The mayor of Hartford, Connecticut, Luke Bronin has been intimating for a number of months that the city may need to file Chapter 9 bankruptcy. Chapter 9 bankruptcy is a form of bankruptcy where a municipality can seek to reorganize its debts, and arrange such debts in a reduced payment over a period of years.
According to reports, Hartford currently has a $65 million dollar deficit and has problems meeting its obligations, including upcoming shortfalls in revenue of $7 million in November, 2017 and $39.2 million in December of 2017. In September, 2017 Bronin allegedly informed the Connecticut Governor, Daniel P Malloy and numerous legislative leaders that he expects the city to file Chapter 9 bankruptcy if the city does not receive sufficient state funding by early November.
Bronin had requested the state provide at least $40 million dollars more this year, in addition to the $260 million dollars previously granted. Democrats in the state legislature offered to provide $40 million dollars to $45 million dollars. However, the Republican budget was adopted, which offered the city only $7 million dollars in additional aid. The Republican budget was vetoed by Malloy. Currently, the state of Connecticut is operating without an approved budget. Representative Brandon McGee (D), “It’s been really impossible to reassure people that bankruptcy is not there. It’s there. It’s real.”
Bronin has scheduled a number of public hearings to discuss the possibility of a Chapter 9 bankruptcy filing. A number of panelists have been invited to provide insight into the ramifications of the filing of a municipal bankruptcy, including Kevyn Orr, the former emergency manager for Detroit, which filed Chapter 9 in 2013, Central Falls, Rhode Island Mayor James Diossa, whose city filed Chapter 9 bankruptcy in 2011, and Don Graves, the senior director of corporate community initiatives at Key Bank.
Bronin commented, “The discussions are aimed at shedding light on the Chapter 9 process in other cities, so we can learn from the experience. As we consider all of our options for putting the city of Hartford on a path to sustainability and strength, it’s essential that our residents are a part of that conversation. We’ve had a number of requests for a more detailed discussion of what bankruptcy would mean for our city.”
The police and firefighters unions, which are two of the city’s largest and politically powerful unions, have undertaken the procurement of advice from attorneys who specialize in Chapter 9 bankruptcy. In addition, the American Federation of State, County and Municipal Employees Council 4, Local 1716, which represents about 400 city employees, has sought advice from its national leadership.
Vincent Fusco, the leader of Hartford’s fire union said, “If bankruptcy goes through, it’s over. Forget everything we gave up, it’s over.” The president of the Hartford Police Union, John Szewcyzk said, “We’ve met with counsel, and obviously we’ll be protecting our members that are relying on their pensions they paid into their whole careers. We would fight to keep our pensions.” A spokesman for Local 1716 stated, “What we don’t want to happen is some kind of grand bargain that destroys the quality of life for dedicated servants and destroys the quality of work they do for the residents and business of Hartford.”
Hartford’s biggest bond insurers, Assured Guaranty and Build America Mutual, is assessing the situation in Hartford, and constructing a proposal for a solution outside of bankruptcy. Assured Guaranty alone insures over $311 million dollars of Hartford’s debt. Build America insures approximately $103 million dollars of the city’s bonds.
One news article stated that Hartford’s fire union agreed to concessions in 2016 that are claimed would save the city $6 million dollars over the span of its four year contract. The teacher’s union also agreed to a contract extension with provisions for no wage or benefit increases. Local 1716 declined a tentative agreement that would purportedly save the city $4 million dollars over six years.
Hartford faces many fiscal challenges. High taxes, declining revenue, $73 billion dollars in pension and debt obligations, and continuing flow of people and business leaving the city, are among the most prominent difficulties confronting Hartford.
CHAPTER 9 BANKRUPTCY TEST
Hartford’s Chapter 9 bankruptcy must establish that the city is insolvent and that it has negotiated in good faith with its creditors. Bronin must also obtain approval from Governor Malloy to file Chapter 9. Some in Hartford argue that Bronin must also obtain the city council’s permission. While some city council members maintain such permission is necessary, Bronin disagrees.
Council president Thomas “TJ” Clarke II opposes the filing of the Chapter 9 bankruptcy, but conceded it is an option, “If we are forced to take that option, then I think everybody would be on board.”
