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Is The Detroit Bankruptcy Ruling A Game Changer For Pensions?

The City of Detroit bankruptcy may prove to be very educational in dealing with uncertainty in pension payments. There was a lawsuit launched against the City of Detroit alleging that pension payments should not be included in dealing with a bankruptcy scenario because they were protected by law. (1)(2)(3) So far, it seems that everyone will be treated equally whether times are good or bad, or in spite of the past agreements. If there is a surplus of money in a city, it can be shared among the city workers, management and citizens. If there is a shortage of money, all of these same people will end up getting less. Whether payments occur in the present or in the future (as is the case with pension payments) will not matter.

What lessons can be derived from this case? It does not matter what the guarantee is: if the guarantor has no money, the guarantee will not be honoured. Economics takes precedence over law and politics. Everyone may agree that payments should be made, but if money disappears, these payments will not be made. The most important issue in dealing with public affairs is the management of the finances. There could be good intentions, a solid legal framework, and much debate and discussion - but if the finances are mismanaged, sooner or later the situation will deteriorate. On the flip side, if there is a bigger entity to guarantee the contracts made by the city, in this case the state of Michigan, the cycle starts all over again and must be evaluated at the state level. It does not appear that this has taken effect so far, but it has been discussed.

With respect to pensions, retirees are being treated as creditors by the court, and this bankruptcy situation is very similar to a corporate bankruptcy. In the corporate case, proceeds are wound down and divided up among the stakeholders. The pensioners are also not being prioritized above other creditors. What does this mean for you? If you discover that you are part of a pension plan that is being mismanaged to the point of bankruptcy, the worst case scenario would play out in a case like Detroit. The laws may be different in different jurisdictions, but beware of what can happen if the money runs out.

Sources:

1) http://www.pionline.com/article/20131203/ONLINE/131209974?AllowView=VDl3UXpKSzdDdmVCblIzQURleUhaRUtxams0VUErOWFIUT09&utm_campaign=smartbrief&utm_source=linkbypass&utm_medium=affiliate

2) http://www.freep.com/article/20131203/NEWS01/312030159/Retirees-brace-pension-cuts-wake-Detroit-bankruptcy-ruling

3) http://www.bloomberg.com/news/2013-12-03/detroit-to-remain-under-bankruptcy-protection-judge-says.html

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.