Milwaukee Bankruptcy: The Consequences Could Be Severe, Including to Cops

Should Milwaukee cops worry about their pensions? If there is a Milwaukee bankruptcy, probably.

What are the consequences of a Milwaukee bankruptcy? A narrative has grown on the right that bankruptcy might be a better solution to Milwaukee’s pension and budget mess than allowing the city and county’s elected representatives to decide whether to increase the local sales tax or endure massive cuts in police and other services.

On the left, there is lingering concern that sales taxes are regressive, hitting the poor harder.

Here is the reality: Without a sales tax increase, Milwaukee faces two worse choices: Massive service cuts (we’re talking 500 Milwaukee police officers on a 1,700-member force) or bankruptcy. Although the Legislature would need to pass new legislation to authorize the latter, Assembly Speaker Robin Vos said previously that bankruptcy might not be a bad thing.

On June 8 came the news that Republican leaders in the state Assembly and Senate and Democratic Gov. Tony Evers have agreed on a new shared revenue deal that would allow the Milwaukee Common Council and County Board to approve the new sales tax increase on a two-thirds vote to solve their fiscal woes. That sales tax revenue would address the city’s and county’s unfunded pension liabilities, if approved, avoiding bankruptcy or catastrophic service cuts. The full Legislature still needs to approve the plan. And, obviously, the Common Council and County Board would have to sign off on a sales tax too.

Previously, Vos was standing firm on a referendum requirement for the sales tax hike, but he traded it away for a school choice expansion and other conservative wins. A referendum could have been a risky move in an anti-police city that might not care if the MPD is gutted by 25%. Then again, the same could be said about the liberal elected bodies, which are packed with Democratic politicians who hate cops.

Meanwhile, the conservative MacIver Institute and some talk radio hosts have called the Assembly plan/sales tax provision a “Milwaukee bailout.” A sales tax approved by elected representatives is not a “bailout.”

But what are the consequences of municipal bankruptcy? We researched what happened in other cities, and we would encourage all stakeholders to consider the consequences long and hard before advocating for bankruptcy over the sales tax option.

What we found: In some communities that went bankrupt around the country, a Wisconsin Right Now analysis has found, city workers, including retired police and firefighters, saw pension, benefit or cost-of-living cuts. Indeed, we’ve started hearing from Milwaukee police officers who are deeply concerned about the potential effect on their hard-earned pensions.

“Everyone would walk off the job” if pensions are cut, one officer told us. That frustrated officer warned that many cops would be “done” with Republicans at the ballot box if that happens, noting that the police union is often a supporter of GOP candidates.

The effects on pensions are just the start of the potential consequences of municipal bankruptcy, though. Research shows a city’s reputation suffers, its bond rating and economic investment can drop, bond holders are stiffed, and sometimes taxes rise and services are slashed anyway. Bankruptcy would be a PR nightmare with the Republican National Convention coming to town. These ramifications could send shock waves throughout the state.

In Central Falls, Rhode Island, for example, retired firefighters saw their benefits cut by 55 percent, and property taxes rose, under bankruptcy, according to Mercatus.org.

There are few actions that should carry greater stigma in the municipal credit markets than a bankruptcy filing,” an analysis by Standards & Poor’s Rating Services warned. “We believe any potential weakening of an obligor’s willingness to pay its obligations may reflect degraded credit quality.

“Moreover, once a bankruptcy occurs, we anticipate the credit implications will remain after the municipality technically emerges from bankruptcy. Restoration of market access could be many years into the future,” Standards and Poor’s found.

“Municipal bankruptcies do not wipe away a distressed local government’s problems,” Pew Charitable Trusts wrote in a lengthy analysis of municipal bankruptcies. “Policymakers are still left with agonizing decisions: whether to raise taxes to pay for key services or to cut them, how to keep existing residents and businesses from fleeing, and how to improve economic conditions in the long run.”

We called Rob Henken, President of the Wisconsin Policy Forum, which has written extensively on Milwaukee’s fiscal issues.

He explained that the city and county would have “three big buckets” to draw from under a bankruptcy. “Pension and retiree healthcare liabilities, capital debt, and all of the services they provide.” If the city went bankrupt and was placed in receivership, how those concerns would be balanced is speculative, he said, but could possibly include retiree pensions, service cuts, or bondholders losing money.

“What bankruptcy could do, is it would somehow be a mechanism to allow the government to potentially not have to completely fulfill all of their obligations, to their retirees and to their bondholders,” said Henken, who stressed he was not taking a side on the question. He pointed out that some services are mandated, like running a county jail.