Assured Guaranty officials have not publicly stated whether they will oppose the bankruptcy. However, Holly Horn, the company’s chief executive officer stated in September, 2017 that “bankruptcy is not the solution.” Continues Ms. Horn:
“It’s going to be a long, expensive process and there are no guarantees. There are no guarantees that Luke (Bronin) is going to get any certain percentage of haircut out of the creditors. We think there are solutions outside of bankruptcy that are more beneficial for the state and for Hartford.”
CHAPTER 9 BANKRUPTCY BASICS
A city that files Chapter 9 bankruptcy does not relinquish governmental control to a bankruptcy trustee or bankruptcy judge. The operational control over the city is typically the same as that existed before the filing of the Chapter 9 bankruptcy. The mayor will remain the mayor. The elected officials are typically the determiners of the city’s reorganization plan, and not an outside party or trustee. However, in order to obtain state approval for its bankruptcy filing, the city undoubtedly will need to cede much of its financial control to an oversight board.
All interested parties will undoubtedly attempt to influence the plan that is submitted to the bankruptcy judge. Such parties include bondholders, general creditors, lessees and lessors, pension recipients and current employees. The plan must be feasible, or have a reasonable chance of success. Additionally, the plan must be in the best interests of the creditors.
The plan must be “fair and equitable.” This does not mean that all stakeholders or creditors are treated identically. The Detroit bankruptcy, for example, is purported to have decreased pensioners benefit values by 6%, existing employees 12%, and bondholders suffered a 30% reduction.
CHAPTER 9 BANKRUPTCY RAMIFICATIONS
Municipal Market Analytics in a newsletter to bond holders and other investors enumerated some of the issues Hartford might experience from filing Chapter 9 bankruptcy, including higher interest rates, and reduction in the state’s bond rating. Wrote Municipal Market Analytics:
“Should the city of Hartford actually default or be permitted to file Chapter 9 bankruptcy, other Connecticut cities are likely to face somewhat higher borrowing costs going forward.”
Connecticut has already suffered downward adjustments to its bond rating. In May, 2017, Moody’s Investors Service and Standard & Poor both reduced Connecticut’s bond rating during the state’s budget negotiations. Recently, Standard & Poor lowered Hartford’s bond rating to CC, four levels lower than its previous B- rating. Moody adjusted Hartford’s rating downward from Caa3, from a previous Caa1. Hartford is approaching junk bond status. This will have a large effect on its future borrowing costs, as the city will have to pay higher interest rates to finance its accumulating debt.
PRE BANKRUPTCY NEGOTIATIONS
According to the Hartford Courant, bond insurers have made offers to Bronin to refinance Hartford’s debt. These include extending payments and reducing immediate contributions. However, according to the same publication, Bronin has resisted such efforts, because he does not wish to prolong payments and burden future administrations.
DETROIT’S MUNICIPAL BANKRUPTCY
The Chapter 9 bankruptcy filed by Detroit has been hailed by some as an exemplar of a successful reorganization. The mayor of Hartford appears to be a strong proponent of his city committing to a Chapter 9 filing. The mayor has invited a number of officials who were involved in Detroit’s bankruptcy to his numerous public meetings, and appears to rely heavily on their counsel.
The Detroit Mayor, Mike Duggan, told the City Council that the city’s 2016-2017 financial plan contained the third consecutive year of balanced budgets for Detroit. Duggan said, “We are running the city in a responsible manner.” Provided the city remains within a balanced budget, the city may remove itself from oversight by the state as soon as December, 2017. A budget deficit will renew a three year period of oversight by the Financial Review Commission, a city and state board that has controlled Detroit’s public finances, since Detroit completed its Chapter 9 bankruptcy in 2014.
Detroit currently receives 78% of its annual revenue from the city’s income taxes, property taxes, utility users tax, casino revenues and state revenue. The police, fire, and emergency services consume approximately 40% of the city’s budget.
It appears that 40% calculation does not include the full expense presented by the city’s public pensions. The city has a $490 million dollar unpaid obligation to the Police and Fire Retirement System and the General Retirement System.
