Taxpayers, Pensioners Riding a Wave of Bankruptcies in Detroit and California

Taxpayers, government workers and retirees alike have been riding a wave of municipal bankruptcies all across the country in recent years. In places such as Detroit and California, this wave of pension obligations and other debts looks more like a tsunami than the breakers at Surf City, USA.

Californians are all too familiar with the bankruptcy dance. One might say that California has been the “leader” in municipal bankruptcies. Other than Detroit and Jefferson County, Alabama, which is looking to shave $1.2 billion off its $4.2 billion debt and emerge from bankruptcy by the end of the year, the largest municipal bankruptcies have been in California.

People walk past Compton City Hall on July 19, 2012, in Compton, California. The City of Compton located south of Los Angeles with a population of nearly 100,000 must decide by September 1 whether to file for bankruptcy. According to city officials, Compton is one of several cities in California that has struggled with a deficit.

There was the $2 billion Orange County bankruptcy in 1994, caused when the county’s high-risk, leveraged investments in interest-rate derivative contracts went bad. More recently, Stockton ($1 billion) filed for Chapter 9 bankruptcy in June 2012 following what U.S. Bankruptcy Judge Christopher Klein described as a “multi-decade, largely invisible pattern of above-market compensation for public employees.” San Bernardino ($492 million), reeling from the bursting of the housing bubble and rising pension obligations, filed for bankruptcy last August. And we cannot forget Vallejo ($175 million), which began the current surge of California bankruptcies in 2008 when it got into trouble primarily because of mounting pension liabilities.

According to a USA Today analysis earlier this year, 10 additional California cities are on the brink of bankruptcy. These cities range from small, rural towns to large, urban cities, including Atwater, Azusa, Compton, Fresno, Hercules, Mammoth Lakes (which withdrew its petition for bankruptcy after filing last year, but remains on shaky financial ground), Monrovia, Oakland, San Jose and Vernon.

While not all municipal bankruptcies and financial emergencies are due to overly generous pension promises that can no longer be kept, pensions remain a common theme among many of the bankruptcies. A Stanford Institute for Economic Policy Research report noted that between 1999 and 2010, pension spending grew an average of 11.4 percent a year in California’s largest cities and counties – more than any other spending category and more than twice as much as spending on education, public safety, welfare, health and recreation.

Increasing employee pension and retiree health-care contributions and retirement ages are good first steps toward fixing the troubled cities’ financial problems – and one that many state and local governments have taken – but the experience of California shows that it will not be enough. It is simply too easy under existing defined-benefit pension plans to fudge the numbers and pass along unaffordable costs to taxpayers that will not be known for many years. Switching to 401(k)-style retirement plans, as the private sector has done for several decades, would make government pension contributions much more transparent and stable.

Even this would only stop the bleeding, as it would still take years to accumulate significant savings. If state and local governments are to really achieve savings quickly, they must broach the “third rail” of pension politics: decreasing the unaccrued future pension benefits of current employees. These employees would be able to keep all the benefits they’ve earned to date, but their benefits going forward would be reduced. San Jose did this with its pension reform last year and is currently litigating this issue, among others, with the city’s public employee labor unions.

Leaders in financially troubled cities throughout the state will no doubt be watching the proceedings in San Jose and Detroit closely to see if they should follow the same paths.

Adam B. Summers is a senior policy analyst at the Reason Foundation. This article originally ran in the Orange County Register.