In bankruptcy you can protect your retirement accounts if they are ERISA-qualified: things like 401(k)s, 403(b)s, and pension plans, or IRAs (IRAs are not ERISA-qualified, but they are still protected due to the U.S. Supreme Court opinion in Rousey v. Jacoway, 544 U.S. 320 (2005). By this I mean that they are protected from the depredations of bankruptcy trustees, and hence from the claims of creditors, because they can be exempted using the appropriate exemption table. In a previous blog I discussed the exemption process in great detail. As long as you hire a high-quality attorney you should be able to keep all of your retirement. In sum, if you file for bankruptcy protection your retirement accounts will not be in jeopardy – at least not because of your bankruptcy.
But what about the underlying solvency of your retirement accounts? How sure are you about the stability of the accounts themselves? Is your retirement plan one of the many that invest in municipal, state, and federal bonds? If so, do you know how safe these investment vehicles are?
The well-known financial analyst, Meredith Whitney, of the Meredith Whitney Advisory Group, was interviewed on 60 Minutes. If you’re short on time, there is anabbreviated version of the interview on youtube. The interview focused, in part, on the financial well-being of municipal bonds – the financial instruments used by municipalities to fund their budgets and public works projects. In the interview she predicted a future wave of municipal bond defaults.
From the transcript of the episode:
The most alarming thing about the state issue is the level of complacency,” Meredith Whitney, one of the most respected financial analysts on Wall Street and one of the most influential women in American business, told correspondent Steve Kroft. Whitney made her reputation by warning that the big banks were in big trouble long before the 2008 collapse. Now, she’s warning about a financial meltdown in state and local governments. “It has tentacles as wide as anything I’ve seen. I think next to housing this is the single most important issue in the United States, and certainly the largest threat to the U.S. economy,” she told Kroft. Asked why people aren’t paying attention, Whitney said, “‘Cause they don’t pay attention until they have to.”
From later in the interview:
There’s not a doubt in my mind that you will see a spate of municipal bond defaults,” Whitney predicted. Asked how many is a “spate,” Whitney said, “You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars’ worth of defaults.” Municipal bonds have long been considered to be among the safest investments, bought by small investors saving for retirement, and held in huge numbers by big banks. Even a few defaults could affect the entire market. Right now the big bond rating agencies like Standard & Poor’s and Moody’s, who got everything wrong in the housing collapse, say there’s no cause for concern, but Meredith Whitney doesn’t believe it. “When individual investors look to people that are supposed to know better, they’re patted on the head and told, ‘It’s not something you need to worry about.’ It’ll be something to worry about within the next 12 months,” she said.
A few months later, in the Wall Street Journal’s Professional Mrs. Whitney wrote:
Defaults in a variety of forms by states and municipalities are already happening and more are inevitable. Taxpayers have borne the initial brunt of these defaults by paying higher taxes in exchange for lower social services. And state and local government employees are having to renegotiate labor contracts that they once believed were sacrosanct. Municipal bond holders will experience their own form of contract renegotiation in the form of debt restructurings at the local level. These are just the facts.
Jefferson County, Alabama, recently defaulted on their municipal bond obligations, and almost filed for Chapter 9 bankruptcy protection. However, as reported by Martin Z. Braun, Margaret Newkirk and Simone Baribeau in the September 16, 2011 Bloomberg:
Jefferson County, Alabama, commissioners approved a provisional agreement with holders of $3.14 billion of sewer debt to avert what would have been the largest municipal bankruptcy in U.S. history. The County Commission voted 4-1 today to accept the terms of the agreement, which includes $1.1 billion in concessions from creditors. JPMorgan Chase & Co. (JPM), which arranged most of the debt, would take the biggest loss. . . . The deal hinges on action by state lawmakers, and Commission President David Carrington said bankruptcy is still possible if final terms aren’t agreed on. The commission will negotiate with creditors to reach a definitive agreement over the next 30 to 45 days, he said.
While bankruptcy may still be a possibility for Jefferson County, Alabama, it is now a reality for Harrisburg, the capital of the State of Pennsylvania. As reported by Michael Corkery and Kris Maher in the Wall Street Journal:
After months of contentious debate among city and state officials, Harrisburg, Pa., filed for municipal bankruptcy protection Wednesday, days before the state Senate was scheduled to vote on taking over the capital city’s finances.
State governments are now expressing alarm over the possibility of a series of municipal bankruptcies. As reported by Deborah Levine, in the October 12, 2011 edition of the Wall Street Journal’s MarketWatch:
The other well-known bankruptcy filing came from the city of Vallejo, Calif., in 2008 to free itself from existing contracts with firefighter unions and others. Just this week Gov. Jerry Brown signed legislation changing how cities and counties may file for Chapter 9. . . . States have actively tried to discourage municipalities from filing for bankruptcy because of the possible contagion on other weak credits. “States don’t want [a bankruptcy or default] to spread to other local communities because then people look at other, weaker holdings and worry they may also file so they avoid them,” Buscone said. The city of Central Falls, R.I. filed for bankruptcy in August, also in part related to unfunded pension obligations.
Of course, prohibiting municipalities from filing for bankruptcy protection will not solve the huge problem of genuine insolvency. This is because if a municipality doesn’t have the money to pay its creditors – including the bondholders – prohibiting bankruptcy will not suddenly make the municipality able to pay the creditors.
Although Mrs. Whitney’s dire municipal bond prediction may be starting to come to pass – it’s still too soon to know for sure if we’ll see a real wave of municipal defaults – the even bigger elephant in the room is state insolvency. In the same 60 minutes episode in which Mrs. Whitney was interviewed, Chris Christie, the Governor of New Jersey, and Dan Hynes, Comptroller of Illinois, both discussed the looming insolvency crises of their respective states, and the looming insolvency trend across the country.
However, unlike municipalities which can file for bankruptcy protection under Chapter 9, there is no provision in the Bankruptcy Code for states to obtain bankruptcy protection. This statutory lacuna led Former Governor of Florida, Jeb Bush, and former Speaker of the House, Newt Gingrich, to propose amending the Bankruptcy Code to add a provision allowing the states to file for bankruptcy protection. In the January 27, 2011 Los Angeles Times they wrote:
The figures for next year’s budgets are staggering. California, which faces a $25.4-billion budget shortfall, will pay $100,000+ pensions to more than 12,000 state and municipal retirees this year. A Stanford study puts the state’s unfunded pension obligations at more than half a trillion dollars. Illinois has a $15-billion budget deficit, prompting its governor and lame-duck Legislature to hike its personal income tax rate by 66%. New York, where 73% of the government workforce is unionized, is staring at a $10-billion deficit. There has been an organized federal bankruptcy process for municipalities since the 1930s, and a handful of cities, towns and counties — most notably California’s Orange County in 1994 — have gone through municipal bankruptcy and gotten their fiscal houses back in working order. A bankruptcy option for the states would look very similar to Chapter 9 municipal bankruptcy, with some necessary modifications.
All of this suggests that retirement accounts that have invested in government bonds – whether municipal, state, or federal (recall that federal debt was recently downgraded by Moody’s) – might face some real challenges in the future.
So while you can protect your retirement accounts from your creditors and the Trustee in bankruptcy, you cannot protect the solvency of the underlying investment. Perhaps a reevaluation of your retirement portfolio is in order. The next financial bomb could hit retirement accounts that have invested in government debt quite hard.