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End of accounting tricks offers harsh realities for Detroit, others

End of accounting tricks offers harsh realities for Detroit, others

Detroit’s recent bankruptcy filing, the largest of any municipality in U.S. history, has drawn a lot of attention to the sustainability problem that has long been facing many state and local governments.

While the bankruptcy has been attributed to a number of factors, the majority of the city’s $18.5 billion debt can be traced to unfunded liabilities.

The population flight no doubt has played a big role in the city’s ability to generate the necessary revenue to fund these programs. However, Veronique de Rugy of NRO argues that there is a more systemic failure in the calculation of pension funds, which has led Detroit into bankruptcy.

Pension funds need to assume a certain rate of return on their current assets in order to gauge whether or not the assets held today will be enough to pay future benefits. Obviously, the assumed interest rate or rate of return has a major impact on whether a pension plan is adequately funded. Most [private] pension plans would rather play it conservatively and assume a lower rate of return, so that they ensure that the assets they have today will be enough to cover tomorrow’s promised benefits. But the states would rather put less money up front today, so they’re pinning all their hopes of being able to pay benefits tomorrow on an 8.5 percent annual growth rate. If that 8.5 percent growth rate doesn’t come to fruition, either tomorrow’s beneficiaries will see a cut in their benefits or taxpayers will be asked to pick up the tab. It would be much more prudent to assume an adequate risk-adjusted rate of return closer to the rate offered on 15-year Treasury bonds—3.5 percent, say—and fund their plan accordingly.

Prudent, yes. But Detroit has not utilized this level of prudence in its accounting practices, instead opting to project annual growth at 7.9 to 8 percent. Failing to hit that mark results in greater than anticipated debt. What’s worse, Detroit is not alone in having to face up to these realities.

A change in accounting practices to a more realistic projection like that described by de Rugy has just been green-lighted in California, and could potentially double the amount of the state’s unfunded liabilities, bringing the total to $328.6 billion. Facing their respective budgetary realities will also have a significant effect on many municipalities.

The pension changes from Moody’s, and separately the Governmental Accounting Standards Board, scheduled for this month, could result in Los Angeles, San Francisco, San Jose, Azusa and Inglewood joining fiscally troubled Stockton and San Bernardino, among others, as severe credit risks.

Although the ultimate fate of Detroit remains uncertain, California illustrates how important it is for struggling state and municipal governments to take proactive measures in reassessing their liabilities.

Principally, they must consider opting for reasonable projections on their investments, instead of kicking the can down the road until bankruptcy becomes the only option. If not, a recent Senate report succinctly characterized the likely outcome.

When the states with the worst pension systems come knocking at Washington’s door for a bailout, it will ultimately be taxpayers in more prudent states who will pay for the recklessness of the negligent states.

A refrain the American people have surely grown tired of hearing by now.

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Comments

For 50 years, Detroit has been run by the unions, and (pardon my langauge), blacks.

For 50 years, they have played the game ‘We’ll give you this and that and the other’ with unions, all based on IOU’s (never ending increases in pensions, retirement health funding, etc, etc.

Now it’s all crashing down on them. And us (US citizens in general), becuase, count on it, one way or another, we are ALL going to end up paying those union pensions for all those city union employees.

What amazes me, what blows my mind (OK, not much of an explosion), is that they have a museum with $1 – $2 BILLION DOLLARS of artwork (depending on what report you read), that some elements want to say are ‘off the table’ in bankruptcy. WTF ?

Not to mention some little county circuit court judge-ette, in a distant city, and distant county, thinks she can issue orders about the state Constitution, and cities / counties far out of her jurisdiction ???

How is that order not already moot, based on simple jurisdiction ? SHe thinks she has global power to order the state, the Governor, and distant cities, based on WHAT ? That she thinks those entities ‘failed to honor President Obama’ ????

What law is that, exactly, that requires her wishes be met on that point ???

    serfer1962 in reply to pjm. | July 21, 2013 at 5:27 pm

    Do NOT forget the primary reason that still continues…VOTES & MONEY.
    Kommiecrats have always given tax payer funded benefits in exchange for campaign donations & votes. Overburden the system with shovel-leaners? So what

Let us recall that most private pensions 30 years ago were also “defined benefit plans,” which promised the employee he would get X per month on retirement, usually a % of his average income. But sometimes these plans failed, for essentially the same reason – not enough money put into them by the sponsoring company over the years to pay the promised benefits.