“Why do you declare bankruptcy? Essentially you can’t pay your bills,” said Henken. “You get a court to agree with you that your debts shouldn’t be fully paid.” In the case of a municipality or county, those debts are, in part, to pensioners. Another option could be slashing benefits to current or future workers, not retirees, Henken said.

Fitch’s recently downgraded Milwaukee’s bond rating because of its financial problems. A lower bond rating can have significant effects on taxpayers because it can lead to the city paying higher interest rates.

“The recent succession of municipal bankruptcies shows that a city’s residents and workers often suffer significantly during and following a Chapter 9 bankruptcy,” Pew Charitable Trust wrote in a study.

“Once a municipality’s officials decide to file a Chapter 9 petition, we believe its prospects for future economic growth, and its credit standing, will likely be much weaker,” Standards and Poor’s analysis warns.

“In exchange, the municipality may obtain temporary cash flow relief and, potentially, the court’s backing for a stronger negotiating position with some of its creditors. However, our review suggests to us that these benefits are likely to dissipate within a few years. They are also typically offset by the potential residue a bankruptcy can leave on the municipality’s reputation … We believe the fallout from bankruptcy often includes reduced prospects for economic investment of all types.”

Municipal bankruptcy is rare due to the consequences.

“Chapter 9 is used infrequently. Only 29 municipalities filed for bankruptcy between 2001 and 2017. Detroit, with more than $18 billion in debt, filed for bankruptcy in 2013, making it the largest municipal bankruptcy case to date,” a study published by Emory Law found.

Milwaukee could find it tougher to attract business. As a net exporter of personal income to the suburbs and an economic engine for the state, Milwaukee’s viability has ramifications throughout Wisconsin.

Bankruptcy becomes a balancing act of competing interests and how to weigh them, the research shows: The interests of pensioners (as collective bargaining and other contracts can sometimes be voided); of bondholders; of taxpayers; and the interests of other creditors.

“Under current bankruptcy law, Chapter 9 debtors have significant freedom to modify their outstanding pension obligations through the bankruptcy process,” a 2018 analysis by the Congressional Research Service says.

“Milwaukee’s leaders have been making bad decisions for many years. They have been warned the cost of those decisions would eventually catch up with them, and lo and behold, that has come to fruition,” Republican state Sen. Chris Kapenga said, opposing the sales tax authorization.

“As with every community, the local elected officials in Milwaukee have made their own decisions on local matters. They should bear the fruit of good decisions as well as bear the burden of bad decisions,” he said.

Indeed, the City of Milwaukee and Milwaukee County failed to contribute enough to their pension systems for years, according to Reason Foundation. “The city government failed to put enough dollars into the pension plan to improve funding,” Reason wrote. The county struggled because of the pension backdrop scandal but started meeting and even exceeding its pension obligations, starting in 2015, according to Reason.

Henken says investment losses contributed to the pension liabilities. “Various forms of state aid have not increased nearly at the rate of the consumer price index over time,” he said, while adding that expenditures need to be looked at. As recently as 2010, the Milwaukee pension fund was overfunded, he said, meaning the city was not required to “put in any taxpayer dollars.”

Of course, city leaders could have prepared and re-calibrated, when the pension fund started to go south.

At the same time, Milwaukee officials pursuing a $353 million expansion of the street car, demanding millions of dollars for a new museum or Brewers stadium, and creating new diversity, equity and inclusion positions don’t seem like good fiscal stewardship in times of trouble.

However, the question is what to do now.

MacIver focused on Detroit’s 2013 bankruptcy to basically leave the impression that bankruptcy concerns are overblown, a narrative quickly picked up by some talk show hosts and legislators.

MacIver pointed out that, in Detroit, police and fire pensions were not cut (other city workers’ pensions were and cops’ cost-of-living increase decreased). However, that’s only part of the story.

How were police pensions saved in Detroit? According to the Citizens Research Council of Michigan, the city got a reprieve for nine years from paying its pension debt as part of the bankruptcy deal. Instead, the pensions “were met through contributions from private parties and the State of Michigan as part of an agreement commonly referred to as the ‘Grand Bargain.'”

In other words, preserving police pensions required an actual state “bailout” in Michigan.

“The ‘Grand Bargain’ was an unprecedented collaborative effort that yielded $820 million worth of donations to make payments into the city’s pension plans on the city’s behalf. The city’s philanthropic community contributed $370 million, the State of Michigan contributed $350 million, and the DIA (Detroit Institute of Arts) committed an additional $100 million,” according to the Citizens Research Council.

