One chapter of the Bankruptcy Code that up until the last few years had not gotten much use is Chapter 9.  It is the chapter under which municipalities such as cities and counties file for bankruptcy protection.

On October 13th, 2011, I wrote a post predicting that a wave of municipal bankruptcies would start breaking on our shores.  On August 15th, 2012,  I discussed several municipal bankruptcies that had just been filed.  One of those bankruptcies, the Stockton, California, one has just been in the news because of a dispute over whether Stockton could reduce its payments to CalPERS, the retirement plan for California public employees.

Here’s an excerpt from the L.A. Times article written by Chris Megerian, Melody Petersen, and Dean Starkman, describing the ruling by the bankruptcy judge, Christopher Klein:

A federal bankruptcy judge dealt a serious blow to California’s public employee pension systems by ruling Wednesday that payments for future worker retirements can be reduced when a city declares bankruptcy — just like its other debts.  U.S. Bankruptcy Judge Christopher Klein ruled that bankruptcy law supersedes California pension laws that require cities to fund their workers’ future retirement checks.  “I’ve concluded the pension could be adjusted,” Klein said.

What does that mean for California public employees who work for a municipality that files for Chapter 9 protection?  Quite simply it means that the Rolls Royce retirement plan might end up as more of a Yugo plan.

This ruling gets at the heart of the reason why we have seen a big surge in Chapter 9 filings since 2010, and why we should expect to see quite a few more over the next several years:  Unfunded retirement obligations.  This municipal problem parallels the problem that drove many large corporations into Chapter 11 bankruptcy.

For example, GM had to seek Chapter 11 protection because it had contractual obligations to pay its former employees very generous retirement incomes and medical benefits, but didn’t have the revenues to fund those plans.  The result:  $450 million in benefit obligations were wiped out in the bankruptcy:

A federal judge said General Motors is not required to pay $450 million to cover medical benefits for retirees, in a defeat for the United Auto Workers union.  In a 36-page decision, U.S. District Judge Avern Cohn in Detroit said on Tuesday that the post-bankruptcy GM did not assume any obligation for the payment, which the automaker had contracted to make two years before its June 2009 Chapter 11 filing.

In the same Detroit bankruptcy court, the (alleged) city, Detroit, filed its own Chapter 9 bankruptcy.  Detroit’s public employees and public retirees could see the same handwriting on the wall, though it was hard to make out because of all of the graffiti on the rotting building walls.  As a result, they voted overwhelmingly to accept pension cuts.

Interestingly, Article IX § 24 of Michigan’s Constitution prohibits the cutting of public pensions:

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.

There were some who objected to the idea of pension cuts on that ground.  However, the Bankruptcy Code is federal law made pursuant to article I, section 8 of the U.S. Constitution:  “The Congress shall have Power . . . To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States . . .” so it trumps the Michigan Constitution because article VI of the U.S. Constitution states:

This Constitution, and the Laws of the United States which shall be made in Pursuance thereof . . . shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.

Therefore, if Chapter 9 permits the cutting of pensions, it trumps the Michigan Constitution.

Detroit may be an especially bad case of multi-generational corruption.  For example, its former mayor, one Kwame Kilpatrick, is spending the next twenty-eight years of his retirement in prison.  But Detroit is not alone in having a kakistocracy for its government.  And it is certainly not the only municipality that is insolvent.

Stephen Moore predicted in the August 8, 2013 Newsmax that twenty other municipalities were on the bullet train to Chapter 9 land.  A few of his picks, such as Harrisburg, Pennsylvania and Jefferson County, Alabama, had already gone through recent bankruptcies.

Watch the news to see how accurate Mr. Moore’s predictions turn out to be.  I’m guessing most of his picks are right on the money.

Of course, most bankruptcies are either business ones (watch for Radio Shack’s — it’s coming soon to a newspaper near you), or personal ones.  But municipal bankruptcies may well be the big news over the next couple of years.

Finally, what about the states and the federal government?  Chapter 9 is not available to them.  They just have to tax the living daylights out of the populace to cover their shortfalls.  And here is where being ruled by a kakistocracy really hits home.  We’re headed for a national fiscal cliff and none of the politicians have anything like a plan to fix the problem.

On January 17, 2012, I wrote:

In the November 17, 2011 Los Angeles Times Michael A. Memoli reported: “The Treasury Department confirmed this week that the national debt has surpassed $15 trillion – that’s 15, followed by 12 zeros . . .”

Where are we today?

According to the federal debt as of October 1, 2014 is $17,852,607,000,000 — I rounded down because the numbers change so fast that it’s hard to keep up — the total state debt is $1,187,967,200,000 (again I rounded), and the total local debt is $1,890,484, 560,000 (again, I rounded).  These debts are impossible to repay, and they keep growing with such rapidity that it almost seems like an abstraction.  I predict that this will lead to the collapse of our currency.  Stay tuned for more good news.

If you’re a debtor and need bankruptcy protection, contact an extremely knowledgeable and highly skilled bankruptcy attorney to guide you through the process.


Image courtesy of Flickr (Licensed) by aussiegall