Pursuant to the Chapter 9 bankruptcy, Detroit was permitted until 2024 to make a $112.6 million dollar payment to the pension plans. However, new calculations may place the payment at $196 million dollars or more. Mary Sheffield, one of the council members, questioned how the city could spend $177 million dollars on law firms and consultants, and receive calculations that were short by almost half a billion dollars.
New calculations place the 2024 payment at $167 million dollars and provide an increase of 2% each year for the next 20 years. The payment was revised upwards from the city’s bankruptcy exit plan. Mayor Duggan has said that the prior estimate was based upon unrealistically optimistic projections that the former emergency manager, Kevyn Orr did not reveal to him.
According to 2015 audit of the city of Detroit, transportation costs the city approximately $100 million dollars per year. The Detroit pension settlement will cost the city about $979 million through the year 2023.
In addition to the city’s pension issues, the public school system in Detroit carries a debt of approximately $3.5 billion dollars. Enrollment has been declining, almost half the children are now enrolled in charter schools, school buildings are in serious disrepair, and the city’s students are among the lowest performing in the nation.
HOW GENEROUS ARE DETROIT PUBLIC PENSIONS?
It appears that the primary force driving the municipal bankruptcies of Detroit, San Bernardino, Stockton, Vallejo, and possibly Hartford, are the costs associated with the respective cities public pensions and medical coverage promised to its public workers by elected officials.
In the example of Detroit, retired general city workers, for example, librarians and sanitation workers received average annual payments of $18,275 in 2011, according to the Detroit General Retirement System. This is the average payment. A general city employee who retired in 2011 with an average salary of $60,000 and 40 years of service can receive an annual pension of $45,000.
As with most municipalities, the pension benefits granted the police officers and firefighters are typically much more generous. For Detroit police and firefighters, pension checks averaged about $30,000 in 2011. However, a 30 year veteran of the fire department who retired in 2016 with an ending salary of $60,000 could receive an annual pension payment of $45,000.
In Chicago, the pensions awarded its police and firefighters are more generous. Retired police in Chicago receive an average annual benefit of $55,104 and its retired fire fighters receive annual benefits of more than $60,000.
Such benefits continue for the duration of the life of the retired public employee. In addition to lifetime payments, these public employees also receive retiree healthcare. Such plans carry coverage that exceeds those available to those in the private sector.
In addition, the retiree can often extend such payments to a spouse after they die.
DETROIT AFTER BANKRUPTCY
While Detroit did make some substantive changes to its public pension commitments pursuant to its Chapter 9 bankruptcy, it is doubtful such changes are sufficient to restore the financial health of the public sector in Detroit. The city did not reduce the public pensions of the police and fire fighters but simply reduced the cost of living adjustments of such pensions by 55%. The general employee cost of living adjustments were eliminated and benefits were reduced 4.5%.
The Detroit pension system in 2017 is still underfunded by approximately $1.59 billion dollars. A recent Detroit audit claims the city hopes to have its pension system funded 75% by 2023.
The city has less public employees than before its bankruptcy filing. Full-time Uniformed police employees numbered 2,389 in June, 2013, and number 2,260 today. The fire department has lost 100 employees and the public works department counts 209 fewer employees.
Detroit has stopped accepting new employees into its defined benefit pension plans, and now offers a hybrid plan, with features similar to a 401(k).
While there has been some reform of the public pension system in Detroit, such reforms and reductions in benefits were not of significant value to enable the city to recover from its financial malaise. The public pensions continue to strangle the city’s finances. The city has little available revenue to meet its basic obligations in terms of investment in infrastructure. The Detroit pension system is currently still underfunded in the area of $1.6 billion dollars. The Detroit bankruptcy of 2013 is probably simply a precursor of the Detroit bankruptcy of 2024.
MUNICIPAL BANKRUPTCY AND BONDHOLDERS
In a Chapter 9 bankruptcy, bondholders are supposed to receive varying treatment depending upon the type of bond issued. General Obligation Bonds (GOs) are considered to be general debt of the municipality and unless secured by a statutory lien, are treated as general unsecured debt. Bonds secured by specific contracts or revenues are generally to be given special revenue status and carry a continuing lien past the filing of the Chapter 9. It appears the general treatment of the bonds in Chapter 9 filings is a restructuring of such debt through principal or interest reductions, maturity extensions, or refunding of the debt.