With ERISA, the law made such plans prohibitively expensive, there was no longer any way to skip a year’s funding or under-fund the plans, and the pension plan could no longer be used for any other business purpose. This gave rise to “defined-contribution plans,” like 401Ks, overnight. You know what goes in, you can direct how it is invested, but you get out whatever is there at retirement.

It is far more realistic, and employees are better protected. BUT virtually all government employee pension plans remained “defined benefit plans,” and virtually every government entity supervising those plans behaved in ways that would get a private employer locked up.

I see no reason the people of my state should undertake to fulfill the broken promises the state of California or City of Detroit made to their workers 30 years ago.

    madshark in reply to Estragon. | July 21, 2013 at 4:12 pm

    “When the states with the worst pension systems come knocking at Washington’s door for a bailout, it will ultimately be taxpayers in more prudent states who will pay for the recklessness of the negligent states.”

    I don’t believe it will come to that, because I believe that most taxpayers are going to be of the opinion “I see no reason the people of my state should undertake to fulfill the broken promises the state of California or City of Detroit made to their workers 30 years ago.”

    I happen to be a former employee of two different municipalities in California, and thus a beneficiary of CalPERS. I am currently drawing retirement benefits, but in all honesty, I do not expect them to collect them at their current rate through the remainder of my life, because I do not believe that the taxpayers will allow for any kind of bailout. I also believe that Social Security benefits will have to be trimmed back, and am trying to plan ahead accordingly.

    When the time comes to shave everyone’s benefits (and I do feel that it is inevitable), I hope that all government retirees (including law enforcement and others who worked in the field of public safety) are included and subject to the same cuts.

      pjm in reply to madshark. | July 21, 2013 at 5:01 pm

      “most taxpayers are going to be of the opinion “I see no reason”

      – you anticipate that this will have WHAT effect on the politicians and power-wielders, exactly ?

        mzk in reply to pjm. | July 22, 2013 at 6:06 am

        Oh, there are limits. The last “immigration reform” got killed in spite of all of the politicians wanting it. And Obama didn’t get another huge spending plan.

      mzk in reply to madshark. | July 22, 2013 at 6:04 am

      I appreciate your attitude.

      When and if California goes, it should get FEMA and nothing else. Food, water, and public shelters. Relocation programs. That’s it.

LukeHandCool | July 21, 2013 at 4:02 pm

The end of accounting tricks marks the beginning of lefty blame games:

From Melissa Harris-Perry whining about a government portion too small to Ed Schultz dining on charbroiled madness: “But thanks to a lot of Republican policies, the city is now filing for bankruptcy.”

Mitch Ryder and the Detroit Spinning Wheels:

“Little Liberal Looney Lu.”

Sharpshooter | July 21, 2013 at 4:02 pm

“When the states with the worst pension systems come knocking at Washington’s door for a bailout, it will ultimately be taxpayers in more prudent states who will pay for the recklessness of the negligent states.”

Well, this is a consequence of two factors:
1) Public sector unions, which even that old school fascist FDR warned against, and, 2), the bureaucratic/welfare state, which took 80 years to arrive, during which time our grandparents and great-grandparents went along for the ride.

We can see the same ostrich-like refusal to acknowledge debt with regard to the Democrats in the federal government.

Re Detroit, buried in the accounting tricks was a quiet settlement of “credit swap” debt. Conveniently hidden. This is the new bubble. And it’s global. Just wait…

Time for some “tough love” for munies that mismanaged their pension systems. I’m with Rand Paul. A bailout “over my dead body.”

ColonialGal | July 21, 2013 at 5:12 pm

They have a big black fist is there really anything more that needs to be said?

Ed Schultz: Michigan used to be a symbol of industrial strength in manufacturing in this country. But thanks to a lot of Republican policies, the city is now filing for bankruptcy.

    avwh in reply to Neo. | July 21, 2013 at 8:49 pm

    I expect to see this meme a LOT by the Dem mouthpieces in the MSM.

    Blame “Republican policies” and “deindustrialization” for Detroit’s failure, when Dems have run the city for over 50 years.

    Lots of other blue cities and states have played the same game, over-committing to public employee unions for health and retirement benefits (in return for campaign $$ and get-out-the-vote shoe leather), and seriously underfunding those same benefits (because they’ve been unaffordable for a long time).

