 65 onto Medicare and putting retirees under 65 onto a healthcare plan that requires a 20 percent co-share—the city will save $28 million, in addition to the $7.1 million being asked of tax-exempts. However, a state judge recently blocked the city’s attempt to move retirees over age 65 onto Medicare, and Taveras says he expects the other changes he proposed to undergo a similar analysis if they are challenged in court.

While the mayor admits that asking retirees for concessions is “not fair,” he also recently accused them of “hiding behind decades‐old contracts” and avoiding shared sacrifice. The latter, says Paul Doughty, president of the Providence firefighter’s union, sends a dangerous message: “If we don’t have the protection of contracts [that] mean something, really our word as people amongst each other doesn’t exist. It’s the foundation of this government—particularly of a capitalist economy—that our word has to mean something.” Exactly!

Providence is a harbinger for things to come in most US municipalities. Vallejo, California has already closed down and cities like Oakland, California won’t be far behind. Like most US cities, Providence was hit hard by the housing crisis and recession, which slowed the economy and reduced tax revenue. But factors unique to Providence have contributed to the city’s budget shortfall, as well. While property taxes, for example, are a primary source of revenue, about half of the city’s land cannot be taxed because it is owned by tax-exempt institutions, like Brown University, Providence College and Rhode Island Hospital. Additionally, Providence has $828 million in long-term, unfunded pension liabilities due in part to agreements made in the 1980s and ’90s, which included guaranteed 5 and 6 percent COLAs and a reduction in the minimum amount of service required for retirement.


Vallejo, CA after bankruptcy.

While the average COLA is now lower than 5 or 6 percent, says the mayor’s press secretary, David Ortiz, “it is these 5 and 6 percent compound COLAs that are really driving the pension crisis.”

As an example of the impact of compound COLAs, let’s assume you are retiring today and your retirement income is just $40,000 a year. You are contractually guaranteed a 6% COLA every year for the next 20 years. With zero increase in base pay, and considering ONLY the COLA adjustments, your pay at the end of 20 years would be $128,285.42! See?

Who thought that the inflow of revenue from property taxes alone could fund pensions like that in perpetuity without any other increase in taxes? Did it not occur to any of these administrators that maybe the housing market might slow down, or even God-forbid go flat, or EVEN as amazing a thought as that might be, actually go DOWN? George Carlin said once, “Look around you and think of how stupid the average person is, and then realize that at least half of them are even stupider than that.” He must have been in a city council chambers somewhere.

During the Providence town hall meeting, retirees were told that twenty-five of the city’s top-paid retirees take home six-figure pensions. What was left unsaid—even after retirees in the audience shouted “What’s the lowest?!”—was that the median pension is just $27,800 per year, partly because retirees can take out a lump sum upon retiring. If COLAs are suspended now, they won’t be reinstated until the pension fund is 70 percent funded; now, it’s just 32 percent funded. Which might be like, forever?

Of course, Providence is hardly alone in its struggle to cover retiree healthcare and pension costs. Researchers from the Kellogg School of Management at Northwestern University estimate that municipalities nationwide have $574 Billion in pension fund liabilities, (California alone will have over $500Billion in unfunded pension liabilities this year) and that six major cities—Philadelphia, Boston, Chicago, Cincinnati, Jacksonville and St. Paul—would be able to pay for retirees’ benefits only through 2020. In some states, the consequences are clear already. Cities in New York State, for example, are fulfilling pension obligations by borrowing from the very pension fund to which they owe money. In 2009 the city of Prichard, Alabama, stopped paying retiree pensions altogether. That’s one way to solve the problem. Oh, gosh. Sorry about those pesky contracts, but we just don’t have any money left. 

Stockton, CA … The biggest city to ever go bankrupt in US History.

In Stockton, California, where the mounting cost of retiree healthcare and pension benefits is only one of many financial problems, the city council recently approved a plan to cease payments to creditors and begin talks with municipal bondholders and employee unions in an attempt to avoid Chapter 13 bankruptcy.

Providence, by contrast, is not seeking to negotiate with bondholders. And, if the city does file for bankruptcy, it won’t be able to, because a controversial state law requires that cities in bankruptcy repay their bondholders first and in full. Other creditors, such as retirees, lack the same protection even though federal bankruptcy code treats retirees and general-obligation bondholders as equals. Surprise, surprise!

Signed just weeks before nearby Central Falls filed for bankruptcy in August, this law grants bondholders a “first lien” on bankrupt cities’ resources, meaning that if Providence does file, its bondholders—Bank of America, TD Bank, Citizens Bank and others—could emerge unscathed while retirees face severe pension losses. Banks emerging unscathed? Shocked face goes here.

Some observers expect the bondholder priority law to spur a nationwide trend, as credit-rating downgrades are among the biggest risks associated with Chapter 9 bankruptcy. As Professor David Skeel of the University of Pennsylvania Law School told Reuters, “One of the big issues with a municipality filing bankruptcy is the effect on bonds so if that’s off the table, you can bet more states will think about passing these kinds of laws.” Woo hoo.

But Providence is in no way immune to credit downgrades. Last week, Fitch Ratings axed the city’s bond rating from A to BBB, reducing it to near “junk” status. One day later, Governor Chafee released a legislative package of reform and relief measures meant to “empower local officials to take the needed steps to achieve fiscal health,” according to a press release. The legislation would allow Rhode Island cities to suspend COLAs until pension systems are better funded, reduce disability pension benefits, place limits on binding arbitration for collective bargaining for firefighters and police, require cost estimates on collective-bargaining agreements, and more.

At the town hall meeting earlier this month, city officials told retirees they had just three weeks to form a steering committee that will meet and negotiate with the city. If by May 1 an agreement has been reached, Taveras says he will impose agreed upon changes to save the city money. One of the reasons the town hall meeting was so important, he says, “is because if we can do something with an agreement, it’s less likely that it [will be] challenged, even if not every single person agrees. If we do it without an agreement, if we do it unilaterally, then we just need to be prepared for the court challenges that will certainly follow.” Ah heck, who needs agreements anyway?

But negotiations are also important because they could lead the mayor to close the budget gap by borrowing money. Ortiz says, “If we know that we have partners in our effort to finally put Providence onto a sustainable path, then borrowing for the short term”—and thereby avoiding bankruptcy—“makes sense.” But for many, many years, the city has borrowed and resorted to one-time fixes. We’ve pretty much reached the end of the road.” That’s government speak for “you can squeeze all you want, but the toothpaste is all gone.”


About Steve King

iPeopleFINANCE™ Chief Operating Officer. Former CEO of Endymion Systems, Inc. a $36m Information Systems Services company. Co-founder of the Cambridge Systems Group, the creator of ACF2, the leading IBM Mainframe Data Center Security product; acquired by Computer Associates. IBM, seeCommerce, marchFIRST, Connectandsell alumni. UC Berkeley alumni. View all posts by Steve King

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