By Josh Barro
I traveled to Woonsocket, Rhode Island, last week for an on-the-scene look at the city’s fiscal troubles. Having established that they were not created by the American Legislative Exchange Council, I came away thinking that Woonsocket is the first victim of a state law that should have been controversial but wasn’t.
That law says cities must make payments to bondholders before addressing any other financial obligations. This makes it impossible to default on a municipal bond in Rhode Island, which is a real problem for a city like Woonsocket, which is up to its eyeballs in debt.
Last year, when Rhode Island enacted the law, legislators seemed to view it as a free lunch. It helped to reassure the bond markets that Rhode Island would perform on its obligations, and indeed Rhode Island borrows more cheaply than some states with objectively healthier fiscal situations, such as California. That’s great if you’re a bondholder, and it’s great if you’re a fiscally healthy municipality trying to go out and finance a capital project.
It’s not so great, however, if you’re Woonsocket.
The city has the highest ratio of liabilities to taxable property in Rhode Island, and 20 percent of its budget goes to servicing debt, pension obligations and retiree health benefits. If it were being fully responsible, the city would spend an even larger share of its budget on servicing liabilities. Currently, Woonsocket is only paying for retiree health care being used today, not setting aside reserves for current workers; and it is $2 million short on its annual required payments into its pension system.
This debt burden is what makes Woonsocket a candidate for receivership and bankruptcy. Wiping away some of those debts would make it easier for the city to provide services and attract new residents and businesses. But the bondholder priority law “takes bankruptcy out as a preferred option,” says John Ward, who chairs the city council. According to the law, even in bankruptcy, Woonsocket wouldn’t be able to discharge its bond debts.
Instead, the city is trying to manage its budget while servicing its bond obligations. As usual, even where a government’s real problem appears on its balance sheet, the political fight is about the income statement. The focus of most voters is what taxes they’ll have to pay this year, and what services they will get in return. The city’s budget fight is what drew the attention of The New York Times to Woonsocket city hall.
This year, Woonsocket faces a $7 million gap in a budget of $129 million. City officials passed a budget with a 13.8 percent supplemental rise in property taxes, above the 4 percent increase that is allowed by state law. That would have raised $6.6 million and nearly closed the gap. But Woonsocket’s delegation to the state legislature, including Representatives Jon Brien and Lisa Baldelli-Hunt, blocked that proposal, saying it would make taxes too high.
Now, the city is left to find $7 million in spending cuts. The city has been cutting back for years, and it’s widely agreed that further reductions in personnel will cause an unacceptable drop in the quality of public services. Instead, the savings will have to come from cuts in wages and benefits per employee, and cuts in benefits to retirees.
One matter that both sides agree on is that Woonsocket should not go bankrupt. For a man who was recently pushing for property taxes to rise 18 percent in a year, Ward is remarkably confident that the city can balance its budget all on the spending side.
He says the bulk of the savings will come from health benefits -- putting all public employees and retirees on a more private sector-style health plan, with a $1,000 deductible and employees responsible for paying 20 percent of premiums, could save as much as $6 million a year. He also hopes to get concessions on both pensions and health benefits from retirees. If necessary, the city would then proceed to cut salaries across the board.
In Rhode Island, all these provisions are subject to collective bargaining. The city will try to negotiate voluntary concessions with both public employee unions and retired workers. But if that fails, the state’s receivership process for fiscally troubled cities offers avenues to impose concessions over the unions’ objections, if necessary culminating with Chapter 9 bankruptcy. Ward, Brien and Baldelli-Hunt all agree that the unions will be motivated to avoid bankruptcy and that negotiations are therefore likely to succeed.
Unions’ fear of bankruptcy comes from nearby Central Falls, where workers and retirees refused to make sufficient concessions and sent the city into bankruptcy -- and then saw their oxen gored anyway, with some pensions cut by as much as half. Subsequently, Providence has had success in negotiating voluntary concessions from its unions, largely because they fear even worse losses if Providence went bankrupt.
This is the heart of Brien and Baldelli-Hunt’s argument against the tax increase. Why would the city raise taxes first and then go to the unions for concessions once the threat of bankruptcy was averted? “Nobody moves faster than when you have a piano over your head,” says Brien. He and Baldelli-Hunt say they are open to a supplemental tax as part of the solution to fix Woonsocket’s finances, but they want the city to seek labor concessions first.
Ward is not sure that extracting big concessions from the unions is the right policy for Woonsocket. The city is already below average in employee compensation. Per pupil spending on education ranks 32nd out of 36 districts in the state; the city recently eliminated all-day kindergarten due to its tight budget.
Ward also worries that reductions in compensation will harm the city’s ability to recruit workers. The neighboring town of Lincoln has a more generous teacher salary schedule.
But while Woonsocket is below average in compensation, it’s also above average in taxes. The city already has the second highest residential property tax rates in Rhode Island, trailing only Providence. Spending cuts could make Woonsocket uncompetitive, but so could tax increases.
That brings us back to Woonsocket’s debt burden: the reason the city has such high taxes and low service spending is that it devotes such a large percentage of its budget to servicing liabilities. Discharging some of those liabilities would do much more to improve Woonsocket’s competitiveness than tax increases or cuts to employee compensation.
Woonsocket officials hope to follow Providence’s lead, where retirees agreed to greatly reduce cost-of-living adjustments on pensions. But in a key way, the Providence and Central Falls cases do not apply here.
Both Central Falls and Providence were primarily saddled with non-bond obligations to retirees. Central Falls had run its pension fund balance to zero and Providence was down to 32 percent, meaning that retirees had to worry that the city would be unable to pay benefits.
But in 2002, Woonsocket issued $90 million in pension obligation bonds. That took the city’s only pension system from totally unfunded to 100 percent funded. In the ensuing decade, the city has underfunded the system and its investments have performed badly, but assets still cover about 60 percent of pension liabilities.
This changes both the incentive for retirees to give up benefits and the city’s ability to save money through restructuring. There is no imminent danger that Woonsocket’s police and fire pension fund will run out of money, and even in bankruptcy, the existence of the fund limits the extent to which benefits are likely to be cut. Asked for concessions, police and fire retirees may well tell the city to get lost.
All of Woonsocket’s other employees participate in a statewide pension system. The state cut benefits in this system last year, providing some budgetary relief to Woonsocket and every other member jurisdiction. But the city has no ability to extract further savings on its own.
Meanwhile, about half of Woonsocket’s liabilities are bonds, including $87 million in pension obligation bonds. The state law protecting bondholders means that the city has essentially no ability to negotiate reductions in the bond liabilities -- and, even if it gets to bankruptcy, wouldn’t be able to discharge them.
The law might not hold up in court. States have to authorize municipalities to file bankruptcy, but once they do, they go through bankruptcy in federal court. The federal government does not have to honor states’ guidance about how to prioritize creditors, and it’s possible that the courts would simply toss Rhode Island’s law and force bondholders to take haircuts.
Nobody in Woonsocket seems to want their city to be the test case. But if retirees resist calls to give back pension benefits, and cuts to current employee salaries interfere with recruiting, city leaders may have no choice but to try their luck before a bankruptcy judge.
(Josh Barro is lead writer for the Ticker. Follow him on Twitter.)
Read more breaking commentary from Josh Barro and other Bloomberg View columnists and editors at the Ticker.
-0- Jul/02/2012 17:43 GMT