    It’s only a matter of time until more of these fiscal fiascos surface in other blue strongholds.

[…] they might as well call it Trayvon City. A citizenry that will not face facts. A citizenry that votes and supports leadership based on skin color has no right to criticize anyone […]

Words of Wisdom from the American Experience: Detroit Court Case Presents an Impossible Choice

Because there is no money, there is no solution that gives the unions the relief they seek. Total obedience to the state constitutional mandate might not be possible, and that’s a problem. The government can pass a law saying that everyone has a constitutional right to a free trip to the moon, but if it doesn’t build the spacecraft that can get you there the right is void.

While the principle that federal law trumps state law on most issues is pretty clear, there are real arguments on both sides in this complicated case. But if the state constitution is unenforceable as well as being in conflict with federal law, it would be that much harder for the state constitution to block the execution of federal bankruptcy law.

However the courts eventually decide, decades of misgovernance, the criminal corruption of the Democratic Party in Detroit, and the depraved indifference of politicians at every level as crooks and hacks conspired together to loot and wreck a great American city have brought us to a place where Detroit’s problems seem almost beyond solution. The saddest part of this story is that there is still much, much more pain to come for a lot of people. Both the residents of current day Detroit and the cops, teachers, firefighters and others who trusted in the promises of Detroit politicians and union officials face a world of hurt.

Detroit is going to need some outside help to get back on its feet…

It’s interesting that the federal government got Detroit hooked on government money way back in 1966 via the Demonstration Cities and Metropolitan Development Act of 1966 or “Model Cities Program”. That law is still on the books and could be used to funnel federal money to Detroit should congress agree.

Even if an investor didn’t know Bernie Madoff was corrupt, being aware that he was above the market average for months at a time entitle the court to some claw back? While those receiving pensions were not necessarily at the heart of this scheme, they should have been aware that things were too good. Perhaps giving them 10 cents on the dollar will teach other public employees not to get too greedy.

When Enron collapsed, not all employees lost their shirts in their 401(k)s. One fellow had been employed by Exxon. Exxon is also very profitable. Whenever he asked for any expenditure, he had to ask several times and be well justified in the needed equipment. At Enron his requests were filled on the first asking. He could tell something was wrong, he just wasn’t sure what. So he took the matching funds and got them out of Enron as quickly as he could.

    Olinser in reply to Milwaukee. | July 22, 2013 at 9:41 am

    The problem, Milwaukee, is even worse than that.

    The pension funds aren’t investing in Madoff.

    The pension funds ARE Madoff.

    They know damn well what rate of return they are getting. They choose to project stupidly unrealistic rates of return so they can kick the can down the road a few more years until they got theirs and are out of office.

    Why do you think we always talk about ‘unfunded liabilities’? That’s the difference in a REALISTIC rate of return and the rainbow-shitting-unicorn rate of return.

    These people are criminal. And unfortunately, Republicans are just as bad when they get in office, because they either let them get away with it, or they do it themselves.

Myself, I collect a pension from Wisconsin teachers retirement fund. In the 1980’s mean old Tommy Thompson tried to raid the fund. The union sued, and Wisconsin had to make the fund whole. That is one government pension which is in good shape. Had it been a Democratic governor, I’m not sure the teachers union would have made such a stink.

    The WEA has been selling the Tommy Thompson story and the “fully funded” pensions story for a long time. The fact is that all public pension funds have been using a too-high ROI numbers in order to keep the unfunded liabilities number low. In 2010, JSOnline reports that the Wisconsin Teachers pension was $10.9 billion short.

Yesterday, US Rep.John Conyers, (D) Detroit wrote a letter to Congress saying the following.(From Channel 7 news, Detroit)

“DETROIT –
U.S. Rep. John Conyers of Michigan is calling for congressional hearings on Detroit’s bankruptcy.

The Detroit Democrat says Chapter 9 bankruptcies by local governments are on the rise, and Congress should explore a number of “troubling” ramifications of Detroit’s bankruptcy. Conyers wrote a letter to the House Judiciary Committee’s Republican chairman saying he’s concerned the bankruptcy process is being misused to “unilaterally” abrogate Detroit retirees’ pension and health care benefits.

He also has questions about whether the state misled pension funds’ lawyers before making the filing and if an unelected official such as Detroit’s state-appointed emergency manager should have been able to commence the filing.”

