Guest Post: Will Governor Rauner’s New Bankruptcy Proposal Break Chicago’s Pension Obligations?

Michelle Wilde Anderson is a Professor of Law at Stanford Law School.

Illinois Governor Bruce Rauner has decided that allowing his state’s municipalities to declare bankruptcy is an important arrow in his quiver to break “the corrupt bargain that is crushing taxpayers”—namely union influence and membership rates in Illinois.

Chicago, which he says “is in deep, deep yogurt” with pension obligations, seems to be his primary concern. The premise of his reform proposal is that a contract promising retiree pensions, as The Economist put it, “can be made cheaper only by breaking it.” And breaking a contract requires a Contracts Clause workaround. Enter Federal Bankruptcy. Enter Rauner too, who must enact law to authorize the state’s larger municipalities to file for Chapter 9 and to override any special state protections for worker contracts.

Even assuming an Illinois city petitioned for bankruptcy and got the state and federal court go-ahead to open pension agreements, what impact would it have in practice? Under Chapter 9, a municipal debtor writes its own plan for the adjustment of debts. That means that any Illinois municipality to avail itself of a bankruptcy option would need to decide how and whether it would cut into pension obligations, as compared to other debts.

If Illinois cities followed in the footsteps of the two biggest city bankruptcies, they’d essentially cancel all health care benefits for retirees, but keep their pensions payments intact (as in Stockton) or mostly intact (as in Detroit). Eliminating health care was wildly unpopular, but it was more tolerable to retirees than the alternative of lost income. That preference turned on the existence of the Affordable Care Act, which meant that even an ailing 85-year old retiree would be able to find some kind of health care coverage. Will that ACA safety net still be there to catch Illinois’s retirees after a bankruptcy?

So the recent big city Chapter 9’s eliminated costly health care benefits and deeply discounted capital market creditors’ debts, but nonetheless preserved most of their pension payments. Why they struck that balance is critical for Illinois voters and politicians to understand. Rationales in each city varied, but two main themes emerged.

First, the plan authors in Detroit saw that cutting their retirees’ benefits would sink many retirees below the poverty line in the city and the region. This was a painful humanitarian reality, but so too was it an economic one: a municipal debtor has to be stable enough to pay its obligations under its bankruptcy plan. More concentrated local poverty does not help. A second main argument against cutting pension benefits showed up in Stockton. Officials determined that cutting benefits and thereby being excluded from the state pension system would make the city uncompetitive for public employees, especially police. That was a hard pill to swallow for a city with a spiking homicide rate and no cash to spare on competitive wages. Many other concerns surfaced in both cities as well, but they amounted to a bottom line determination that there were vanishingly few fat cat pensioners to be found, and the municipalities would be even worse off—as a debtor, as a city—if they cut into their retirees’ payments. (Because these big cases and others have effectively settled, the legal fairness of the decision not to cut pension payments has never been tested by a higher court, but there are compelling arguments that these decisions are consistent with Chapter 9.)

Interestingly, the party politics of these choices are not as clear as Rauner’s anti-union rancor might suggest. It’s not just majority Democratic city governments that might well opt to preserve pensions, even in bankruptcy. Stockton had Republican mayors all across the years leading up to the bankruptcy, and the city’s bankruptcy steward was Republican too. Detroit’s bankruptcy plan was written by an outside emergency manager, and he was appointed by a Republican Governor who has made right-to-work laws a centerpiece of his administration.

Governor Rauner may well make municipal bankruptcy part of his bid to out-Walker Scott Walker, but it’s not at all clear that breaking pension contracts is the best antidote to too much debt. Or yogurt.