Public Pensions, Muni Bond Ratings, and Who Gets the Financial "Haircut"

Earlier today, I talked with a postal clerk at the PO where I get my business mail. He told me, when asked, about the USPS' brave new world of job cuts and pension plan "reform." Yes, he has a job, and he's grateful for it. However, the clerk is now on what the USPS calls a "weekly schedule," and does not know which post office branch he'll be assigned in any particular week. In addition to the ambiguity of his schedule, he was concerned about his pension and health benefits. The clerk's concern was legitimate, as he's worked for the Post Office for around two decades.

I suggested he read an article in today's New York Times about a municipal employee pension case in Central Falls, Rhode Island. It's not exactly fresh news: the story's particulars are months old. What is new, and unsurprisingly provided on a slow-news August Saturday, is the story's punch line for the town's pension plan participants. The Times article interviewed a legal academic, who suggested publicly what others have privately whispered: some of the pension guarantees "are unclear or untested....Just how those promises would stack up against promises made to others, like bondholders, is unclear. It is unclear how (state laws) would hold up in federal bankruptcy court, which has its own ranking of creditors."

The key concept here is that pension beneficiaries are defined as "creditors." That means they have no particularly special standing when an entity declares bankruptcy. "The federal bankruptcy code," the story notes, "says pensioners and general-obligation bondholders are both unsecured creditors, stuck at the back of the line and treated as equals."

Well, maybe some are more equal than others. The Times article cited the state of Illinois' approach to state pension funding requirements and bondholder payments. The Land of Lincoln "has some of the strongest bondholder protections anywhere, which explains how a state that began its fiscal year with $3.8 billion in unpaid bills from last year -- and whose pension system has less than half of the money it needs -- is able to keep selling bonds. Meanwhile, the muni bond market is ripe for corrupt practices, as I pointed out in a blog post earlier this year regarding the JP Morgan/SEC settlement regarding bid rigging allegations.

The prevailing wisdom about pension plans is that their benefits are legally sacrosanct. This smug belief emerges in conversation I've had with just about anyone unfamiliar with the finer points of pension regulations. I'm certainly not an expert in pension law, but a reading of history suggests these seemingly solid legal guarantees could be in play, especially during inconvenient times for society.

It seems likely that government entities may compel its employees for greater pension plan and health care contributions, similar to what occurred in Wisconsin earlier this year. A story in today's San Jose Mercury News reported that a "pension reform" group funded by a former Enron trader and current hedge fund manager proposed that California state and local governments move their pension plans to a "hybrid retirement plan" similar to that used by the federal government. The idea is that the move would "save billions." (Click here for California Watch's background report on the group, ironically named the California Foundation for Fiscal Responsibility.)

The employee givebacks and increased payments into their benefit packages are de facto "haircuts". This concept, while relatively new to individuals, is not news in the bond markets. The current Euro sovereign debt crisis profoundly involved the degree to which institutional bondholders, including Europe's largest banks, would endure losing money -- the "haircut" -- on Greek, Irish, and other Euro nation bonds. That approach is strikingly different from the United States, where the pension beneficiaries get the trim. Bondholders get paid in full.

Underlying the American scenario is the use of credit ratings as a financial hammer. In Rhode Island, Central Falls officials were informed that postponing or stiffing bondholders' payments would not only affect the municipality's credit rating, but would negatively impact those of all Rhode Island towns and cities. Meanwhile, the same credit agencies that routinely provided AAA ratings to fraudulently packaged mortgage backed securities -- and got away with it -- are now demanding fiscal probity from municipal and state governments. At the same time, major US financial players have avoided "haircuts" on dog shit financial instruments they held; many were simply used as collateral by the Federal Reserve for TARP money and other backdoor subsidies.

A couple of years ago, I discussed the brewing pension/benefit crisis with a hard-working, capable municipal library director. I told her that I wouldn't be surprised if she received a notice stating that, due to unfortunate, unforeseen fiscal conditions, municipal employees and retirees would be "asked" to take a "haircut" on their benefits. I suggested the trim would be forty cents on the dollar, all in the name of financial solvency. It would be an offer they "could not refuse."

The librarian, whose parents had survived the Great Depression and told her vivid stories about similar situations, looked at me and paled.