Chapter 9 Hysteria in the Wall Street Journal

The Wall Street Journal ran a column on municipal bankruptcy that is straight out of fantasyland. According to the WSJ, if municipalities are not able to shed their pensions in bankruptcy, the result will be a stampede of bankruptcy filings as cities file in order to stiff their bondholders. 

This argument is demonstrably wrong for two reasons. First, as bankruptcy law has been practiced for the last 80 years, pensions are inviolable in Chapter 9, yet we have never seen more than a handful of Chapter 9 filings.  To be sure, we don't have any legal rulings prior to the current spate of filings on the issue one way or another, but the understood practice is that pensions are unassailable in Chapter 9. I cannot find a record of any municipal bankruptcy filing since the 1930s that has resulted in an impairment of a pension plan, while many have impaired bondholders. Yet only a handful of municipalities have ever filed. That alone should show beyond any doubt how silly the WSJ argument is.  (I'll stay away from speculating on why it took such a preposterous position, but one will note, below, that the WSJ seems to see the issue as being about unions, rather than about pensions.)

Second, chapter 9 bankruptcy isn't very useful for municipalities hellbent on stiffing their bondholders. This is because most municipal bond debt is not unsecured general obligation bonds. Instead it is either secured debt or revenue bonds, which are functionally secured. Thus Detroit has about $6.4 billion in revenue bonds, but only $650 million in general obligation bonds. I can't say how representative this particular debt mix is, but the tsuris that attends a municipal bankruptcy filing surely isn't worthwhile to Detroit just to slough off $650 million in debt when total obligations are some $18 billion. 

The WSJ suggests that Chapter 9 wasn't adopted with a background of public employee union pensions.  That is simply false regarding both Chapter 9 and the major revision of Chapter IX in 1976. The dearth of public employee union pensions in the background might be true about the original Chapter IX; I just don't know what public employee unionization rates were in the 1930s (does the WSJ?). But there were surely municipal pensions in the 1930s, and the legal issue is pensions, not unions. The pensions at risk may well include non-unionized employees (e.g. political appointees). For the WSJ, however, the political issue seems to be unions, not pensions. 

If we want to look for the background to Chapter 9, we should take a time-machine back to 1974, when ERISA was passed.  ERISA (and PBGC) coverage excludes public employee pension plans. This makes sense if you think that public employees' pensions are protected outside of bankruptcy by the Contracts Clause of the federal constitution and that municipalities cannot touch pensions in bankruptcy. But if it were otherwise, then public employees' pensions would have less protection than private sector employees' defined benefit plans. That's a result that makes no sense, not least because of the vulnerability of public employees in bankruptcy, when they are accused of being the holdouts preventing the city from getting back on its feet. 

There are important questions about the role of state law in Chapter 9 bankruptcy, but seeing Chapter 9 as an interaction between co-equal federal and state sovereigns that acknowledges the role of state law is hardly going to bring about the parade of horribles envisioned by the WSJ.