Detroit Prompts Governors’ Call for More Local Finance Oversight

Detroit’s record U.S. municipal bankruptcy shows that states need to do more to oversee localities’ finances and unfunded liabilities, Republican and Democratic governors said.

States should demand that municipalities more accurately account for long-term pension and health-care obligations, said North Carolina Governor Pat McCrory, a Republican who took office in January.

“It’s a serious issue that politicians have been passing on to their successors,” McCrory said in an interview at an annual National Governors Association meeting over the weekend in Milwaukee. “It’s going to catch up, and Detroit’s the wake-up call.”

A more aggressive approach by states may forestall bankruptcies or other fiscal woes that can lead to municipal defaults and affect a state’s bond ratings and finances, governors of both parties said in interviews at the meeting.

Detroit, once an industrial giant built by U.S. automakers, filed an $18 billion bankruptcy on July 18. Kevyn Orr, the Detroit emergency manager, has estimated the city’s pension deficit at about $3.5 billion and $5.7 billion for retiree benefits.

As of fiscal 2009, the 61 most populous U.S. cities had a combined $99 billion in unfunded pension liabilities while covering only 6 percent of retiree health-care obligations, according to a report in January by the Pew Charitable Trusts, a Philadelphia-based research and public-policy group.

Pushing Transparency

Governors should push local governments to provide more transparency about their unfunded pension and health-care liabilities, said Colorado Governor John Hickenlooper, in an interview. Getting an accurate accounting can be difficult because it’s not always clear what assumptions are behind the calculations, said Hickenlooper, a Democrat.

“Transparency will go a long way towards helping us resolve many of those issues,” he said. “If there had been more transparency in Detroit, I think this would have gotten resolved sooner.”

Cities sometimes make poor short-term financial decisions, and states have to monitor that, said Rhode Island Governor Lincoln Chafee, a Democrat.

“The state should have some kind of oversight to prevent those short-term decisions that are harmful down the road,” he said.

Bailing Out

While governors said they need to exert more oversight over localities, they said states shouldn’t bail them out.

“We have responsibility for our pensions,” said Nebraska Governor Dave Heineman, a Republican, in an interview. “Local governments have responsibility for theirs.”

Heineman said when state pensions have a shortfall, the state government typically funds half and the participants cover the rest as a partnership. He tells municipalities to follow the same approach, he said.

“I give them encouragement to act like we are,” Heineman said. “You cannot let your pensions get out of hand.”

States could make it more difficult for municipalities to accumulate unaffordable obligations in the first place, said Donald Boyd, senior fellow at the Nelson A. Rockefeller Institute of Government in Albany, New York.

That can be done by requiring proper disclosure of the true costs and encouraging pension agreements in which future benefits don’t have the same protection as benefits already earned, he said.

Monitoring Localities

“More disclosure would make it harder to accumulate obligations you can’t afford,” Boyd said. “Governors, should they choose to take more responsibility for local governments, can do monitoring, they can do technical assistance to local governments to help them plan.”

There are 19 states with laws allowing them to intervene in municipal finances, mostly by reacting to crises instead to taking steps to prevent them, and states have different traditions of dealing with troubled cities, a Pew report last month said.

California, where Stockton and two other cities moved to file for bankruptcy last year, has a history of not taking action, the report said. In contrast, Rhode Island, where Central Falls went bankrupt in 2011, appointed a receiver to take over city finances. A measure in Michigan also allows the governor to appoint an emergency manager for distressed cities.

Wisconsin Approach

In 2011, Wisconsin Governor Scott Walker, a Republican, limited public-employee collective bargaining rights and required increased worker contributions for health care and pensions. While the moves drew weeks of protests at the state Capitol and an unsuccessful recall of Walker, he said Wisconsin cities now have the tools they need to manage their budgets.

“If Detroit were in Wisconsin, it wouldn’t be going to bankruptcy,” Walker said in an interview. “You’d be hard-pressed to find a Democrat mayor in this state who, if you pulled him aside privately, would argue that we should repeal what we did because it’s empowered them to take control of their budgets in a way they couldn’t before.”

It’s possible for states to work with local governments to win concessions from unions and make other needed changes without having to “kick working people in the teeth to make progress,” Vermont Governor Peter Shumlin, chairman of the Democratic Governors Association, said in an interview.

Chicago ‘Hole’

Illinois has almost $100 billion in unfunded state pension liabilities, which prompted Democratic Governor Pat Quinn to suspend state lawmakers’ pay last month until they address the shortfall.

Quinn said having the state fix its pension system can set an example for Chicago, the state’s largest city and the third-largest U.S. municipality. Moody’s Investors Service lowered the city’s credit rating last month, citing a $36 billion retirement-fund deficit.

“The city government, over a number of years, dug a hole on their pension liability,” Quinn said in an interview. “We want to work with them on reform, but ultimately the mayor and city council, they have to take the lead in curing their problem.”

Detroit’s situation shows what can happen when city finances are allowed to deteriorate, said Iowa Governor Terry Branstad, a Republican. He suggested that state auditors be able to look at municipal books to calculate a true financial picture of unfunded liabilities according to Governmental Accounting Standards Board guidelines.

“The message is clear: you can’t let major economic engines in your state, like cities the size of Detroit, just continue to pile up massive debt and not look to what has to be done to be fiscally responsible,” Branstad said in an interview. “Governors need to have the courage to blow the whistle and then help solve the problem.”

Before it's here, it's on the Bloomberg Terminal.