Detroit has already declared bankruptcy and has looked at new ways to outsource. Failing that, Detroit has to plan to just stop providing any services to city residents, possibly demolishing some of its neighborhoods. When the news just couldn't get any worse, Detroit has yet another financial "oopsie!" The city's population has been shrinking since the 50's, nothing new there. The city gave out more benefits to city workers than it could afford, but we knew that.
Besides, a lot of other cities have had problems with old union contracts and they haven’t gone bankrupt. However, Detroit made some financial projections for its pension fund that went far beyond mere optimism.
Detroit’s pension fund managers assumed 8% annual returns through the last couple of decades. That may have made some sense when 8% was a reasonable expectation. However, even in those days, poor fund management gave their pensions sub-par returns. When the markets cooled in the early years of the 21st century, they had poor returns… when they got a return at all. And in the years of the financial collapse, when their pension funds were heavily in the negative and losing money, they still assumed 8% returns. Somehow, money would appear in the future and wipe out years with bad or negative returns. Good wish, bad financial plan. Still, Detroit is not alone in guilt. Many other municipalities have based their financial planning on similar wishful thinking, but haven’t yet had the sort of extensive independent financial review that Detroit has, and their financial faux pas are still secret.
Of course, Detroit compounds this error with what they have come to call the “13th-month month payment.” In addition to the money that the fund was supposed to pay out, “bonus” payments were made in periods when the pension funds over-performed their financial expectations. The problem, of course, is that some months you’re up, and some months you’re down. When you siphon money out of a fund during the up periods, and do nothing during the down periods, you’re going to magnify losses. Which is what Detroit did. Then they did one more thing.
Through the board of directors, which the union has a majority of the votes, yet more payments were made. The board reviewed “special cases,” exceptions, hardships, and payments to individuals who died before their families were eligible for benefits. The combination of bonuses and special payments was not mentioned during the bankruptcy proceedings. Now, in addition to all the very difficult financial hardships exposed in the bankruptcy hearings, we know that Detroit has an ADDITIONAL $3.5 billion-dollar shortfall in their budget. Ouch!
That’s a pretty harsh analysis. Detroit’s exhausted pension fund must deal with these shortfalls. What are the options that Detroit is faced with? Basically, there are four options. Detroit can increase the pace of layoffs to try to absorb the financial shortfalls that were outlined in the bankruptcy analysis, and then find yet another $3.5 billion in layoffs. The second option is to make severe cuts to benefits and pay, to all current and past employees. That’s a very difficult to execute plan. Which leads to a third option, Detroit can create a two-tiered pension system that allows current workers to keep all or most benefits, but will provide far fewer (or no) benefits to the next generation of city workers. This option, which has been chosen by other unions when big cuts are needed, could spell the eventual end to Detroit’s unions. The fourth and last option? Outsource!
In the end, Detroit will probably need to choose a combination of all of these options in order to close the budget gap. And, they’re going to need to start putting these plans into place very soon. Detroit has no easy options. Whichever options they choose, they need to get started as soon as possible, because the price tag for the old sins of Detroit’s pension funds have a price tag that is going up every day.
Besides, a lot of other cities have had problems with old union contracts and they haven’t gone bankrupt. However, Detroit made some financial projections for its pension fund that went far beyond mere optimism.
Detroit’s pension fund managers assumed 8% annual returns through the last couple of decades. That may have made some sense when 8% was a reasonable expectation. However, even in those days, poor fund management gave their pensions sub-par returns. When the markets cooled in the early years of the 21st century, they had poor returns… when they got a return at all. And in the years of the financial collapse, when their pension funds were heavily in the negative and losing money, they still assumed 8% returns. Somehow, money would appear in the future and wipe out years with bad or negative returns. Good wish, bad financial plan. Still, Detroit is not alone in guilt. Many other municipalities have based their financial planning on similar wishful thinking, but haven’t yet had the sort of extensive independent financial review that Detroit has, and their financial faux pas are still secret.
Of course, Detroit compounds this error with what they have come to call the “13th-month month payment.” In addition to the money that the fund was supposed to pay out, “bonus” payments were made in periods when the pension funds over-performed their financial expectations. The problem, of course, is that some months you’re up, and some months you’re down. When you siphon money out of a fund during the up periods, and do nothing during the down periods, you’re going to magnify losses. Which is what Detroit did. Then they did one more thing.
Through the board of directors, which the union has a majority of the votes, yet more payments were made. The board reviewed “special cases,” exceptions, hardships, and payments to individuals who died before their families were eligible for benefits. The combination of bonuses and special payments was not mentioned during the bankruptcy proceedings. Now, in addition to all the very difficult financial hardships exposed in the bankruptcy hearings, we know that Detroit has an ADDITIONAL $3.5 billion-dollar shortfall in their budget. Ouch!
That’s a pretty harsh analysis. Detroit’s exhausted pension fund must deal with these shortfalls. What are the options that Detroit is faced with? Basically, there are four options. Detroit can increase the pace of layoffs to try to absorb the financial shortfalls that were outlined in the bankruptcy analysis, and then find yet another $3.5 billion in layoffs. The second option is to make severe cuts to benefits and pay, to all current and past employees. That’s a very difficult to execute plan. Which leads to a third option, Detroit can create a two-tiered pension system that allows current workers to keep all or most benefits, but will provide far fewer (or no) benefits to the next generation of city workers. This option, which has been chosen by other unions when big cuts are needed, could spell the eventual end to Detroit’s unions. The fourth and last option? Outsource!
In the end, Detroit will probably need to choose a combination of all of these options in order to close the budget gap. And, they’re going to need to start putting these plans into place very soon. Detroit has no easy options. Whichever options they choose, they need to get started as soon as possible, because the price tag for the old sins of Detroit’s pension funds have a price tag that is going up every day.