Pension Lawsuits and the Blame Game: Detroit is Harbinger of the Inevitable – WP Original
By: Mark Glennon*
Detroit last week gave us a glimpse of what to expect on a much larger scale in Chicago and across the country as the sheets are gradually pulled off on public pensions.
Reality ultimately invalidates wrong assumptions. In the public pension world, that means taxpayer liabilities eventually will spike. Scapegoats will be found, fairly or not. Lawsuits will come. Heads must roll as anger erupts — all financial meltdowns are that way. Officeholders and voters bear primary responsibility, but that won’t matter.
Detroit’s mayor announced the startling (to some) conclusion that the city’s two pensions, even after liabilities were reduced in bankruptcy, face a long term shortfall of almost $500 million that wasn’t anticipated or incorporated in its reorganization plan. Somebody must be to blame and ought to pay, he figures, so he asked his legal department to look into who he can sue.
Some background: Prior to bankruptcy, Detroit officially reported its pensions were in pretty good shape — over 90% funded, based on work by Actuary A. After filing for bankruptcy, Detroit’s emergency manager thought that was too optimistic and ordered a new report from Actuary B, which concluded the pensions were in far worse shape — under 60% funded. Detroit based its reorganization plan on Actuary B’s work, and bonds and pensions were cut based on it. But Actuary B was still too optimistic, Detroit is now saying, which is why the funding schedule approved in its bankruptcy will be almost half a billion dollars short.
And here’s a strange part: It’s Actuary A that’s now reportedly advising Detroit that Actuary B’s work was too optimistic. Actuary A was already sued for allegedly understating pension problems in its pre-bankruptcy work.
Whatever. The point here is not to figure out who, if anybody, is blameworthy in Detroit. I don’t know. Detroit is alleging its new shortfall results from use of a mortality table that was too optimistic, but that’s a complex issue in this case that reporting to date hasn’t really covered, according to a couple actuaries I talk to.
The point, instead, is what Detroit portends and the lessons it offers:
• Blame for unfunded pension liabilities far beyond those officially reported will be imposed. Other assumptions used by pensions besides mortality tables are suspect if not outright senseless. When experience voids them, politicians and taxpayers will want blood. But they, most reporters and juries still won’t entirely understand pensions, so don’t expect any fairness in who gets smeared or sued.
• Consider the next levels of liability. Detroit’s anger reportedly is focused on an actuary and, perhaps, its former emergency manager and his law firm, which negotiated the reorganization plan. But think about bondholder reaction as pension projections prove false. Once their damages are ascertainable, isn’t litigation against a range of municipal bond industry regulars, including law firms, rating agencies, underwriters and accounting firms all but certain? That kind of litigation attracts the most aggressive class action lawyers.
Again, actual guilt won’t necessarily matter. Remember Arthur Andersen? The entire firm was shut down over its accounting work for Enron, throwing thousands of people out of work who never heard of Enron.
• Even bankruptcy won’t help if defined benefit pensions are maintained. Detroit’s experience shows their core deficiency, which is that taxpayer liability for them is little more than biased guesswork making a reliable reorganization plan — or any other rational fiscal plan — impossible. As now-retired U.S. Bankruptcy Judge Steven Rhodes warned Crain’s Detroit last year, “cities need to consider switching to 401(k)-style defined contribution plans in order to grapple with mounting liabilities.” Detroit blew its chance to do that.
Dozens of Illinois municipalities have pension problems far worse than Detroit’s, whether before, during or after its bankruptcy — including Chicago. The stone silence of much of Chicago’s business community about the severity of our crisis has many causes — laziness, ignorance, crony capitalism and cowardice about confronting political leadership intent on denial.
But there’s probably one other factor at work, which is fear of liability. It’s safe to assume that nothing written here would surprise people in law firms, actuaries, ratings agencies, underwriters and accounting firms who have worked on pensions and bond transactions. Some have to be, well, peeing in their pants — even the ones that behaved honorably.
Politicians will want scapegoats. Plaintiff’s lawyers will want deep pockets. It’s just a matter of time.
*Mark Glennon is founder of WirePoints. Opinions expressed are his own.