In case Rep.Conyers name is unfamiliar, here are some of the highlights of his career.
He has represented Detroit since 1965, second only to John Dingell(to whom he was an assistant before being elected)as the longest serving Congress fossil.
He is fully and completely a major progressive, borderline Marxist. He has a long list of pet projects including providing special protection to Islamic interests, has been investigated and admitted to Congressional Ethics violations, was implicated in the Congressional banking scandal of 1992, etc. etc. Founding member of the Congressional Black Caucus.
His wife, Monica, was a Detroit City council member, who in 2009, plead guilty to receiving $60,000 in bribes for preferential city contracts after a lengthy FBI investigation. She was sentenced to appx.three years in prison(she is at Alderson, Martha Stewarts old hangout). John of course, said he knew nothing of this, LOL.

Gee, yes, it was all those awful Republican policies that put Detroit in the toilet.

    Conservative Beaner in reply to Uh Huh. | July 21, 2013 at 7:54 pm

    As that old saying goes, follow the money. If Conyers issist on an investigation then let us go anywhere the money trail leads.

    Start with his wife, past/current mayors and all city council members past and present. Include union leadership and all contractors, especially any family members who did business with the city of Detroit. When you find the corruption, start siezing the money to help fund all those pensions.

    randian in reply to Uh Huh. | July 21, 2013 at 9:35 pm

    he’s concerned the bankruptcy process is being misused to “unilaterally” abrogate Detroit retirees’ pension and health care benefits.

    Can Conyers really be this stupid? Bankruptcy is by definition unilateral.

    if an unelected official such as Detroit’s state-appointed emergency manager should have been able to commence the filing

    What does “unelected” have to do with anything? The manager was appointed, pursuant to state law, precisely because Detroit’s elected officials were unable or unwilling to do their jobs. There is nothing to see here.

Along with Detroit’s demise in finances was the total destruction of their public school system. Their Democratic leaders got away with the damage they caused because they had no one to judge their lack intelligence, quality, or integrity. All of the former mayors (and people like Conyers) spoke to those who weren’t taught how to make smart decisions.
They voted for the wrong kinds of power.

    Bruno Lesky in reply to Barbara. | July 22, 2013 at 7:00 am

    The Detroit School District pres was a functional illiterate. Otis Mathis forced to resign in 2010 as a school official reported him for repeated masturbation in meetings with her.

    Odd about the “repeat” but that’s what how the report read.

    All tragic.

In February, Moody’s Investors Service announced that the unfunded liabilities for Calpers would rise from $128.3 billion to $328.6 billion if a 5.5% return on investment was used in the California pension fund’s unfunded calculation. Interesting, the world’s largest pension fund was using 7.5% in their own calculations, while Ed Ring, the director of the California Public Policy Center believes that 4.5% more fairly represents Calpers long-term future ROI.

As unfunded liabilities rise, Calpers is forced to charge participating communities with higher and higher fees and unions are successfully suing local governments to prevent privatizing services. Here is the story of Costa Mesa’s failed attempt.

Since public pensions are not covered under ERISA law, look for a move by the blue states to get government employees covered in order that certain pension payments will be paid through the Pension Benefit Guaranty Corporation.

Emil de Blatz | July 22, 2013 at 12:00 am

The critical consideration is – can the costs of Detroit’s mismanagement be offloaded onto the taxpayers of Michigan, or spread even more widely over the taxpayers of the United States?

I know enough about bankruptcy law and economics to have understood several years ago that Detroit was a Chapter 9 case, waiting to be filed. (I still find it hard to believe that they were able to raise about $250M in a bond offering in 2010 – who buys such shit?) I also know that in every conflict between state law and federal bankruptcy law that I have seen, state law is trumped. When I saw Friday’s ruling from Judge Aquilina in Ingham County, I initially laughed. Especially when I saw her handwritten addition to the end of the order: “A copy of this Order shall be transmitted to President Obama.”

On further consideration, if withdrawing the bankruptcy case would make it less likely that federal taxpayers are going to have to make good the excessive promises of the City of Detroit to its retirees, maybe I like her way of thinking.

