House Judiciary Chair Weighs In on Pensions, Bankruptcy

WASHINGTON — The chairman of the House Judiciary Committee said on Monday that while he remains open to exploring how Congress may play a role in restoring fiscal sanity to state and local government budgets, he does not believe Washington should dictate public pension standards or allow states to seek bankruptcy protection.

“Despite the high cost of these pensions, it is not for Congress to admonish states for spending their money as their elected leaders see fit,” Rep. Lamar Smith, R-Tex., said in a statement provided to members of the subcommittee on courts and commercial and administrative law during a hearing on pensions and state bankruptcy. “States are sovereign in our system of federalism and are free to make even very expensive decisions.”

“And while bankruptcy for states may seem like an attractive alternative to state bailouts, there are constitutional and policy concerns with this approach,” Smith wrote. “First, I am unsure whether Congress has the constitutional authority under Article I to allow a state to seek bankruptcy relief. States are co-sovereigns in our system of federalism and have authority to tax and spend.”

“Even if Congress could enacted a state bankruptcy chapter, it is also highly unlikely that any state would ever take advantage of it,” he said, adding that he worries a bankruptcy option would actually encourage states to borrow more money “knowing that they could later restructure their debt in bankruptcy.”

Smith’s remarks spell trouble for Republicans who fear growing unfunded pension liabilities will lead to the collapse of some states and are exploring the idea of crafting legislation that would permit them to seek bankruptcy protection.

Any such legislation would have to be approved by the House and Senate Judiciary Committees.

But Smith said in his release: “Congress should not hinder restructuring efforts at the state level by passing laws that make it more expensive for states to access capital in the bond market during a recession. And it should not pass laws that unfairly punish states with higher interest rates.”

Of the four witnesses who testified at the hearing, Joshua Rauh, associate professor of finance at the Kellogg School of Management at Northwestern University, seemed to support pension reforms such as those proposed in a bill introduced last Wednesday by Rep. Devin Nunes, R-Calif., as well as a bankruptcy option for states.

The Public Employee Pension Transparency Act would require state and local governments to submit annual reports to the Treasury Department disclosing detailed information about their pension plans. The bill would require them to determine their  unfunded liabilities based on a Treasury rate, as well as any other rate they may choose to use. It would bar state and local governments from issuing tax-exempt bonds going forward for as long as they failed to disclose such information.

Rauh strongly supported the idea of governments using a lower rate — like the private sector does — to calculate unfunded pension liabilities, saying the current practice of using a 8% rate of return on investments is unrealistic.

“The trouble with this methodology is that it ignores the fact that if the assets do not return 8%, the taxpayers will have to come up with the difference,” he said.

Rauh said in his testimony that an alternative to bankruptcy protection would be to allow states to issue tax-subsidized bonds to finance pensions for 15 years if they agreed to specific austerity measures. He said that he and another professor had determined that the net cost to the federal government of subsidizing pension bonds — which currently can only be taxable — would be $75 billion.

Keith Brainard, research director at the National Association of State Retirement Administrators, said pensions account for a relatively small portion of state and local budgets and that many governments are taking steps to bring their pension plans into long-term solvency.

Matt Fabian, managing director of Municipal Market Advisors, told the lawmakers in his testimony that “even an unused bankruptcy law would amplify related headline risk that has already been highly disruptive to normal capital markets functions, exacerbating systemic illiquidity and pushing yields and spreads higher.”

James Spiotto, a partner at Chapman and Cutler, said a state bankruptcy option would create practical problems and face legal challenges. He suggested, as an alternative, that states consider creating authorities to examine their pension obligations as well as the resources that are available to meet them. The authorities could adjust pension obligations if they needed to.

Spiotto said the Civic Federation of Chicago has proposed creating an Illinois Municipal Pension Protection Authority to assist local governments with determining what post-employment benefits are affordable and sustainable.

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