Pension Reform

Staff Reports
Posted: 07/25/2013 12:09:10 PM PDT
Updated: 07/25/2013 12:11:20 PM PDT

From San Bernardino to Detroit and in many smaller cities in between, a legal question rages that could change the course of American politics forever. When a city declares bankruptcy, does it still have to pay the retirement benefits promised to its city workers?

Getting this one right is a truly daunting legal challenge.

Bankruptcy is a legal process that allows a judge to determine who gets what, when a debtor doesn’t have enough money to pay its debts.

If the debtor is a company, there are two primary types of bankruptcy.

The company can “restructure” its debts and continue operations or the company can close down and sell all of its assets to pay its creditors. Many issues go into the choice of bankruptcy including the business’ viability and fairness to those who are owed money. And these two issues are not independent.

Suppose Bill’s machine shop borrowed $50,000 just before the economy tanked to buy a new computerized lathe. When the recession hit, Bill’s business fell off, Bill couldn’t make his debt payments, and Bill ended up in bankruptcy court. If Bill could show the judge that he had a plan for paying off the debt as soon as the economy recovered, Bill’s business could continue under a restructured set of payments. If the bankruptcy judge doesn’t think that Bill’s business will ever recover, Bill will have to close down, sell all of his assets and pay the creditors as much of what he owes as he can.

Let’s switch gears (possibly gears that were made in Bill’s shop) and talk about pensions.

Broadly defined, there are two types of pensions: Defined contributions and defined benefits. Most of us have defined contribution pensions: a 401k — The employee and the employer set aside a fraction of the employee’s pay into an investment account and the employee gets whatever that’s worth when he or she retires. There are no guarantees with this type of pension since the value depends on the return on the investments.

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