Detroit Bankruptcy Uncovers Disastrous Pension Fund Fudge Factor

Detroit filed the largest municipal bankruptcy case in U.S. History last Thursday.  Then, on Saturday, Helen Thomas bit the dust.  No doubt, both passing were long overdue.

As far as we can tell, the demise of Helen Thomas and Motor City has no direct correlation.  Nonetheless, in certain ways, they are both rich in consequences.

For five decades Helen Thomas had the best job in the world.  As Presidential Correspondent, she was responsible for peppering the President with questions he’d rather not answer.  Who wouldn’t relish the opportunity to wag their finger at the world’s top public servant and pour salt on their flubs and flaws?  Particularly Nixon and Obama…that must have been a hoot.

Thomas, unfortunately, stuck around long after she’d lost her marbles.  She could have gracefully exited stage left a decade – or two – ago with her reputation intact.  But instead she remained in the spotlight until May 27, 2010, when she made public utterances about Israelis and Palestinians that should have been reserved for private company.

Two week later, after much ballyhoo, she retired.  President Obama called her remarks “offensive” and said her retirement was “the right decision.”  Bill Clinton, Ari Fleischer, Robert Gibbs, and Mike Huckabee, among others, pig piled on her verbal slipup.  In the end, Ralph Nader was the only politician to come to her defense.

No More Milk and Butter

Like Thomas, Detroit rode its good fortunes into the ground.  The auto boom of the early 20th century was too much for city managers to handle.  A seemingly endless inflow of money was eventually overcome with an endless outflow of promises.

Decades of mismanagement, population flight, and shrinking tax revenue, racked up $18.5 billion in debt.  In fact, between the 1950s and today, Detroit’s population fell by over 60 percent or from about 1.8 million to 700,000.  Ultimately, the math didn’t add up.

Overtime, the auto manufacturing cash cow also stopped churning out milk and butter.  During the second half of the 20th century U.S. auto companies lost market share to Japanese made cars.  When the U.S. auto industry collapsed with the entire economy in 2008-09, Detroit was ground zero for the fallout.  Yet despite Obama’s bailout of Detroit auto companies, the city couldn’t address its structural impossibilities.

Since then, all of Detroit’s problems have gone from bad to worse.  Basic public services like trash removal and law enforcement have become difficult for the city to maintain.  “In addition,” reports FoxNews.com, “Detroit has a roughly 18 percent unemployment rate, one of the country’s highest violent-crime rates and about 80,000 blighted or abandon buildings.”

Still, an Ingham County judge won’t let the old haggard city crash and burn with respect…

Detroit Bankruptcy Uncovers Disastrous Pension Fund Fudge Factor

On Friday, Circuit Judge Rosemarie Aquilina ruled that Detroit’s bankruptcy filing violates the Michigan Constitution because it would result in pension payment reductions for retired workers.  Obviously Ms. Aquilina misses the point of the bankruptcy or even why it must occur.  Trying to prevent it with legal rulings is like trying to stop gravity – or cow farts – by edict.

In addition, speaking of pensions, Detroit’s bankruptcy uncovers a dirty little actuarial secret that’ll spell disaster for pension funds across the nation…

“Many in Detroit were alarmed recently when, seemingly out of nowhere, a $3.5 billion hole appeared in the city’s pension system,” reports the New York Times.

“Until mid-June, there was one ray of hope in Detroit’s gathering storm: For all the city’s problems, its pension fund was in pretty good shape.  If the city went under, its thousands of retired clerks, police officers, bus drivers and other workers would still be safe.

“Then came bad news.  Seemingly out of nowhere, a $3.5 billion hole appeared in Detroit’s pension system, courtesy of calculations by a firm hired by the city’s emergency manager.”

Good grief.  How could a $3.5 billion hole appear out of nowhere?

“For several years, little noticed in the rest of the world, their staid profession [actuaries] has been fighting over how to calculate the value, in today’s dollars, of pensions that will be paid in the future.

“It may sound arcane, but the stakes for the country run into the trillions of dollars.  Depending on which side ultimately wins the argument, every state, city, county and school district may find out that, like Detroit, it has promised more to its retirees than it ever intended or disclosed.  That does not mean all those places will declare bankruptcy, but many have more than likely promised their workers more than they can reasonably expect to deliver.

“The problem has nothing to do with the usual padding and pay-to-play scandals that can plague pension funds.  Rather, it is the possibility that a fundamental error has for decades been ingrained into actuarial standards of practice so that certain calculations are always done incorrectly.  Over time, this mistake, if that is what it is, has worked its way into generally accepted accounting principles, been overlooked by outside auditors and even affected state and municipal credit ratings, although the ratings firms have lately been trying to correct for it.

“Since the 1990s, the error has been making pensions look cheaper than they truly are, so if a city really has gone beyond its means, no one can see it.”

Oops!

Sincerely,

MN Gordon
for Economic Prism

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