Judge Rejects Bondholders' Lawsuit Over Pension Debt

In bankruptcy, the federal courts have ruled that cities can reduce pension obligations. They can, but they don't have to. In Detroit, bondholders were sacrificed to maintain police and fire pensions with minimal haircuts.

On Monday, U.S. Bankruptcy Judge Meredith Jury ruled against bondholders in favor of Calpers in the San Bernardino bankruptcy. She acknowledged that her decision is likely to be seen as unfair to the municipal bond market and might even discourage investors from buying pension obligation bonds in the future.

Please consider Calpers' Pension Hammer Forces 'Unfair' Bond Ruling by Judge.

California's public retirement fund holds so much power over local officials that pension-bond investors can't expect equal treatment when a city goes bankrupt, a judge said in a ruling that she acknowledged seems "unfair."

"What I see as unfair, and might seem unfair to the outside world, does not matter under law," Jury said, referring in part to the powerful remedies Calpers can seek if the city doesn't honor its contract.

Monday's ruling sticks with a pattern seen in the bankruptcies of Stockton, California, and Detroit, said Marilyn Cohen, president of Envision Capital Management in El Segundo, California.

Up to Cities

Federal bankruptcy courts have many times ruled that cities can cut pension obligation, but nothing forces them to.

For example, in the Stockton California bankruptcy, a federal judge ruled that Stockton could have tried to reduce its obligation to Calpers. However, Stockton chose not to do so, arguing that fighting Calpers would take too long and could endanger employee pensions.

Conflict of Interest

I believe Stockton's rationale is nonsense. Instead, I propose Stockton city officials had a conflict of interest.

City officials wanted to preserve their own pensions.

Chicago Connection

So what does this have to do with Chicago and the state of Illinois in general?

Lots, so let's tie it all together.

As a result Tuesday's Illinois Supreme Court Ruling that the 2013 Pension Reform Law Is Unconstitutional Moody's cut Chicago's bond rating two notches to junk. Moody's specifically cited Chicago's pension crisis.

I discussed this yesterday in Chicago Bond Rating Cut to Junk; City Faces $2.2 Billion in Various Termination Fees; Irresponsible to Tell the Truth.

In light of the San Bernardino ruling today, cities that have huge pension issues will see bond yields soar.

The Chicago Board of education is already paying 285 basis points more than other cities because of pensions. If bondholders keep getting hammered, those yields will rise further.

Pass a Bankruptcy Law, Give Taxpayers a Chance

A Chicago Tribune editorial by Henry J. Feinberg, says Pass a Bankruptcy Law, Give Taxpayers a Chance.

Under federal law, state governments can't file for bankruptcy. Local governments can do so if their states give them permission. A bill now before the Illinois legislature would extend that permission to Illinois municipalities, most of which now can't seek protection under bankruptcy law.

The right way is to amend House Bill 298 so people who hold Illinois bonds have a "secured first lien," the fancy words needed in the law to make sure bondholders are first in line to get their money back. Passing this amended bill would do three things that the state's local governments have not been able to accomplish for decades.

Three Reasons to Amend Bill 298

Feinberg cites three reasons to amend the pending bankruptcy bill.

• First, it would bring opposing sides to the table to have meaningful discussions about how to save the borrower, in this case the local government, from financial ruin.
• Second, the government could ask the bankruptcy court to modify labor contracts and order the parties to renegotiate the terms of collective bargaining agreements.
• Finally, a law that puts bondholders first in line to get repaid would be a stroke of fairness that would help Illinois cities, school districts and other local governments avert a short-term solution like Detroit's. There, some people who had lent money to the city by buying its bonds lost two-thirds of their investment. Meanwhile, members of the politically powerful police and firefighter unions took no cuts to their pensions (their cost-of-living adjustment was reduced). Other workers took a 4.5 percent base cut in pensions and the elimination of an annual cost-of-living increase, The Detroit News reported.

I agree with Feinberg on all three points. Bankruptcy is the only real solutionfor many of these plans and many cities as well.

Beware the Tax Man

Tax hikes cannot possibly address the shortfall. As discussed on May 4, in Beware, the Tax Man Has Eyes on You, the potential hike for Illinoisans is staggering.

Nuveen estimated 50% property tax hikes would be necessary. Those hikes were just for Chicago. They did not include money to bail out other Illinois pension plans. Nor did it address the $9 billion budget deficit for the state.

Finally, Nuveen's estimate assumed pension plans would make their plan assumption of 7% returns or higher.

Stock Market Bubble Will Hit Pensions

I believe another serious decline in the stock market is likely. So do some of the biggest fund managers in the world.

Please check out Seven Year Negative Returns in Stocks and Bonds; Fraudulent Promises.

Pension promises were not made in good faith.

Rather, pension promises were the direct result of coercion by public unions on legislators, mayors, and other officials willing to accept bribes because they shared in the ill-gotten gains of backroom deals at taxpayer expense.

Illinois taxpayers cannot be held accountable for coercion of public officials by public unions.