Pension Cloud May Cast a Long Shadow for Munis

Municipal credit prospects may be clouded for the next several years by underfunded pension obligations and a possible uptick in bankruptcies, according to panelists at a forum in New York.

The concerns were discussed by four specialists Tuesday at a forum on "The Municipal Credit Crisis" at the Penn Club in New York City.

University of Pennsylvania Prof. David Skeel, Jr. focused on the legal aspects of municipal pensions. Five years ago the conventional wisdom was that these debts were untouchable for both political and constitutional reasons. However, in recent cases, court judges have said they can sometimes be restructured in bankruptcy.

Outside of bankruptcy, in recent years courts have generally said municipal pension promises cannot be restructured, at least in those states with strong constitutional pension protections, Skeel said.

Skeel said there were two big benefits to allowing pension restructuring in bankruptcies. First, some municipalities may simply be unable to pay all of their pension obligations.

Second, since both managers and unions in municipal contract negotiations are representing staff who would get these benefits, they have an incentive to make them generous. By making pension restructurings possible in bankruptcy, both sides are given an incentive to keep the pensions reasonable.

Charles River Associates vice president Mark Meyer said underfunded state and local pensions were a growing problem. Actuarial shortfalls are usually due to either underfunding or to insufficient funds available, he said.

Underfunding has stemmed from underestimating employee life spans, using too high a rate to discount future obligations, or underestimating the amount of payments that will be needed as participants find ways to accrue extra benefits. Insufficient funding can be due to inadequate contributions to retirement plans or unexpectedly low returns on investments.

Retirement health care obligations are more uncertain and less funded than defined benefit pensions, Meyer said. The credit of some states, like Illinois and New Jersey, look weak when unfunded pensions are taken into consideration and much worse when unfunded retiree health benefits are added to the picture. Others, like New York, look fine on pensions but bad when these other benefits are examined.

Meyer said he was pessimistic about the resolution of the problem.

Michael Scarchilli, editor-in-chief of The Bond Buyer, quoted Nuveen Asset Management in saying in the coming years there may be a few bankruptcies in Illinois cities and towns.

He said the infiltration of corporate bankruptcy experts into the municipal space may contribute to future municipal bankruptcies.

However, he also said he thought defaults and bankruptcies would remain rare.

UBS Wealth Management co-head Thomas McLoughlin also spoke at the forum.

University of Pennsylvania Law School and Charles River Associates sponsored Tuesday morning's event. Charles River Associates is an economic, litigation and business consulting firm based in Boston with offices worldwide.

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