30 October 2013

Rock, Paper, Scissors

Much has been written by many (and posted by me--try here, here, and here for a few) about the impending financial crisis of many cities and states. This crisis is due in part to the after-effects of the real estate bubble that burst in 2008 and continuing slow economic growth in the United States (and, indeed, the world). But another very large part of the long-term financial viability of various units of American civil governments are unfunded promises to retirees for pensions and medical care.

Recent municipal bankruptcies reveal three contending approaches to defusing the bombs of unsustainable long-term obligations. Stockton, California has decided to pay almost all of what it owes its retirees and thus has reduced what it will pay its other creditors such as bondholders and general unsecured creditors. Conversely, San Bernadino has taken the opposite tack by cutting payments to retirees.

While it remains to be seen exactly what Detroit will do, you can read here (probably behind a pay wall) a report of the testimony of emergency city manager Kevyn Orr during the fourth day of the trial on Detroit's eligibility of be in Chapter 9 bankruptcy. In short, he's keeping all options open including cutting pension obligations. He also testified that some settlements have already been reached with some bondholders. And he raised the possibility of the "nuclear" option of bankruptcy reorganization: cram-down (where a plan is confirmed over the vote to reject it by a class of creditors).

Orr is exactly correct. As I argued in my paper Fairness and Risk in Stockton: Pensions, Bond, and Taxes (download here), settlement is always best but when parties are not inclined to settle the twin threats of cram-down or dismissal are the catalysts (or hammer over the head) that should induce sufficient cooperation. It's a game of Chicken and I hope no one will drive Detroit over the cliff.

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