Bonds Trump Pensions in Rhode Island
A new law puts investors first -- to save the system.
Facing the prospect of a statewide financial crisis arising from Central Falls' bankruptcy case, the Rhode Island Legislature took steps to assure municipal bond investors that their interests will not be impaired by pensioner's claims. The new law enables the city's receiver to subordinate the pensioners' claims to bondholders, with chilling implications for public pensioners and employees who typically regard their claims to be ironclad by law as well as in the court of public opinion.
This unprecedented statute is now under attack by unions and retiree groups that say it puts fat-cat investors ahead of the little people. A national police union leader claims that somebody "should go to jail for this" and vows to raise funds for retirees to file lawsuits, as the union lacks standing to represent them directly. However, this probably won't be the last time we see lawmakers forced to move pension rights over to the passenger seat, lest they put their own state's debt ratings into the category of Greece.
The case in Central Falls has its unique features, so it's unwise to generalize this tiny berg's problems and compare it to a nationwide trend. Its pension obligations reportedly dwarf the town's capacity to pay. That appears to be the city's central financial problem, unlike the more-common causes of municipal fiscal distress, such as stupid bond swaps, harebrained investments, the pull-out of a major employer or overbuilt incinerators. As pension advocates will tell you, it's rare that the benefits plan alone causes a public employer to go under.
That said, however, it won't surprise me to see this issue resurface in the course of pension-reform battles in other jurisdictions. In several states, the rights of public pensioners have been elevated to a guaranteed position in the hierarchy of state and local government obligations, on par with or arguably ahead of bondholders. It won't take the municipal bond community too much longer to figure out that such arrangements present a problem that should be remedied by explicit legislative action or even constitutional protection. In light of the sovereign debt crisis and the recent loss of AAA status by our own federal government, the state legislatures must soon begin to rethink their priorities. If they cannot borrow money in the capital markets because of competing pension priorities, then they can't refinance their own pension funds by issuing lower-cost debt to provide the bail-out capital. This circularity alone informs us that the bonds have to take priority over all other creditors, if only to save the system in times of financial duress.
The states would be wise to rethink their remedies for pension funding problems, so that adjustment can be made under laws that preserve the benefits plan as much as possible, protect elderly pensioners living on meager stipends (but not the "$100,000 club") and provide for reasonable work-outs that don't require draconian measures, such as those now imposed by the Central Falls receiver. If the state needs to issue pension obligation bonds in order to recapitalize a pension plan (with state guarantees and a first claim on intergovernmental revenues and local surtaxes in order to provide bridge financing along the lines of the New York City bailout in the 1970s), that would be preferable to the costly messes that will land in bankruptcy courts. But the price of such bailouts must be genuine reform of retirement benefits that assure these problems never recur. The pain needs to be pre-packaged as well, or at least the dental drills that a receiver can use.
The national association of bond lawyers has done some fine work this year on pension disclosure. Now it looks like they have more work ahead of them that may carry over to the legislative side. The public employer, finance and pension organizations need to get ahead of the curve on this issue and part company with their labor-union lobbyist friends, who are sure to fight such reforms every step of the way in the state capitols.