General Motors Corp.’s spin-off of components manufacturer Delphi Corp. won reluctant approval from the United Auto Workers in 1998 thanks in part to a key concession: The automaker agreed to guarantee Delphi’s pension obligations in the event that its former subsidiary went bankrupt. At the time, GM executives thought the spin-off was a masterstroke. Delphi, after all, was a huge liability, undermining GM’s profit potential year after year. Pensions were a side matter, they thought.
They were wrong.
Delphi went bankrupt in October 2005. Its underfunded pension plan destroyed any hope for a short-term turnaround at GM and contributed directly to the automaker’s own entry into Chapter 11 last June.
GM’s experience with Delphi provides a prophetic warning to states whose towns and counties participate in statewide pension plans. Although no state has yet gone bankrupt, municipalities have, and states may well be left holding the bag.
Consider the City of Vallejo, California, which filed for Chapter 9 bankruptcy in May 2008. Vallejo’s largest unsecured creditor was the California Public Employees’ Retirement System. Under state law, a municipality cannot default to CalPERS. But laws change as facts change, and the facts are devastating for this once-vibrant city of 72,000, now reporting an annual operating deficit of $4.2 million. For now its retirees are not affected; the city can pay out benefits by drawing on the $412 million it has with CalPERS. But that money won’t last forever.
“This is a ticking time bomb in California,” says Marc Levinson, a partner with the law firm Orrick, Herrington & Sutcliffe, which represents Vallejo.
The crisis in municipal pension obligations is particularly severe in New Jersey, a state that, not helpfully, granted local governments a funding holiday in the late ‘90s. An effort by New Jersey lawmakers to allow municipalities to defer payment of some of their 2010 pension obligations was narrowly derailed in the closing minutes of the 2009 legislative session, only to be reintroduced by the assembly majority leader in January.
“Ultimately, state and local governments are going to have to address the underlying reality,” says Orin Kramer, the state’s investment council chairman.
That’s not an easy reality to address. Consider Alaska.
In 2003 the state of Alaska realized that it was going to have to pay more in pension and other retirement obligations than it had anticipated — billions more. As a result, the state legislature approved closing its defined benefit plans and replacing them with a defined contribution system for future employees. Despite the reform, many municipalities found they were unable to afford the recalculated obligations, so the legislature passed a second law shifting the payment burden to the state. The additional pension hit to state coffers: an estimated $5 billion.
Jerry Burnett, deputy commissioner for the state’s treasury department, sees similarities between Alaska’s predicament and what happened at GM. “Alaska took on future liabilities that were unsustainable for the local municipalities,” he says.
Fortunately, Alaska is rich in oil and gas reserves, a revenue source not available to states like California and New Jersey.
