Tag Archives: Brookings Institution

The “pension tapeworm” and Fiscal Federalism

In his annual report to shareholders, Warren Buffett cites the role that pension underfunding is playing in governments and markets:

“Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made. During the next decade, you will read a lot of news –- bad news -– about public pension plans.”

He zones in on pension mathematics – “a mystery to most Americans” – as a possible reason for accelerating liabilities facing state and local governments including Puerto Rico, Detroit, New Jersey and Illinois. I might go further and state that pension mathematics remains a mystery to those with responsibility for, or interest in, these systems. It’s the number one reason why reforms have been halting and inadequate to meet the magnitude of the problem. But as has been mentioned on this blog before: the accounting will eventually catch up with the economics.

What that means is unrelenting pressure building in municipal budgets including major cities. MSN Money suggests the possibility of bankruptcy for Los Angeles, Chicago and New York City based on their growing health care and pension liabilities.

In the context of this recent news and open talk of big municipal bankruptcy, I found an interesting analysis by Paul E. Peterson and Daniel J. Nadler in “The Global Debt Crisis Haunting U.S. and European Federalism.”(Brookings Institution Press, 2014).

In their article, “Competitive Federalism Under Pressure,” they find a positive correlation between investors’ perception of default risk on state bonds and the unionization rate of the public sector workforce. While cautioning that there is much more at work influencing investors’ views, I think their findings are worth mentioning since one of the biggest obstacles to pension reform has been the reluctance of interested parties to confront the (actual) numbers.

More precisely, it leads to a situation like the one now being sorted out in federal bankruptcy court in Detroit. Pensioners have been told by Emergency Manager Kevyn Orr that if they are willing to enter into a “timely settlement” with the city and state, they may see their pensions reduced by less than the 10 to 30 percent now suggested. Meanwhile bondholders are looking at a haircut of up to 80 percent.

If this outcome holds for Detroit, then Peterson and Nadler’s findings help to illuminate the importance of collective bargaining rules on the structure of American federalism by changing the “rules of the game” in state and local finances. The big question for other cities and creditors: How will Detroit’s treatment of pensions versus bonds affect investors’ perception of credit risk in the municipal debt market?

But there are even bigger implications. It is the scenario of multiple (and major) municipal bankruptcies that might lead to federalism-altering policy interventions, Peterson and Nadler conclude their analysis with this observation:

[public sector] Collective bargaining has, “magnified the risk of state sovereign defaults, complicated the resolution of deficit problems that provoke such crises, heightened the likelihood of a federal intervention if such crises materializes, and set the conditions for a transformation of the country’s federal system.”

Saving Flint

According to a recent article in the British Telegraph, Flint, Michigan once had 79,000 workers for General Motors and now has 8,000. The population of the city has fallen from 200,000 to 100,000. The unemployment rate is 20%. Young people are leaving in droves in search of jobs and better prospects elsewhere. Large parts of the city are emptying out, leaving at least 4,000 abandoned homes. Although the city has demolished 1,000 of them, 3,000 remain standing. Whole neighborhoods are crumbling rapidly.

So what to do? The normal political response is to take public actions to “save” places like Flint.  The urban renewal programs 50 years ago were designed to arrest the decay of older American cities such as St. Louis and Detroit – typically built in the nineteenth century and with decaying housing stock and outmoded land use patterns based originally on streetcar systems of transportation. Many federal billions were spent in futile efforts to reverse the market verdict, reflecting a refusal to accept that these old city neighborhoods were outmoded and their highest value economic use was as cheap housing for poor people. A “slum” was a pejorative term in those days for old housing – in many cases not all that bad structurally – that people with lower incomes could afford. But for American politicians, every part of every city should be thriving. If not, the government had to do something.

Reflecting the failures of past programs to “revitalize” the inner cities, the Brookings Institution now identifies 50 cities, most of them in the industrial “rust belt,” that need to shrink significantly to survive. After decades of failed efforts to halt downward economic forces, there has been a new acceptance that some American cities simply must get smaller. Facing its dire problems, city planners in Flint have finally come to accept this. The current economic crisis and the large number of foreclosures emphasize the need to rethink urban strategies that automatically assumed upward growth for every city.

One Brookings study proposes that the government adopt a program of “land banks” – government would acquire the land in old declining neighborhoods and then turn it over for redevelopment. It sounds unfortunately like of the thinking that was on exhibit in New Haven, Connecticut, leading to the Kelo Supreme Court case.

A much better approach would be to leave redevelopment to be determined in the market by the collective actions of property owners in a neighborhood area and land developers. Property owners could be facilitated in organizing a collective land bargaining association that would then solicit developer bids for the whole neighborhood. If a high enough bid was forthcoming, and if a large supermajority of property owners – say, 80 percent – voted to accept the offer, the neighborhood would be turned over to the private developer. A whole new neighborhood land uses compatible with present day market economics would result. It is possible that in places like Flint, a few neighborhoods might even be turned back to urban farming of high value local products. Whatever the result, market forces rather than urban planners would decide.