By: Mark Glennon*
If Chicago or another Illinois municipality let its pensions run dry, either willfully or not, would that municipality be obligated to pay the pensions’ obligations? ‘Yes’ has been the widely assumed answer, but it’s in fact an open question, and the answer has monumental implications.
We were the only ones who saw the significance at the time, but buried in a few articles a couple weeks ago was mention that Chicago now claims it is not legally liable. On May 12, we wrote, as a comment on a link to a Chicago Tribune article, “This highlights an important issue: What, if any, entity is on the hook if pensions aren’t paid? The state is for its five pensions, but the answer is unclear for many others, knowledgeable lawyers have told us.”
Since then, I’ve checked with more good lawyers with municipal expertise, including one who is a trustee of one of the biggest Illinois pensions. They don’t know the answer. I’ve checked with a few folks in the municipal bond industry. They generally assume the municipality would be liable but shrug off the issue. They think it has only long term implications and they are more focused on near term cash liquidity. They are wrong to dismiss it.
It’s not that just ignoring the pension obligations is an option to consider. On the contrary, that would be morally wrong and, hopefully, nobody would try it. But if Chicago’s legal position is correct — that it’s not liable — the implications are huge.
First, understand that we are not talking about the the obligation to pay annual contributions. Those requirements are set by state law for Chicago and other municipalities. But they can be changed at Springfield’s whim.
Here is why the question is so crucial. If there is no underlying liability of the municipality to pensioners, then:
• Pension reform, with much flexibility, could be accomplished easily by letting them go dry but replacing the loss to pensioners with something else in amounts determined by the municipality to be fair and affordable.
• In a municipal bankruptcy, pension obligations almost certainly wouldn’t even be included. It would be unlike Detroit, where the unfunded liabilities were treated like other unsecured debt of the bankrupt city (although that other debt ended up settling for larger losses than pensioners sustained). The annual payments scheduled by Springfield would be recognized as debts in the bankruptcy, but, again, those can be changed if Springfield chooses.
• The argument that pensions are a separate entity eligible for a separate bankruptcy proceeding would be strengthened. That argument has been discussed before but it would be hard to make if municipalities are liable.
One reporter has now directly addressed the question. Kudos to Mark Brown who just wrote an excellent, detailed piece, specifically about how the question relates to Chicago. Read it in full. He talked to Chicago’s lawyers and confirmed their position that the city disclaims liability for certain pensions. A lawyer for pensioners has the opposite opinion. He also says the city says it is fully liable on two of it’s funds, the police and fire pensions, based on the 2010 pension reform legislation. I think that’s a mischaracterization by the city. The 2010 set a new payment schedule requiring a gradual increase in annual city contributions to reach 90% funding by 2040, along with an enforcement mechanism. But, again, that is statutory and could be changed. The 2010 law had nothing like an assumption of full liability by the city, or an imposition on the city of direct liability to pensioners.
But the same, open question applies not just to Chicago but to some 650 other police and fire pensions for other Illinois municipalities. Mr. Brown did not address those. And how about pensions for Cook County, RTA, CTA, MWRD and others? To my knowledge, the same question needs to be answered for them as well. What about Chicaago Public Schools? Is the district, which is an entity separate from Chicago, liable for its pension? Dunno. My own look at the question for all of these, as an admittedly rusty former-lawyer, yields no clear answer, but I am currently inclined to think the city’s position is quite reasonable. There are multiple statutes under which pensions were authorized by the state, so the answers may vary.
About the only place where the answer may be clear is with the five state pensions. Lawyers have told me they have no doubt that the state is liable for its pensions, though they cannot point to the authority offhand.
If anything is clear, it’s that the question has huge implications for the direction of pension reform, and should bear on the credit ratings of municipalities. (Wake up, rating agencies, this is critical.)
To say this issue needs research, and perhaps a court ruling, would be an extraordinary understatement, but we know for sure that Chicago is disclaiming liability, at least for certain of its pensions (see Mark Brown’s article for details). Unfortunately, lengthy litigation may be needed.
Is the city’s position correct? Does it apply to other municipal pensions? Please, you army of lawyers working on pensions, we need answers.
*Mark Glennon is founder of WirePoints. Opinions expressed are his own.