Tuesday, December 20, 2011

All Pension Roads Lead to Rhode Island?

In my last comment, I covered one of the worst state pension funds in the United States, Illinois' TRS, which is betting big on alternatives as it goes for broke. Today we cover the absolute bottom of the barrel, the city of Central Falls, Rhode Island. Michael Corkey of the WSJ reports, Pensions Chopped but Investors Paid:

Retired firefighters and police officers in Central Falls, R.I., agreed to cut their pensions and support a plan that would likely give bondholders everything they are owed by the struggling city.

The unusual arrangement is being watched closely by municipal-bond investors and government officials across the U.S. because it could be cloned in an effort to keep borrowing costs from spiraling higher in municipalities near financially shaky cities and counties.

The deal also could spare Central Falls from a costly legal battle with retirees, while giving bond investors more clarity about the security of their investments.

Central Falls, with a population of 19,300 and a severely underfunded pension plan, filed for bankruptcy protection in August. The city has about $20.5 million in bond debt and $47 million in pension liabilities, according to state officials.

As of Monday, 82 of about 130 Central Falls workers had agreed to support the pension cuts, which will total 25% over the next five years for many recipients, said Matthew McGowan, a lawyer for about 100 police and fire retirees. A minimum of 75 retirees had to support the proposed agreement.

The state-appointed receiver overseeing Central Falls is expected in the next few days to ask a bankruptcy judge to approve the agreement with retirees, said Theodore Orson, a lawyer for the state.

Before the city's financial collapse, Rhode Island lawmakers passed a law that puts bondholders first in line among all creditors of municipalities in the state. The retirees vowed not to challenge the state law as part of the agreement.

Mr. McGowan said retirees backed the deal partly because the state director of revenue will ask lawmakers to appropriate about $2.6 million to help them cope with smaller pensions. Without the state aid, the cuts would be 55% for some. "We have many strong legal arguments," Mr. McGowan said. "But in a practical sense, they don't get you very far if the city has no money."

State officials said the aid, which would be distributed to pensioners annually for the next five years, would give former Central Falls employees time to adjust their lifestyles to meet lower pension payments. Some pensions in Central Falls have been cut to $12,000 a year from about $27,000 a year.

The deal also would help Central Falls emerge from bankruptcy in as soon as a year, some officials said. It took Vallejo, Calif., which filed in 2008 for protection from creditors, about three years to escape from Chapter 9, leading to millions of dollars in additional legal fees and other costs.

Central Falls has kept making its bond payments since the bankruptcy filing. But officials faced a potential court fight from retired workers over pension cuts sought as part of the bankruptcy.

"The retirees represented the biggest challenge," said Rosemary Booth Gallogly, Rhode Island's revenue director, who helped negotiate the deal with retirees. With the likely agreement, "we can see the light at the end of the tunnel."

Remaining hurdles include contract negotiations between teachers and the state-appointed receiver. If lawmakers fail to approve at least $2 million of Ms. Gallogly's request for state assistance, the retirees would likely challenge the bondholder law, Mr. McGowan said.

Central Falls has attracted attention because many other troubled municipalities are grappling with how to rein in pension costs. Investors are trying to figure out how to protect their interests before or during bankruptcy. And political leaders want to contain the collateral damage from Chapter 9 filings.

Alabama Gov. Robert Bentley, a Republican, worries that borrowing costs for municipalities could climb after Jefferson County filed in November for the largest municipal bankruptcy in U.S. history, a spokeswoman says. Harrisburg, Pa., and Boise County, Idaho, also sought protection under Chapter 9 this year.

Rhode Island set up a program in which state officials can take increasing control over a troubled city's finances. Michigan and Pennsylvania have similar programs, but Rhode Island went a step further by passing the law that puts bond investors ahead of other creditors.

"If this survives, it could be utilized as a model for other states," Lisa Washburn, managing director at Municipal Market Advisors, a municipal-bond research firm, said about Rhode Island's bond-investor protection.

