A federal judge’s ruling yesterday that Detroit worker pensions can be cut as part of the city’s bankruptcy case has angered city workers and shocked some of their supporters. Workers carrying signs outside the federal bankruptcy court yesterday blamed big banks for Detroit’s fiscal woes and demanded, “No cuts to our pensions.” They carried photos of Michigan governor Rick Snyder, painted to make him look like the devil. But if workers seek a culprit, they might look at the city’s pension-system trustees and the unions that were supposed to have influence over them. For years, the trustees granted annual bonuses to retirees and fattened worker-savings accounts with high guaranteed rates of return, siphoning crucial assets out of the retirement system, even as Detroit’s finances deteriorated. By one estimate, reported in the Detroit Free Press in September, the bonuses and guaranteed-interest programs cost the pension funds nearly $2 billion in contributions and foregone investment returns—money that might have made the pension system well-funded today and allowed retirement benefits to remain untouched.
Most press accounts note that city-worker pensions in Detroit are modest. They rarely mention that, for two decades, the city supplemented those pensions with annual, so-called “13th checks” for retirees—an additional monthly pension payment. Pension-fund trustees—themselves city workers, retirees, city residents, and elected officials—handed out nearly $1 billion in these annual payments to retirees in the city’s general pension fund. The trustees defended the payments as rewards to workers in years when the pension system’s investment returns exceeded projections. In lean years, they justified them as social policy. “Many retirees relied on that check to pay their increased utility bills during the winter,” wrote an attorney for the city’s pension system in 2011. “Also remember that the money would go directly into the local economy.”
Some reform-minded Detroit officials tried to halt the payments, understanding that they undermined the pension system’s finances. When he succeeded Coleman Young as mayor in 1994, Dennis Archer grew alarmed at the extra payments. He was rightfully concerned—as the Free Press noted, the pension system “was largely controlled by union officials acting as trustees.” Archer placed a voter initiative on the ballot in 1996 to cease the extra payments, but ferocious union opposition helped defeat it. “That’s a whole lot of money that if it was in the pension fund today, that may have made a difference in terms of where the pension fund stands,” Archer recently said.
Astoundingly, the 13th checks continued even after the city borrowed $1.44 billion in 2005 to plug a funding hole. Even today, the city’s unions are pursuing legal action to restore the bonus checks. Retirees haven’t been the only beneficiaries. The pension plan also created a savings system for workers to deposit their money. Unlike most private plans, though, this one offered workers guaranteed high rates of return. In some years, according to a report by the Conway MacKenzie consulting firm, workers got an interest rate far exceeding pension investment gains. In 2009, for instance, the pension system gave workers a 7.5 percent return on their savings, even though pension assets slumped by 24 percent. In its report, Conway MacKenzie called such payments “an abuse of discretion” and noted that the trustees, who determined the yearly guaranteed return, were “effectively robbing (the General pension fund) of precious funds necessary to support the traditional pensions the city had promised.”
The long-running pattern of granting these bonuses and guaranteed investment returns is one reason why the city’s emergency financial manager, Kevyn Orr, is seeking to make reductions in worker pensions part of Detroit’s bailout plan. He’s also considering efforts to freeze the city’s current pension system and replace it with a new one for workers. That would likely keep the current trustees from having any future role in the system.
What has happened in Detroit ought to shine a light on guaranteed returns and bonus payments elsewhere—they’re more common than many taxpayers realize. Recently a judge ordered Wayne County, Michigan, to pay $32 million into its pension system to restore the 13th check to county retirees. Facing a budget crunch, the financially troubled county eliminated the checks in 2010. The 13th check is also part of a continuing dispute between the city of San Jose, California, and its workers over pension changes. Voters passed a reform initiative in November 2012 that would eliminate the bonus checks, saving the city about $20 million annually, but workers have taken the city to court to overturn it.
One good reason to eliminate such bonus payments, especially when they’re tied to investment returns, is that they violate the basic principles of defined-benefit pension plans, which guarantee government workers a pension based on a preordained formula. Giving retirees a bonus lets them enjoy the upside when markets are good, while the structure of the plan protects them on the downside by ensuring their basic pensions. That leaves taxpayers on the hook when pension-fund performance lags. Only when a government goes bankrupt are municipal workers likely to share in the pain. That’s exactly where Detroit’s employees find themselves right now.