Indiana bill may provide a glimpse at the playbook for muni bankruptcy


Indiana State Senator, Republican Ed Charbonneau of Valparaiso is pushing a new bill in the state that would make it easier for local municipalities to file for bankruptcy the way Detroit did. The bill is the latest entrant into a shift toward municipal bankruptcy that some observers feared would be in the works after Detroit.

Detroit wasn’t the first city in the US to file for municipal bankruptcy, but it was the largest, and much of its claim is due to public pension debt. Before this, municipal bankruptcies tended to be the result of project oriented issues, like overruns on a bridge or large infrastructure project. Because of this, some observers have put up a red flag in the wake of Detroit noting the widespread underfunded liabilities in public pensions which could lead to more bankruptcy. Still, others were quick to tamp down those concerns noting the uniqueness of Detroit’s financial situation and length of its overall decay as a city. Even so, that hasn’t stopped Charbonneau from seeking to make things easier for Indiana cities looking for an escape hatch.

Detroit filed for bankruptcy under Chapter 9 which allows for cities to file only if their state approves it. Just over half of the states have such allowances on the books, but Indiana is not one of them. The state does however, have a mechanism that allows cities in financial trouble to ask the state’s Distressed Unit Appeals Board to designate their local government as distressed. Once that designation has been allowed, the city can get an emergency manager similar to what Michigan allows.

The new bill would move that ball forward and allow for full-scale bankruptcy claims.

According to an Associated Press account of the bill, Charbonneau thinks that making bankruptcy an option would motivate distressed parties to more readily resolve repayment issues.

Supporters of public workers unions have said that the Detroit bankruptcy was a means of providing the city with an unconstitutional out for paying promised benefits. This bill could provide a glimpse into that playbook. Both Michigan and Indiana’s emergency manager laws were ushered in by Republican Governors – Rick Snyder and Mitch Daniels. (Snyder limited unions in Michigan by making it a right to work state last year, and Daniels is on record as saying public unions should be abolished.) The Indiana bill has been authored and ushered in by a Republican State Senator, providing a certain continuity on this issue.

David Skeel at the conservative, Weekly Standard recently wrote “more bankruptcies, please,” offering more clarity on the conservative viewpoint on paying public pension earned benefits,  and municipal bankruptcy, despite the significant costs associated with filing.

The way Detroit’s bankruptcy judge decides to allow pension repayment will be the next critical hurdle for understanding how underfunded public pensions may be dealt with in the future. Kevyn D. Orr, Detroit’s state-appointed emergency manager, has called for pensioners and bondholders to take a significant haircut on what they are owed, leading to several court challenges that will still have to be worked out. The judge hearing the case also has an established record on trying to make corporate bankruptcies easier. The Michigan state constitution provides fairly clear rules around those benefits and their repayment, however, the Indiana state constitution may offer more wiggle room.

Stephen Eide a senior fellow at the Manhattan Institute’s Center for State and Local Leadership, notes that making bankruptcy easier may not solve city’s problems. He points out that even with corporate bankruptcies, few opt for Chapter 11 reorganization, many go for Chapter 7 outright liquidation. Liquidation isn’t really an option for municipalities, and corporate reorganizations rarely work on their own. Reorganizing a municipal government in a similar fashion should raise big red flags in statehouses and at ballot boxes. He also notes that municipal bankruptcies do little to solve underlying problems in the local tax base that led to revenue gaps in the first place. (The conservative mantra of tax cuts above all also leaves out similar considerations.)

According to a report from the Pew Charitable Trusts, cities face a $217 billion gap between the long-term costs of benefits promised to city workers and funding set aside to meet those obligations. A number of public pension funds have recently moved money into hedge funds and private equity investments in an effort to close that gap more quickly, but tepid global macroeconomic growth doesn’t present a rosy picture. In the US, that growth has been further limited by the fiscal drag on the economy imposed by sequestration, drag which is only expected to get worse as Congress heads into yet another debt ceiling fight in the fall.

How cities interact with their state can also have an influence on their pension system. For example, in Wilmington, Delaware, the six city-managed pension plans were on average 69% funded in 2010. In contrast, the pension fund managed by the state, which includes Wilmington police officers and firefighters hired since 1993, was 96% funded. Wilmington has since decided to enroll new general employees in the state-run plan.

Cities, pension fund managers, and municipal bond holders are in for a rocky road to be sure. The conversation over municipal bankruptcy is set against the backdrop of a proposed cap on municipal bond tax exemptions, which may make these vehicles even less palatable to investors and adding more pressure on cities. Over the weekend the National Governors Association held a meeting to discuss options, including increases in transparency around public pension fund positions. More conversations like this will be required to find the best way forward, it seems hard to believe that the best, or only option is to haircut public workers and investors who acted in good faith, providing critical services like police and fire protection, or funding municipal projects.