Detroit’s Bankruptcy and Its Painful Reforms

Detroit’s Bankruptcy and Its Painful Reforms - The American Interest:
The Malfeasance

Had Detroit never been in the defined benefit pension business, it probably would never have gone bankrupt. Even with the collapse of the auto industry, rising poverty, blight and crime, the white and black middle class’ flight to the suburbs, and a legendarily dysfunctional city government, bankruptcy was not inevitable. Federal law makes it extremely difficult for cities to enter bankruptcy by imposing a cash-flow insolvency test. Massive debt is not enough. A city must be literally running out of money in order to break its contractual debt obligations in court. This is one of the most important reasons why so few of America’s many distressed cities actually go bankrupt.

But Detroit was running out of money, and pensions were at the root of the problem. When Detroit filed for bankruptcy in June 2013, 60 percent of its $18 billion in obligations it listed, and 92 percent of its unsecured obligations, were somehow pension-related. The $3.5 billion in unfunded pension liabilities was just the beginning. There was also the $5.7 billion owed for retiree health insurance. This benefit, known as “OPEB” (other post-employment benefits), is common throughout the state and local sector because of the prevalence of defined benefit pensions. Pension eligibility often begins 10 or more years before Medicare eligibility, creating pressure for government employers to continue to provide gap health coverage for the years between retirement and Medicare. (Many governments also supplement Medicare after it kicks in at 65.) Detroit owed another $1.7 billion from a spectacularly imprudent attempt to backfill its pension system with funds borrowed from capital markets.