Editorial: Can employees’ pension benefits be cut?

Could a city in bankruptcy be required to cut its employees’ pensions as part of its reorganization plan, as a matter of fairness to other creditors taking cuts? Christopher M. Klein, the chief federal bankruptcy judge in Sacramento, answered that question with a qualified “yes” this month when considering the bankrupt city of Stockton. His rulings signal that pension contracts won’t necessarily survive if a city goes bankrupt. But by approving Stockton’s plan to reorganize without cutting pensions Thursday, Klein sent another important message: that courts should undermine retirement benefits only as a last resort.

State and local officials in California have long believed that public employees’ pensions are inviolable, even if their employer can’t fulfill any of its other obligations. That belief is rooted in decades-old state Supreme Court rulings that the state and federal constitutions barred governments from interfering with pension contracts. The California Public Employees’ Retirement System reinforced that notion by requiring governments to cover the full cost of the promised pensions even if they defaulted. Had Stockton stopped making its payments to CalPERS, the agency would have imposed a $1.6 billion lien on the city’s assets.

In a preliminary ruling Oct. 1, Klein held that Stockton’s contract with CalPERS, like any other contract, can be “impaired” in bankruptcy. In other words, CalPERS could become just another unsecured creditor, and so could be required to settle for less than the full $1.6 billion that Stockton owed. That loss would then be passed on to Stockton’s beneficiaries, to the particular detriment of those who’d already put in full careers and retired in anticipation of the pensions they’d been promised.

Klein raised the issue of pension cuts in response to a complaint by Franklin Templeton Investments, which Stockton owed $32 million for financing some new city parks and facilities. The city’s bankruptcy plan would pay the firm only about 1% of that debt. One of the options Franklin suggested was to force cuts in the city’s pensions, which Stockton had not sought to do.

On Thursday, Klein noted with considerable understatement that “it would be no simple task to go back and redo the pensions.” The city’s contract with CalPERS couldn’t be tossed out without affecting Stockton’s contract with its workers, who had already agreed to meaningful cuts in their pay and retiree health benefits. Those cuts brought what had been “above market” wages and benefits into line with what other cities are paying, Klein said. He then approved Stockton’s plan with no adjustment in its contracts with CalPERS or city workers.

The ruling only hinted at the confusion that would have ensued had Klein tossed out the CalPERS contract, in part because CalPERS has never before dealt with a city altering or voiding its pension obligations through bankruptcy. Among the unanswered questions are whether CalPERS could cut the benefits of those people who are already retired less than the benefits promised to those who are still working, whether a city would be able to offer a new pension benefit to workers to help reduce the pain of the cuts, whether CalPERS could contract again with a city that had defaulted, and if not, where a city emerging from bankruptcy might go for help in setting up a new pension plan.

The clear message to city officials and union leaders is that they never want to reach the point that Stockton has. The best way to protect pension benefits is to preserve the fiscal health of a city. And when a negotiated pension proves too rich, city officials and unions have to be willing to make mid-course corrections to reduce the cost of future benefits before the obligations become too great to bear.

Such corrections, however, may be hindered by state Supreme Court rulings that require cities to offset any reduction in a promised pension benefit with a comparable improvement, even when the reductions are negotiated in good faith to avert a fiscal disaster. The Legislature should remove any impediments to cities and their unions fixing unsustainable pension plans through collective bargaining before a city is pushed into bankruptcy. Lawmakers and CalPERS should also start putting procedures in place to deal with a bankrupt city that defaults on its obligations to the pension fund, so that vulnerable retirees won’t be treated the same as workers who have years to recover from the cuts.

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