Tag Archives: Emergency Manager Kevyn Orr

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.”

Detroit’s Art is Not the Key to its Revival

This post originally appeared at Market Urbanism, a blog about free-market urban development.

Detroit’s art assets have made news as Emergency Manager Kevyn Orr is evaluating the city’s assets for a potential bankruptcy filing. Belle Isle, where Rod Lockwood recently proposed a free city-state may be on the chopping block, but according to a Detroit Free Press poll, residents are most concerned about the city auctioning pieces from the Detroit Institute of the Arts’ collection.

I’ve written previously about the downsides of publicly funding art from the perspective of free speech, but the Detroit case presents a new reason why cities are not the best keepers of artistic treasures. Pittsburgh’s Post-Gazette contrasts the Detroit Institute of Art’s situation with the benefits of a museum funded with an endowment:

As usual, Andrew Carnegie knew what he was doing.

The steel baron turned philanthropist put the City of Pittsburgh in charge of operating the library he gave it in 1895, but when he added an art museum to the Oakland facility just one year later, he kept it out of city hands.

“The city is not to maintain [the art gallery and museum],” Carnegie said in his dedication address. “These are to be regarded as wise extravagances, for which public revenues should not be given, not as necessaries. These are such gifts as a citizen may fitly bestow upon a community and endow, so that it will cost the city nothing.”

Museums and other cultural amenities  are a sign of a city’s success, not drivers of success itself. The correlation between culturally interesting cities and cities with strong economic opportunities is often mistakenly interpreted to demonstrate that if cities do more to build their cultural appeal from the top down, they will encourage job growth in the process. Rather, a productive and well-educated population both demand and supply these amenities. While an art museum may increase tourism on the margin, it is unlikely to draw additional firms or individuals away from other locations. Detroit is sitting on an estimated $2.5 billion in art, enough to put a dent in its $15 billion long-term obligations.

On a recent episode of Econtalk, Ed Glaeser explains that over investing in public amenities relative to demand is a sign of continued challenges for municipalities:

It is so natural and so attractive to plunk down a new skyscraper and declare Cleveland has ‘come back.’ Or to build a monorail and pretend you are going to be just as successful as Disney World, for some reason. You get short-term headlines even when this infrastructure is just totally ill-suited for the actual needs of the city. The hallmark of declining cities is to have over-funded infrastructure relative to the level of demand in that city.

Similarly, cities throwing resources at museums and other amenities designed to attract the “creative class” are highly likely to fail because bureaucrats are poorly-positioned to learn about and respond to their municipalities’ cultural demands. When cities do successfully provide cultural amenities, they are catering primarily to well-educated, high-income residents — not the groups that should be the targets of government programs.

I think it’s highly unlikely that Detroit will sell off any taxpayer-owned art to pay down its debts based on the media and political blow back the possibility has seen. However, seeing the city in a position where it owns enough art to cover a substantial portion of its unsustainable long-term debts demonstrates why municipalities should not be curators. Tying up municipal resources in art is irresponsible. The uncertainty that the city’s debt creates for future tax and service provision is clearly detrimental to economic growth. While assets like museums are nice for residents, they do not attract or keep residents or jobs.

Detroit does have an important asset; new ideas need cheap rent. Detroit’s affordable real estate is attracting start ups with five of the metro area’s young companies making Brand Innovator’s list of American brands to watch. While these budding businesses could be key players in the city’s economic recovery, top-down plans to preserve and increase cultural amenities for these firms’ employees will not.