Professor David Skeel of the University of Pennsylvania has an op-ed in Thursday’s WSJ discussing some of the legal issues raised by Detroit’s Chapter 9 bankruptcy filing and the potential conflict with the Michigan constitution. Skeel writes:
Article IX, Section 24, of the Michigan state constitution says: “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.” Yet Chapter 9 of federal bankruptcy law clearly authorizes a city to restructure its obligations to restore financial health. How will the conflict be resolved?
Chapter 9 should prevail. The U.S. Constitution (Article VI) states that the laws of the United States are “the supreme law of the land,” and furthermore, that judges in every state are bound by them, “anything in the constitution or laws of any state to the contrary notwithstanding.”
This doesn’t mean that Detroit workers could be left with nothing. As of June 30, 2012, the assets held in trust for Detroit’s general retirement system benefits were valued at $2.16 billion. These funds are property of the retirees, much as the collateral a borrower puts up to secure a loan belongs to the lender. It is only the unfunded portion of the pensions ($830 million by Detroit’s estimate, $2 billion by Mr. Orr’s, plus his estimate of another $1.4 billion in underfunding for the police and firefighters’ pensions) that is subject to restructuring.
Skeel adds that this conclusion does not mean that Detroit pensioners should bear any disproportionate burden.
The pensions for Detroit’s city workers don’t appear to be extravagant, and the bankruptcy judge ought to be mindful of the very real effects on the lives of retirees when he decides whether to approve any reduction in benefits.
Chapter 9 requires that a restructuring of obligations be in the best interests of creditors—including the retirees. This suggests that sacrifice must be shared among all of a city’s general creditors, bondholders as well as public employees.
As the pension issue goes, so goes Chapter 9. If Detroit can make at least modest adjustments to its pensions, and restructure its other obligations as well, the city and other municipalities in dire financial straits may have a fighting chance. If not, the downward financial spiral of too many American cities is likely to continue.