The dubious honor of being the first city in the nation to completely default on pension obligations goes to Prichard, Alabama. The city has sought bankruptcy protection twice and is flat broke. It faces a choice of paying to keep city services like police and garbage running or pay pensions. It selected the former.

The New York Times reports Alabama Town's Failed Pension Is a Warning

This struggling small city on the outskirts of Mobile was warned for years that if it did nothing, its pension fund would run out of money by 2009. Right on schedule, its fund ran dry.

Then Prichard did something that pension experts say they have never seen before: it stopped sending monthly pension checks to its 150 retired workers, breaking a state law requiring it to pay its promised retirement benefits in full.

Prichard stands as a warning to cities like Philadelphia and states like Illinois, whose pension funds are under great strain: if nothing changes, the money eventually does run out, and when that happens, misery and turmoil follow.

The declining, little-known city of Prichard is now attracting the attention of bankruptcy lawyers, labor leaders, municipal credit analysts and local officials from across the country. They want to see if the situation in Prichard, like the continuing bankruptcy of Vallejo, Calif., ultimately creates a legal precedent on whether distressed cities can legally cut or reduce their pensions, and if so, how.

"Prichard is the future," said Michael Aguirre, the former San Diego city attorney, who has called for San Diego to declare bankruptcy and restructure its own outsize pension obligations. "We're all on the same conveyor belt. Prichard is just a little further down the road."

Many cities and states are struggling to keep their pension plans adequately funded, with varying success. New York City plans to put $8.3 billion into its pension fund next year, twice what it paid five years ago. Maryland is considering a proposal to raise the retirement age to 62 for all public workers with fewer than five years of service.

Illinois keeps borrowing money to invest in its pension funds, gambling that the funds' investments will earn enough to pay back the debt with interest. New Jersey simply decided not to pay the $3.1 billion that was due its pension plan this year.

Colorado, Minnesota and South Dakota have all taken the unusual step of reducing the benefits they pay their current retirees by cutting cost-of-living increases; retirees in all three states are suing.

Default No Surprise

I am not surprised by the default, having written about Prichard a couple of times already, the latest on March 16, 2010 BankruptcyCourt Gives Prichard Alabama 2 More Months To Figure Out How To Pay Pensioners

Rule Number One

You can't pay what you do not have. The problem for Prichard is a declining tax base, loss of population, declining property values, and most importantly a pension plan that was amended by the Alabama legislature more than fifteen times, over the years.

Each modification increased the economic burden on the city, every Alabama city in fact.

Every state in the union needs to stop meddling in the affairs of cities. Cities in Illinois are in the same boat.

Prichard never would have made those promises except they were forced by the state. The question is what to do about it. Expect to see more sad cases like these end up in bankruptcy court. Promises were made that cannot be met. The state forced those promises on cities.

Higher taxes are not the answer. At this point, there is no answer that will satisfy anyone, let alone everyone.

If the court declares the city must pay up in full, perhaps the city should pursue dissolution. What I expect to happen is for the bankruptcy court and the city to agree to pay pensioners some minimum benefit, far less than what was promised.

It's only a matter of time before a major city decides to do what Prichard Alabama and Vallejo California did: declare bankruptcy to shed illegitimate pension promises crammed down city throats by socialist state legislatures.

"Prichard is the Future"

The court ordered Prichard to pay money it did not have with easily predictable results. Prichard defaulted. This is what happens when government interferes in the free market, mandating benefits that cities have no way of meeting.

I agree with Michael Aguirre, the former San Diego city attorney, who says "Prichard is the future."

Municipal bankruptcies was my top economic theme for 2011 as noted in Ten Economic and Investment Themes for 2011

1. US Municipal Bankruptcies Head to Center Stage

Look for Detroit and at least one other city in Michigan to go bankrupt. Also look for increasing discussions regarding bankruptcy from Los Angeles, Miami, Oakland, Houston, and San Diego. Those cities are definitely bankrupt, they just have not admitted it yet. The first major city to go bankrupt will cause a huge stir in the municipal bond market. Best to avoid Munis completely.

To survive, many cities need bankruptcy. It's Detroit's only hope. Please see Detroit Mayor Plans to Halt Garbage Pickup, Police Patrols in 20% of City; Expect Bankruptcy, Massive Municipal Bond Turmoil in 2011 for details.

The money is not there. It can't be paid and it will not be paid, by Prichard, by Detroit, by Los Angeles, by Miami, by Oakland, by the state of Illinois.

How Long Before Illinois Blows Up?

Illinois has pension plans that are 23% funded. For details, please see Interactive Map of Public Pension Plans; How Badly Underfunded are the Plans in Your State?

How long will it be before Illinois blows up? If the stock market takes another dive, I think about 3-5 years.

We need to do something about existing pensions and future accruing pensions.

One part of the solution, as I proposed earlier, is to tax pension benefits above a certain amount at a very high rate of 90%. I don't know what the level should be but I talked about $120,000 or $80,000. Some wrote that my level was too low, more wrote it was too high. Some wanted to tax everything above the level of Social Security benefits.

As a practical matter, if you set the number too low and you will not get public buy-ins. Set it too high and you do not accomplish much. Left alone, the market will impose its solution and it's called "default", jut like Prichard did.

A second part of the solution is to privatize government services.

In response, several misguided souls wrote things like "what makes you think you know what wages should be?"

The irony is that I don't. The free market does. The solution is simple, let the free market decide.

Others have stated preposterous things like government workers are underpaid because they tend to have more education and skills.

I say let's find out. Let's entirely eliminate the department of energy as a starting point of discussion. The department of education is another one. If those jobs are needed, the free market is virtually guaranteed to pick those jobs up. I suspect a few people would make a lot more than they do now, while most would struggle to find a job.

Regardless of the result, we would have free market discovery, and it would not be taxpayer dollars paying the salaries.

What's Fair?

Numerous people have written me that "You cannot take away what's been promised". Most say things like "It's not fair".

Well Prichard shows you can take away what's been promised. Default or bankruptcy will do it. I will be the first to tell you what happened in Prichard is not "fair". But that's what happens when government interferes in the free markets. It's certainly not fair to perpetually raise taxes for the benefit of overpaid public union workers, many of whom would have a low-paying job in the free market.

The second major point is most of those deals are based on fraud. Public unions bribed, coerced, and fearmongered their way to untenable benefits and salaries. Corrupt politicians went along, buying votes to get elected. Fraudulent contracts need not be honored.

Regardless, they cannot be honored because mathematically the money is simply not there.

No solution will please everyone. In fact, it may not please anyone. However, if nothing is done, there will be more Prichards, lots more Prichards. Public unions better come to grips with that simple reality.