Public Pensions Face Underfunding Crisis

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Courts have declared public pensions--as distinct from private ones--to be absolutely sacrosanct, inviolate. In California, government's obligation to pay is written into the state constitution.

Says San Diego's Zucchet, "Cities can't just say, 'Whoops, I got in over my head.' They have to find a way to fulfill their promises."

In the private sector, of course, vested pensions get re-jiggered all the time, through bankruptcy. "Look at the airline industry, autos, steel," says John Schotz, co-founder and chief investment officer of Saybrook Capital in Los Angeles.

"In all those industries, benefits paid retirees were adjusted down because of bankruptcy. It's why you've got somebody retired from United Airlines whose pension went from $180,000 a year to $42,000."

What happens when a city declares bankruptcy?

Would-be pension busters and worried unions are watching with interest what happens in Vallejo, California. The town, badly battered by the closing of a naval base on which its economy depended, sought relief from its creditors in May 2008 under Chapter 9 of U.S. bankruptcy law. Its creditors include city unions, some of whose pensions are generous.

In a groundbreaking decision, the judge in the case, Michael McManus, ruled that the city's labor contracts can be overturned in bankruptcy.

Says Schotz, "Most people felt the only reason Vallejo filed for bankruptcy was to pop the unions."

Will Vallejo, through bankruptcy, be able to pay pensioners less than 100 percent of their promised benefits?

Marc Levinson, the lawyer representing Vallejo, is quick to emphasize that no such request has been made yet by the city: "Vallejo has not asked the judge to modify pension benefits." Some lawyers, though, "have contended that the bankruptcy code permits pensions to be modified. I would be very surprised if someone in the future did not try to do so."

The pension debacle, he notes, is huge, nationwide, and only getting worse. That doesn't even count state pension shortfalls -- the Pew Center on the States reckons that there's a $1 trillion shortfall at the state level.

How will it end? Levinson doesn't know, but he thinks any resolution, when it comes, will be grisly. There is, though, one bright spot:

"I'm 62. Happily, I'll be dead by then."

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