The Stockton crystal ball: what a pension guarantee will do to Illinois

With nearly 300,000 residents, Stockton is the largest city in the United States to declare bankruptcy. It is also one of several California cities to file for bankruptcy due to the recession and skyrocketing government worker pension costs.

A U.S. Bankruptcy Court has given Stockton, California, Chapter 9 bankruptcy protection, foreshadowing the coming battle that Illinoisans could face as government worker pensions and retirement costs overwhelm the budgets that fund them.

With nearly 300,000 residents, Stockton is the largest city in the United States to declare bankruptcy. It is also one of several California cities to file for bankruptcy due to the recession and skyrocketing government worker pension costs.

At the heart of the Stockton crisis is the city’s crushing $900 million debt to the California Public Employees’ Retirement System, or CalPERS, which has led the city to make big cuts to core services. Residents are suffering so the city can continue paying overly generous government employee retirement benefits.

Stockton has already slashed spending on services such as police and fire and halved its funding for library and recreation, yet it continues to fully meet its contributions to the state’s pension system. That’s because state law requires that pension payments be met.

Now, a federal judge has granted Stockton Chapter 9 protection that allows the city to restructure its finances. Judge Christopher Klein of the U.S. Bankruptcy Court ruled:

“It’s apparent to me the city would not be able to perform its obligations to its citizens on fundamental public safety as well as other basic government services without the ability to have the muscle of the contract-impairing power of federal bankruptcy law.”

This ruling opens the door for Stockton’s creditors to take a hit. Rather than make major reforms to reduce Stockton’s unfunded pension liability, the actual driver of Stockton’s financial crisis, the city can now go after its lenders.

Prior to the ruling, the city had been asking bondholders to take losses on their loans as part of the city’s restructuring plan. Unsurprisingly, these creditors declined, especially since the city refused to include reductions in payments to CalPERS as part of the solution. Why, bondholders argued, should some creditors be exempt from the negotiations?

Klein’s latest bankruptcy ruling now puts those bondholders at risk.

Imagine the contagion effect across the country if cities and states are able to renege on their bond obligations in order to avoid pension reforms. Half a dozen cities have filed for Chapter 9 bankruptcy since Stockton filed in June.

Which brings us back to Illinois.

This state’s pension crisis is the biggest in the nation, with payments to pensions and pension debt crowding out everything else in the budget. Illinois already has the nation’s worst credit rating and can’t pay its bills – witness the nearly $10 billion backlog of unpaid bills to vendors, schools, hospitals and charities.

And with pension system funding levels at about 40 percent (and low to mid-20s if proper discount rates are assumed), insolvency is a real risk.

But instead of pursuing real reforms that massively reduce the state’s unfunded pension liability and end the crisis, Illinois politicians want something that brings the state eerily close to the California model. They’re calling for a pension funding guarantee that ensures state worker pensions receive priority over all other core spending – education, public safety, health care – regardless of the economic situation.

And with the Stockton ruling, governments could even break promises to lenders.

That makes the Illinois’ pension funding guarantee one of the most dangerous proposals ever to be considered by the Illinois General Assembly. It will simply lock in the crowd-out effect that brought Stockton to its knees.

Guaranteeing a defined benefit system is like providing a blank check to lawmakers – nobody knows just how much it will cost taxpayers going forward. That’s because politicians have no control over the assumptions necessary to make future payouts under a defined benefit plan. They can’t predict investment returns, mortality rates or the misbehavior of future politicians. Which is precisely why the state’s in this mess to begin with.

The private sector dumped defined benefit plans a long time ago because they are unmanageable and unpredictable. Nearly 85 percent of the private sector is now covered by defined contribution plans such as 401(k)s.

And now Illinois politicians want to guarantee the funding of defined benefit plans? That’s not only moving in the wrong direction, it’s irresponsible, unfair and immoral.

Why do Springfield politicians want Illinois to look more and more like California?