Although this Grand Bargain allowed Detroit to emerge from bankruptcy with balanced budgets, its pension payments are scheduled to restart. The city is already tangled in a lawsuit with police over that. In Detroit, other city workers lost 4.5% of their pensions.

According to Reuters, Detroit got rid of $7 billion in debt through bankruptcy, which ended in 2014, but the city did so in part by cutting pensions for retired city workers. The workers sued, and they lost in federal court. “Thousands of retired Detroit city workers were subjected to 4.5 percent pension cuts, the end of cost-of-living increases, and reduced insurance coverage to help the city,” Reuters reported.

In 2012, the year before bankruptcy, Detroit, according to Reuters, “cut pay and healthcare benefits for city workers, including police, by 10 percent.”

Other cities like Stockton and Vallejo, California, managed to avoid cutting police pensions when they went bankrupt (although there were other consequences, and Vallejo cut retirees’ health benefits). “In the Chapter 9 case involving the City of Vallejo, California, the automatic stay allowed the City to reduce retiree health benefits. One of the City’s arguments was that retirees had no vested rights in the health benefits since they were negotiated as part of a collective bargaining agreement, ” wrote HG Experts.

According to a study by Mercatus.org, “Chapter 9 gave the city (of Vallejo) the opportunity to reject its costly collective-bargaining agreements. To deal with rising costs, city officials cut health-care benefits, laid off public-safety workers, and reduced services and payments to bondholders. But left untouched was the source of Vallejo’s budgetary morass: $128 million in unfunded pension obligations. Two years after the city emerged from a bankruptcy, its labor costs are eating up more of the general fund than they did before the filing.”

In 2011, when Central Falls, Rhode Island, went bankrupt, the conversation changed. Suddenly, retirees’ pensions were on the table because bankruptcy laws allow a governmental entity to void collective bargaining agreements and contracts.

In 2011, The New York Times wrote of Central Falls, “Retired police and firefighters from Central Falls, R.I., have agreed to sharp pension cuts, a step thought to be unprecedented in municipal bankruptcy and one that could prompt similar attempts by other distressed governments.”

“The cuts would be up to 55 percent of each retiree’s benefits, which now vary widely, from about $4,000 to $46,000 a year, depending on final salary, years of service and other factors. A few retirees would give up more than $25,000 a year,” The Times reported of Central Falls.

Prichard, Alabama declared bankruptcy after it simply stopped sending pension checks to retired cops and other city workers. The New York Times noted that Prichard “had already taken the unusual step of reducing pension benefits by 8.5 percent for current retirees, after it declared bankruptcy in 1999.”

In Chester, Pennsylvania, police pensions were recalculated, and, thus, reduced.

Since Central Falls, some courts have ruled that retirees’ pensions are now fair game in municipal bankruptcies. In 2014, “a federal judge ruled that California cities may alter pensions in bankruptcy,” according to Governing. The New York Times reported that a federal bankruptcy judge had ruled that Detroit “could reduce public pensions to help shed its debts.”

It’s not a done deal that police pensions would be cut in a Milwaukee bankruptcy. It could end up in court. Cohen, Weiss, and Simon wrote in an analysis that “even if a state authorizes municipal bankruptcies, a bankruptcy court sitting in that state may not allow pension cuts if the state’s constitution provides special protection to public-sector pensions.”

However, “in the Detroit case, the bankruptcy court ruled that public-sector pensions enjoy no more protection under Michigan law than ordinary contracts, even though the constitution of that state prohibits public employee pensions from being ‘diminished or impaired,'” the law firm explained. In contrast, in Arizona, the state Supreme Court in 2014 argued that public-sector pensions have “greater than ordinary contract protection,” the article says.

To be sure, public pensions, especially those of police, have strapped many local governments, and we are not arguing that public pensions do not need any reform going forward. In fact, the shared revenue deal does this by moving future Milwaukee workers into the well-run state pension system.

However, we do believe that the pensions were a promise to retired city workers, especially police officers, who endured extremely dangerous jobs in very difficult conditions as part of the deal. Going after them retroactively would further hobble an already decimated Milwaukee Police Department, making recruiting efforts much tougher. Public pensions often are a trade-off for lower salaries. Retroactively cutting the pensions of retired cops who, in some cases, bled for them and were even shot for them, strikes us as deeply unfair. Minimally, we believe that conservatives, who claim they “back the badge,” should consider whether they have the stomach for this possibility when they debate bankruptcy.

If the city went bankrupt and police and fire pensions were exempted, taxpayers would likely bear the burden through service cuts and tax increases. It’s a no-win situation any way you turn. Police and fire pensions make up a large portion of the whole.

