Detroit's Pension Madness
I'm rarely speechless, but I'm having trouble putting my emotions into words after reading the latest report on the Detroit pension situation. Now, I admit it: I'm kind of naïve. Usually when I see an underfunded pension, I think to myself "poor pensioners -- undone by a combination of stupid tax rules, volatile stock markets and mismanagement by trustees who tried to restore depleted fund assets with an investment approach you might call 'desperate optimism'." Thus, I was not entirely prepared for the new revelations about the Detroit trustees' custom of handing out annual holiday "bonuses" to workers, retirees and the City of Detroit. Between 1985 and 2008, they handed out roughly $1 billion this way. Had they been invested, one estimate says those funds would be worth almost $2 billion today -- or more than half the current shortfall in the funds.
These "bonuses" were used to lower the contribution the city was required to make, to give retirees a little something extra around Christmas time, and to fund individual savings accounts that workers are offered along with their pensions. In 2009, when the financial markets were completely frozen and the automakers were shotgunning through the bankruptcy courts, the pension trust paid 7.5 percent interest into those accounts -- which is about 7.5 percent more than they would have gotten at a bank. This while the pension funds were busy losing about a quarter of their value.
I literally slapped my forehead while reading some of the explanations that the trustees offered for their behavior. The spokesman for the trustees has the nerve to complain about the actuary's report that outlines these wild deviations from sanity. Here is how she justified draining the pension fund assets:
She said that the trustees were administering benefits that had been negotiated by the city and its various unions and that they had established an internal account to set aside "excess earnings" that would cover the cost. She said it was appropriate for retirees to benefit from market upturns because they had paid into the pension fund, so their own contributions had generated part of the investment gains.
"People were having a hard time, living hand-to-mouth, and we thought we would give them some extra," Ms. Bassett said.
It does not seem to have occurred to Ms. Bassett, or the other trustees, that people would have a very hard time when the pension that they were depending on went up in smoke.
It's very hard for me to attribute this to something benign, like total economic illiteracy or gross inattention to their responsibilities as pension trustees. I can't imagine that anyone who can read and do basic arithmetic ever thought that draining off the "excess earnings" in the good years could result in anything other than exactly what it has wrought: a pension fund so disastrously underfunded that it may not be salvageable. No, wait, that's too kind: they were also draining off ... what should we call them? "excess non-earnings"? in years when the economy was melting down, the Dow Jones was trading for less than a Mickey Mantle rookie card and the region's chief industry was teetering on the brink of extinction. What could they possibly have been thinking?
My best guess is that they were thinking the pensions would have to be paid, one way or another. After all, it's in the Michigan State Constitution. So they could pay out bonuses, please various constituencies, and then force the city or the state to make them whole when it all came tumbling down. They didn't reckon with the possibility that the city would simply run out of money, and the state would decline to step in, leaving them with no deep pockets to make up for their mismanagement.
It's hard to overstate how bad this is. I can't find any figures, but I'd guess that for many workers, the pension is at least half their annual retirement income. They may lose a giant chunk of that, because unlike a corporate pension, a municipal pension isn't insured; if Detroit declares bankruptcy, they'll get a fraction of whatever the city gives the unsecured creditors, and no more. The workers who were hoping to top that up with those "bonuses" in their personal accounts may also be unpleasantly surprised to find that a bankruptcy judge can claw that money back if it is deemed to have been improperly conveyed in the first place.
It will be even worse if the firefighter and policy funds turn out to have been similarly abused, because those people don't even participate in social security. Their retirement could end up being lean indeed. But let's hope that that does not turn out to be the case. The current situation is quite bad enough.
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Megan McArdle at email@example.com