Some Rhode Island lawmakers said they worry that the proposed $2.6 million in state aid for Central Falls retirees could encourage other municipalities to seek bail outs for troubled pensions.

In a report released Monday, Moody's Investors Service warned that pension problems and economic stress in Rhode Island cities are "more acute than in most other states and are likely to persist into the future."

Last week, the credit-rating firm downgraded East Providence, R.I. to "junk" status.

On Thursday, East Providence issued $10 million in debt through a private placement with Bank of America Corp. rather than tap the public bond market, partly because of its low credit rating, Ms. Gallogly said. A bank spokeswoman declined to comment.

Is it right to put bondholders ahead of retirees? Well, in this case, they were lucky to have "state aid" or else the deal wouldn't have passed. But all these municipalities are suffering from serious pension woes, which beckons the question, why do we even have municipal pensions?

I say scrap them altogether, and just have well run, well governed state pension plans. Most of the smaller pension plans are struggling and face severe shortfalls. They are a disaster. Years of neglect, corruption, looting, terrible pension fund management, have led down this tragic path where retired police officers, firefighters and teachers have to accept cuts in their pensions or starve to death in pension poverty.

This is why I say all pension roads inevitably lead to Rhode Island whose lawmakers recently approved a major pension overhaul:

A drastic overhaul of Rhode Island's pension system for public sector employees passed in both houses of the state's General Assembly on Thursday in a special session.

Though the legislation passed overwhelmingly -- 57-15 in the House and 34-2 in the Senate -- lawmakers expressed distaste even as they voted for the measure, aimed at addressing rising pension costs.

"It may be necessary, but it's certainly not fair," said House Deputy Minority Leader John Savage, a Republican.

The legislation, called the Rhode Island Retirement Security Act, would suspend cost-of-living adjustments for those collecting state pensions and raise the retirement age for most employees.

It would also set up a hybrid system for state employees and teachers, mixing a traditional pension with a retirement account similar to a 401k. The bill is unusual in that it affects current employees and retirees as well as new hires.

Governor Lincoln Chafee and General Treasurer Gina Raimondo penned the bill to address skyrocketing pension costs.

Without changes, Raimondo's office expected taxpayer costs for pension plans would double to $600 million next year before ballooning to more than $1 billion per year in just over 10 years. Raimondo's office also worried that pension obligations could lead to downgrades for state and municipal bond ratings.

Many states are wrestling with rising pension costs, but Rhode Island's situation is among the worst in the nation. According to research from the Pew Center on the States, Rhode Island is one of only two states to have less than 50 percent of the funding needed to cover benefits that public sector employees have already accrued.

"I don't think that this bill is the panacea it's being purported to be," said State Rep. Charlene Lima, a Democrat. "I think there are going to be unintended consequences."

Opponents of the bill cited worries that raising retirement age for public safety workers would increase on-the-job injury, or that suspending cost-of-living adjustments for already strapped pensioners would drive them to take advantage of state social services, creating financial strain elsewhere.

The bill that passed, however, did not address an area that Governor Chafee considered a key concern. There are 24 towns and cities in Rhode Island that administer pension plans independent of the state, and many of these are even less funded than state plans.

The original draft of the legislation included a framework to force these plans to become solvent. The version that passed contained a weaker form of those provisions, mainly requiring municipalities to commission studies of their pension plans.

"That's to the shame of everyone," said State Rep. Robert A. Watson, a Republican.

Lawmakers vowed to return to many pension-related issues in January, when the General Assembly begins its next regular session. In particular, they promised to address the independent municipal plans and other unfunded benefits such as retiree health care.

Rhode Island's pension reforms are already garnering national attention. I think pension aficionados all round the world better pay attention. Here in Canada, our so-called pension experts are defending the now defunct idea of PRPPs as our finance ministers gathered around for the traditional Christmas turkey dinner, another non-event.

But if we don't address pension reforms, including serious reforms on governance that include independent board members and paying professional pension fund managers properly, then the ultimate turkeys will be pensioners. That's why I fear all pension roads invariably lead to Rhode Island (watch PBS and CNBC clips below).

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