By Dan Kadlec
October 2, 2014

In a shot heard round the pension world, a California judge has ruled that in municipal bankruptcies, public employees are no more protected than bondholders. The ruling opens the door for financially strapped towns across the state to cut pension obligations by filing for bankruptcy.

This is just the latest blow to public pensioners. A federal judge ruled similarly in Detroit. The giant California Public Employees’ Retirement System had argued as part of the closely watched case in Stockton, Calif., that different laws applied and required that public pensioners in California be paid in full before anything went to creditors.

But U.S. Bankruptcy Judge Christopher Klein decided against CalPERS, an influential institution that has been leading efforts to preserve defined-benefit pensions nationwide. The Stockton decision, coupled with rulings like the one in Detroit, has public pensioners in every struggling municipality across the country fearing for their retirement security.

CalPERS essentially argued that it was above bankruptcy law because of its statewide charter. For its part, Stockton wants nothing to do with reneging on promises to police and other public employees, arguing that they would leave and the town would not be able to function. But Judge Klein ruled that public pensions are just another contract, and adjusting contracts is what bankruptcy is all about. He came down on the side of Franklin Templeton Investments, a mutual fund company that had about $36 million of Stockton’s debt.

Like many private businesses in decades past, Stockton and other municipalities lavished unrealistic pension guarantees on employee unions while times were booming. The private sector began its reckoning first as autoworkers and airline employees, among others, were forced to take benefit concessions. Now teachers, police and other public employee unions are feeling the sting of flagging finances—part of the fallout of the Great Recession.

The Stockton ruling is a harsh reminder of how frail the retirement system in the U.S. has become. Scores of both private and public pensions are underfunded, and Social Security is scheduled to become insolvent in 2033. The system is not going to disappear. But change will come and almost certainly result in benefit cuts for some. Young workers are especially vulnerable because they have not paid much into the system yet and have many years left to save for themselves. So take a cue from the Stockton case and start saving now.

 

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