In the Detroit bankruptcy, the police and fire fighters received only a reduction in cost of living adjustments, the general city workers received a moderate decrease in pension payments, and general bondholders received approximately 14 cents on the dollar. Holders of unlimited tax general obligation bonds received about 75 cents on the dollar.
The Chapter 9 bankruptcy filing in Jefferson County, Alabama resulted in a 42% reduction in the bondholders’ investments, while the pensioners received no reduction in benefits. In San Bernardino, Stockton, and Vallejo, bondholders experienced losses of up to 99% of their holdings, while the bankruptcy courts fully preserved the public pensions of the retirees.
The various bankruptcy courts’ treatment of the disparate creditors in these municipal bankruptcies runs contrary to the bankruptcy code. The bankruptcy code provides that secured creditors are to be given priority over unsecured creditors. Additionally, similarly situated creditors, such as pensioners and unsecured bond holders are to be treated similarly.
The Detroit bankruptcy, in particular, and its approval by the assigned bankruptcy judge, violated essential principles of bankruptcy law. The pension recipients who were members of the more politically power unions, such as police and fire fighters, received relatively insignificant reductions in their benefits, in comparison to the bondholders, including such bondholders holding secured obligations.
The recent municipal bankruptcies filed in the United States carry similar patterns. The bondholders and other private creditors of the municipalities received much harsher treatment than the public pension retirees. For some, such treatment is politically popular. Why should we treat the “evil bankers” so fairly?
However, the individuals that typically invest in bonds are generally older persons seeking a safe investment, albeit with minimal returns. Some had their investment protected by bond insurance. For others, for whom such insurance did not protect the losses incurred pursuant to the municipal bankruptcy, any loss of investment could be catastrophic.
Politicians and union officials that negotiated the public pensions and benefits enjoyed by the public employees in these and other municipalities, must have known that such obligations could not ultimately be fulfilled. The cities of Hartford, Detroit, Hartford, and others are mere examples of the many distressed cities in the United States, strangled by the public pension promises of such politicians and union representatives.
It is difficult to find sympathy for the public employees who demand that such promises be delivered in full. Private sector employees typically do not enjoy such benefits. Who in the private sector can receive a pension for life after only a few decades of service? Who in the private sector has access to the medical benefits often extended to governmental employees? Who in the private sector can enjoy a pension for life, approximating their working salary, while contributing very little or no monies to the funding of such pension?
The average working person in the United States has approximately 50% of his or her income extracted through taxation. Income taxes, property taxes, gasoline tax, sales tax, utility taxes, cell phone taxes, and other forms of taxation, when aggregated, consume approximately 50% of a typical worker’s income. This is in addition to the hidden taxation that accrues through unnecessary governmental regulation, and the systemic devaluation of fiat currency through inflation and other means.
For many private sector employees, retirement appears increasingly unlikely. The age of eligibility has been incrementally increased. $6 trillion dollars of the now $20 trillion dollar federal debt represents monies that were taken from the social security “trust fund” and committed to other governmental expenses.
Most public pensions programs in the United States are underfunded. The only difference between the varying governmental entities is the extent of the underfunding. The Detroit and other municipal bankruptcies punished bondholders but left public pension benefits largely unaffected.
The harsh treatment of the bondholders means that for these municipalities, the cost of future borrowing will be much more expensive.
It is only a matter of time before Detroit will enter a second Chapter 9 bankruptcy. It is inevitable that many public pensions will severely curtailed or even eliminated. The recent Chapter 9 municipal filings only delayed the necessary reforms to public pensions.
Many more municipal bankruptcies are certain. The only reasonable solution is significant reductions in public pensions. Further taxation will result in the more productive residents of these cities finding solace in states with lower taxation. Many residents of Illinois are moving to states with lower taxation such as Florida and Texas. Prominent among these refugees are the younger residents of the states such as Illinois, New York, New Jersey and Connecticut, among others, who are unwilling to endure the high taxation imposed upon them. Those with portable skills and businesses are seeking residence elsewhere. Who will be left to pay the taxes when the taxpayers leave?