In contrast, the sales tax would spread the pain. It would mean that, say, the drug dealer who loafs around has to share the pain at the store with the hard-working public works employee or firefighter.

Consider the bankruptcy experiences of these cities and counties:

• Residents of Jefferson County felt “the strain of severely reduced services after the county, home to Birmingham, the state’s largest city… filed the biggest U.S. municipal bankruptcy in history,” Reuters reported. “More than 500 county workers have been laid off. Inmates at county jails are doubled up in cells, business development deals with financial sweeteners are being unwound, and county buildings have been shut.”
• Cal Pensions reported that Vallejo, California, ended up with “budget deficits” even after bankruptcy.
• Stockton ended up solvent after bankruptcy but required tax hikes to do it. Stockton did not cut pensions. However, Stockton did cut retirees’ health care benefits.

Pew Trust, in 2015, compiled an extensive report into municipal bankruptcy. According to Pew:

• “In every recent bankruptcy, courts have allowed cuts in promised pension benefits, saying that costly past promises are unsustainable over the long run. But in most of the cities, municipal bond investors have also had to accept losses,” Pew wrote. Examples:
• “In Jefferson County, sewer system customers will pay some of the highest rates in the nation over the next 40 years as part of the debt restructuring.”
• In Detroit, “Current city workers were put into a new, less generous retirement plan, police and fire retirees accepted a cut in their cost-of-living increases, and other retired city workers agreed to reduced pension benefits and elimination of the cost-of-living increase.”
• “City officials said Detroit lacked sufficient revenue to honor their repayment pledge on the bonds, and investors grudgingly agreed to receive cents on the dollar.”
• “In Central Falls, residents’ property tax bills are increasing 4 percent in each of the next five years.”
• “The Central Falls bankruptcy differed in its treatment of pensioners and bondholders. When that city was teetering toward insolvency in 2010, state lawmakers approved legislation that, among other things, gave priority for repayment to investors who buy tax-free municipal bonds over public pension recipients and other creditors, meaning that the city paid its debt to bondholders in full but cut workers’ pensions and raised their health care premiums.“
• “In Stockton’s Chapter 9, local officials argued that the city had already cut pension benefits before the filing and that the municipal bond industry knows it is selling a product that carries risk and should not be treated differently from other creditors. The federal bankruptcy judge agreed, and bondholders absorbed losses.”
  
• Former Central Falls receiver Robert Flanders told Pew: “It was a very difficult conversation. I had to say, ‘Look, we’re going to have to cut your pensions by half.’”
• “States and cities have to pay the receivers and emergency managers.” This can cost millions of dollars.
• The city sustains harm to its reputation, which can lead to population decline and lack of investment.

Standards and Poor’s found:

• “Vallejo, Calif. was in bankruptcy for three and one-half years and has not issued debt–due to a lack of market access–since prior to its filing. In addition, throughout the bankruptcy process and since it formally ended, the city–according to several of its own measures–inadequately maintained its infrastructure. Service level cutbacks that accompany fiscal distress and bankruptcy will likely impede economic development in most cities.”
• “A municipality can’t be liquidated. In effect, a ‘successful’ bankruptcy requires that a municipality drive a hard bargain with its creditors, including labor unions.”
• “Based on what we have observed, bankruptcy is far from a simple ‘reset’ button. Emerging from bankruptcy is likely to be a long, costly process. And considering that the investment climate of a city that has filed for bankruptcy is likely to have been materially degraded, it is questionable whether it benefited financially.“

A 2018 Congressional research paper by legislative attorney Kevin M. Lewis found:

• “Filing for bankruptcy may adversely affect the municipality’s creditors, especially beneficiaries of underfunded municipal retirement plans (who, along with bondholders, often hold ‘the lion’s share’ of a municipality’s financial obligations).”
• “Because a number of municipalities face a ‘dramatic and growing shortfall in public pension funds,’ many ‘firefighters, teachers, police officers, and other public employees’ who purportedly have ‘a right to pension benefits at retirement’ face a significant risk that their pensions will ultimately not be fully repaid.”
• “Chapter 9 thereby affords a subset of municipal debtors relief from many types of burdensome debts so that they may continue to provide certain services that have been viewed as ‘essential’ to their residents, like police protection, fire protection, and garbage removal.”
• “Most relevantly, Section 365 of the Bankruptcy Code generally gives a Chapter 9 debtor the power to reject an ‘executory contract‘—that is, a contract that the parties have yet to fully perform—subject to the bankruptcy court’s approval.” HOWEVER: “One such contract could be a municipality’s commitments to provide pension benefits to its employees.“