David Skeel is a visiting Professor at Harvard Law School.
In her characteristically thoughtful post, Professor Michelle Wilde Anderson points out that Illinois cities might not alter their pensions (or might not alter them much) even if Illinois enacted legislation authorizing its cities to file for municipal bankruptcy. I think Professor Anderson is completely right about this, and that she rightly points to the recent Detroit and Stockton bankruptcies as evidence that troubled cities will bend over backwards to protect most pension benefits. If I differ from Professor Anderson—and I’m not sure that I do—it’s only in being a little more convinced that the bankruptcy option is necessary and a little more optimistic about its benefits.
Under Chapter 9, the federal bankruptcy rules for municipalities, a city can only file for bankruptcy if state law explicitly authorizes cities, or the city in question, to file for bankruptcy. Illinois currently does not permit its cities to file for bankruptcy. (The only exception is for cities under 25,000, and even for these small cities the authorization may not be sufficiently explicit to qualify.) If the state or troubled Illinois cities such as Chicago could make modest adjustments to their pension obligations outside of bankruptcy, the bankruptcy option might not be necessary. But the Illinois state courts have construed a state constitutional provision that protects “[m]embership in any pension or retirement system” extremely broadly. Last year the Illinois Supreme Court held that this provision prevents any adjustment of retirees’ health benefits. And the Illinois Supreme Court recently heard arguments in challenge to 2013 legislation that would, among other things, reduce cost of living increases and slightly increase the retirement age for current employees. If the court holds that even these adjustments are not permissible, as it is widely expected to do, the state’s hands will be completely tied. It and its largest city will not be allowed to make any adjustments to their pensions for current employees, yet the pensions are so radically underfunded– $111 billion for Illinois, roughly $30 billion for Chicago, by very conservative estimates—that it seems impossible to pay them in full.
It is important to point out that, if it is impossible to make even minor adjustments to the pensions of current public employees, Illinois public employees (or would-be employees) will likely bear a significant portion of the pain in other ways. Illinois cities and the state may be forced to curb future hiring, no matter how urgent the needs that would otherwise be addressed. They may also face pressure to lay off existing employees, a step that would be more damaging for most employees than adjustments to their future pension benefits.
Professor Anderson rightly—and compellingly–points out that Chicago or other Illinois cities might not alter their pensions significantly even if they had the option of filing for bankruptcy. In addition to the incentives she notes for keeping any pension cuts small, even a very troubled city might never file for bankruptcy in the first place. Detroit probably would not have filed for bankruptcy if the state had not appointed an emergency manager who had authority to file for bankruptcy on the city’s behalf (subject to the governor’s approval). Illinois law does not authorize the state to step in in this fashion. A city also cannot file for bankruptcy unless it is insolvent—which is defined to mean unable to pay its debts as they come due. As long as a city can pay its current obligations, it cannot file for bankruptcy, as Bridgeport, Connecticut discovered some years ago.
Despite these limitations, I still strongly favor a bankruptcy option. (As a bankruptcy scholar, I confess that I may not be altogether objective in this). Not only might it make at least minor adjustments to pensions possible, as it did in Detroit; but bankruptcy also would ensure that public employees are not the only stakeholders who share in the sacrifice. Bondholders, for instance, also would bear some of the pain. Indeed, there are several good reasons for bonds to be restructured more fully than pensions. Not only are bondholders better able to bear the cost, but a city’s recovery will be impaired if a significant number of its citizens are in precarious financial condition.
I would favor a bankruptcy option in Illinois even if the Illinois courts were to allow minor pension adjustments outside of bankruptcy. But the option will be far more essential, in my view, if the Illinois Supreme Court rules even minor adjustments out of bounds when it hands down its decision on the 2013 Illinois pension reforms.