DETRITUS

Detritus is an accumulation of disintegrated material. That’s what comes to mind when I’m thinking of Detroit and what its demise portends for the future of our public finances at large. It is irony that the city that is synonymous with the mismanaged private sector auto industry (no offense to Ford) and had to endure the managed bankruptcy of General Motors and Chrysler is now itself at the top of the iceberg of a growing mismatch between publicly made commitments and the capacity to deliver against these commitments now and in the future.

Detroit has the dubious honor of being the test case for how a public entity can finally face the fact that it has promised more than it can deliver, renege on its obligations and try to start anew.

I see it as a flaw of our democratic system that we can let it come this far, with open eyes, and then have no more choice other than seek refuge in bankruptcy.

It is only the scale of the Detroit default that sets it apart from what is happening all over America. Municipal bankruptcies are popping up all over the place, Stockton and San Bernardino, CA, Harrisburg, PA, Detroit, MI and the cause is just about the same everywhere: incompetent, dishonest and self-absorbed elected officials willing to give away the store to their constituents to be popular and get re-elected. It was no different with General Motors and Chrysler. It was much easier for top executives to give in to UAW demands that would not affect the P&L until after they would have retired than to manage productivity, payroll and retirement expenses in a responsible way and get the UAW to see it the same way.

Unfortunately, we are still only seeing the top of the iceberg.

Just looking at unfunded pension liabilities carried by the States, gives us a glimpse of the magnitude of the problem. The State of Illinois, by itself, has a pension fund shortfall in excess of $100 billion, growing by $17 million every day. The Economist, in its July 27, 2013 edition, points to calculations by the Centre for Retirement Research at Boston College that reckon that the combined pension fund shortfall of all States may be as high as $2.7 trillion. It also reports that Moody’s reckons that schemes are 52% underfunded.

Of course, at the Federal level, it is little different. There too, our public officials have promised much more than they can deliver with existing tax revenues and funding authorizations. The scary part there is that the unfunded obligations under our entitlement programs are not even included in the $17 trillion National Debt. No wonder that my children and their peers have no confidence and, therefore, little expectation that Social Security will be there for them. They are right, unless Congress gets its act together and deals with the important issues of deficit elimination, debt reduction, tax- and entitlement-reform.

State and Federal Governments have no access to Chapter 9 Bankruptcy that municipalities and counties have. They have no other option than to restructure their finances in such a way that they can move forward. In almost all instances that means that they will have to renege on earlier made promises.

There are no good solutions when governments of any kind have allowed to let things get out of hand. The bill becomes due someday and the only question is: who is going to pay it. In the case of counties and municipalities, if the public authorities don’t answer that question, it will ultimately be answered by the bankruptcy court.

In the case of Detroit, which reportedly has a deficit of $18 billion, this means that the bankruptcy court will have to decide how to split the burden between creditors and city employees and retirees who will have to learn to live on significantly less that they were promised by a succession of city officials who have failed them. The outcome will send ripples far and wide in that it will most certainly be precedent setting and affect the municipal bond business and the rights of public-sector workers in every municipality, county or State that has failed to tailor the entitlements of its employees to its revenue producing capacity.

The only good thing in this is that it will almost certainly hasten the process of converting public pensions from defined income programs to defined contribution programs. This process, which is nearly completed in the private sector, is well under way, at least for new employees, in States like Alaska, Michigan (!), Nebraska and Utah.

Detritus is the right word for the mess we are in, because our system of entitlements has been disintegrating even though our public officials prefer to live in denial of this reality until they no longer can, like in the case of Detroit. The real question is: “What needs to change in our democratic process to keep politicians from over promising and under delivering and how can such change be brought about.” That is a question for which there is no bankruptcy judge – or any other arbiter – to answer. The answer can only come from the public that has to hold its politicians accountable for the decisions they make.

A good place to start would be to severely cut or eliminate the retirement benefits and other perks of the very same public officials who signed off on the entitlements that now turn out to be unaffordable. If ordinary public servants have to suffer then the officials who brought this misery about should be the first to see their privileges slashed.