Detroit Bankruptcy Constitutional Issues

Bankruptcy proceedings underway in Detroit will go a long way in determining what path cities might take in reducing unsustainable pension benefits. Attorneys for the City of Detroit are taking an aggressive stance in arguing that the city has standing in federal bankruptcy court.  However, the key issue of pension "impairment" is not addressed directly by the city's filing.  City lawyers skirted the constitutional issue of pensions by arguing in their filing that no impairment of pensions has yet been taken by their filing.  An excerpt from Michigan's constitution highlights the conundrum:

§ 24 Public pension plans and retirement systems, obligation.
Sec. 24. The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.

One would think this is case closed, the state of Michigan, through its constitution, is now on the hook for Detroit's pensions.  However, this case has a federalist element.  The bankruptcy was filed under federal bankruptcy laws.  Was it the intent of Congress in passing the bankruptcy laws to supplant state constitutions?  If so, under the Supremacy Clause in Article VI, the city's lawsuit should be heard and trump federal law.  There is an entire section of the bankruptcy code devoted to municipalities, Chapter 9.  Pensioners are arguing that the courts must first hear constitutional issues before the bankruptcy hearing can proceed and have moved to remove the case out of bankruptcy court to district court.

Since I am not a lawyer, I turn to the analysis of University of Pennsylvania law professor David Skeel, to make the case.  From the WSJ:

Article IX, Section 24, of the Michigan state constitution says: "The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby." Yet Chapter 9 of federal bankruptcy law clearly authorizes a city to restructure its obligations to restore financial health. How will the conflict be resolved?

Chapter 9 should prevail. The U.S. Constitution (Article VI) states that the laws of the United States are "the supreme law of the land," and furthermore, that judges in every state are bound by them, "anything in the constitution or laws of any state to the contrary notwithstanding."

Seem clear enough to me.  Here is some more perspective.

Seven states have specific clauses in their constitutions that protect public employee pensions: Alaska, Arizona, Hawaii, Illinois, Louisiana, Michigan, and New York.

Some of these states might eventually have the biggest bankruptcies from pension obligations.  Without at least the threat of bankruptcy, I don't think unions are ever going to back off from claims that the constitution protects retiree benefits, even if there are no taxpayers left to foot the bill.

Who's going to pay for the pensions now?

Bracing for Stormy Economic Weather - UPDATE

Update at bottom.

The leader in the most recent issue of the Economist questions Europe's collective will to defend the euro.  The result of failure would be catastrophic, in that august publication's opinion.  I am not so sure, but it would be bad in the short term.  They recommend a number of steps in the unsigned editorial, most notably, printing more euros, although that's not how it is phrased of course.

That is because much looser monetary policy is necessary to stave off recession and deflation in the euro zone. If the ECB is to fulfil its mandate of price stability, it must prevent prices falling. That means cutting short-term rates and embarking on “quantitative easing” (buying government bonds) on a large scale. And since conditions are tightest in the peripheral economies, the ECB will have to buy their bonds disproportionately.

It is an open question whether the euro will survive in its present form, but regardless of the outcome, we can expect turbulence ahead.  Even if the euro is saved by the aforementioned actions, it will set in motion long term inflationary pressures as the euro loses value against the dollar.  This will have a negative impact on U.S. exports, putting more pressure on our tepid recovery.  However, if the euro zone can't be saved, and widespread defaults on government bonds outside of Greece get started, then a real liquidity crisis could trigger a second global recession.  America would not be immune to this outcome either.

Either way, we are going to see real pressure on our own government's deficit situation, as economic headwinds deprive governments at all levels of revenue.  At the same time another recession increases outlays due to unemployment payments and increased use of food stamps, medicaid and other parts of the social safety net. 

The silver lining is that Obama is unlikely to be re-elected in such a climate.  But many Americans and people all over the world are going to suffer.  The root cause of our troubles is clear; all over the western world, politicians have made promises that were going to be impossible to fulfill.  This is the central appeal of Chris Christie; he is the politician who has best articulated this truth.  The end result is that those dependent on the government, whether retired employees, social security recipients, or others, will not have the standard of living they thought.  Governments will not keep their promises, either through bankruptcy, inflation or abrogation, because the collective promises can't be met. This will lead to lowered consumption as the reality of reduced lifetime income sets in and long term re-adjustment in the economy.  We are not going to have a full recovery for a decade, in my humble opinion.  But the tea party movement is correct in focusing on getting the spending under control now, because the sooner we come to grips with the spending problem, the sooner the economy will recover.

UPDATE

Over at Zero Hedge, Phoenix Capital Research has this to say:

Indeed, with Europe’s entire banking system insolvent (even German banks need to be recapitalized to the tune of over $171 billion) the outcome for Europe is only one of two options:

1) Massive debt restructuring.

2) Monetization of everything/ hyperinflation These are the realities facing Europe today (and eventually Japan and the US).

Either way we are talking about the destruction of tens of trillions of Euros in wealth. The issue is which poison the European powers that be choose.

Personally, I believe we are going to see a combination of the two with deflation hitting all EU countries first and then serious inflation or hyperinflation hitting peripheral players and the PIIGS.

Try Not Paying THEM

So, my state is broke. The controller, John Chiang, announced today he would stop paying tax refunds on February 1. I guess that's what bankrupt firms do, stop paying their just debts. I just wonder what would happen if I stopped paying taxes.

However, this situation reminds of the advice that every tax professional has ever given me, don't over-pay your taxes just to get a fat refund, your just giving the government an interest free loan. Now I've got another reason to follow that advice. Hopefully, I was smart enough to owe a few bucks this year. More likely, I was not.

Meanwhile, the state failed to run a surplus and save for a rainy day when the revenue was pouring into the treasury. I pray the Republicans keep up the good fight and force steep spending cuts during this crisis. Rahm Emmanuel is reputed to have said, "We can't let a good crisis go to waste..." That can cut both ways.

Of course the usual suspects are crying about how their interest group can't stand to give up any of their government funding. For example:

"Cutting crucial health and human services for the poor while demand for those services skyrockets during this recession is simply the wrong approach to solving the financial crisis," Jeffrey Luther, president of the California Academy of Family Physicians, said in a statement.

Meanwhile in Texas, where the legislature meets for about five months, every other year, (H/T Dean), a state almost as big and with as many difficulties as California, their budget problem is vastly less. They are facing a $9.1 billion shortfall compared to California's $41 billion. The California budget gap is actually bigger than every state's budget except New York's, (H/T San Jose Mercury News.)