    Bruce Hayden in reply to Emil de Blatz. | July 22, 2013 at 7:30 am

    I see the Dems trying to unload state and municipal pensions onto the rest of us. I just don’t see it working as long as the Republicans hold the House. Now, if Pelosi retakes the Speakership, I think it is a done deal, even if the Reps retake the Senate. The problem here, I think, is the Hastert rule, where a Republican Speaker isn’t supposed to bring anything to floor that doesn’t have the backing of his caucus. He is under immense pressure by the DC establishment right now to do that with the Senate’s version of Immigration “Reform”, but knows that if he does, he is likely to lose his Speakership. And, a Republican caucus is not about to do something that primarily rewards the Blue State model, and gives any more power to government employee unions.

    Detroit may have gotten where it is more through crashing demographics than excess promises to employees, but the later is still a concern. California though is the place that scares a lot of people, and one of the biggest scares there is the level of abuse seen in their municipal pensions, where people are retiring on pensions of hundreds of thousands of dollars a year. And, part of this is the “spiking” done by retiring police (and fire?), where their pensions are based on their last year or so of work, and so they have first call for overtime, even when it would be much more economical to have much lower paid officers work the overtime. That sort of thing, where the beneficiaries seem more than willing to make everyone else pay for their excessive benefits.

    Making things worse for the current, and esp. former, municipal workers is that the most egregious examples involve government unions, and those government unions give almost entirely politically to the Dems. This essentially means that if the feds were to accept responsibility for these municipal pensions, that some of that money is going to end up in Dem party coffers (just like a lot of the “Stimulus” and some TARP money did). Not something that is going to be popular with the Republican base, or the Republican House caucus.

[…] Accounting Tricks and Detroit – Brian Jacoutot, L.I. […]

start convicting some politicos for fraud

Oh, but you didn’t talk about the biggest trick of all, annexation. One of the lib commentators excused Detroit’s excessive per capita budget by claiming the land area of Detroit was more than SF, NYC and some other city combined. Well, I think I will harsh that narrative… a city grows in land area via the power of annexation of neighboring UNINCORPORATED areas. Why do cities do this? TAX BASE A city attempting to increase the revenue will oft times FORCE others unwillingly to be included in their little club. The only defense against annexation is incorporating to become your own town/municipality. If some of you will remember back in the 1980s Houston was expanding by leaps and bounds via annexation and the citizenry struck back to defend themselves against Houston’s unwanted advances by incorporating, thus there are cities within Houston completely surrounded by it.

The corrupt money grubbing leaders of Detroit swallowed up swaths of illinois like a vacuum cleaner looking for every last penny they could literally steal. So the drop in Detroit’s population is actually far more than from the 2 million high point when it was a much smaller city as every time they annexed unwilling neighbors they then imposed their corrupt blight upon the surrounding communities. The reason why Detroit failed in the end is that they couldn’t kidnap anymore neighbors into paying for their unsustainable Ponzi scheme of social justice with everyone on the government dole.

NC Mountain Girl | July 22, 2013 at 11:50 am

While the entire public pension system is rotten, Detroit is the hardest case because there is so much else that has gone wrong. Many cities that have lost net population have also become havens for a significant core of affluent new residents -even if on a temporary basis. The area around Chicago’s loop and its north lakefront is such a place. Indeed there now seems to be a pattern of families where iy had become a custom that one lives in the city while childless, moves to the burbs for the schools, then moves back to the city when the kids enter college.

With its incredibly poor city services and an at large city council system that diffuses and dilutes political responsibility, Detroit doesn’t offer the same appeal. If Detroit were a business, it would be strictly a Chapter 7 candidate.

If you want to fix the accounting systems NATIONWIDE (not just in Detroit) there’s one simple solution: make them accountable to the same rules as private pension plans.

As it stands, governmental pension plans (city, state, municipal, etc.) aren’t forced to follow EBSA, PBGC, or other relevant statutes like, say, the Village Inn Pension Plan would be obligated to follow. They can use any interest rate, not one that is ORDERED by the DOL. Currently, that rate is hovering around **3%**.

When you assume such a low (if realistic) interest rate, it’s much harder to underfund your plan. But it’s MUCH more expensive. Why do you think such rate regulations were imposed on all private plans?

Because prior to repeated regulation of the private retirement industry (via EGTRRA, GUST, TRA86, etc.) they too saw huge unfunded liabilities and failing plans. Now, they’re solvent or they freeze all future accrual of benefits and liabilities.

Trust an expert with 20+ years experience in this field (QPA, QKA). Government plans are broken like EVERYTHING that government does is broken – because they don’t follow the same rules they place on us, the private citizens.

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