Detroit Driven Like Studebaker

Detroit filed for bankruptcy today. The details of how they will default on pension promises to 32,000 people remains a deep dark secret but we do have precedent in the private sector and there may be a silver lining playbook in Detroit.

In a blog post I did back at nj.com I referred to the story of Studebaker which was the prime driver for the enactment of ERISA:

The closing of the Studebaker automobile plant in South Bend, Indiana, is generally regarded as a pivotal event in the history of the movement toward comprehensive federal regulation of private pension plans. On December 9, 1963, Studebaker Corporation announced that it was closing its automotive manufacturing plant in South Bend, Indiana, and consolidating its remaining automating activity at its Hamilton, Ontario, plant. This announcement followed a long period in which the American plant had been losing money. As a result of the plant closing, some 5,000 workers were dismissed in addition to the 2,000 that has already been laid off. In the end, 1,800 workers eventually lost their jobs. The dismissed workers were members of the United Automobile Workers and were covered under a single-employer defined benefit pension plan negotiated between the United Auto Workers (UAW) and Studebaker.

When the plant closed, the UAW and Studebaker entered into an agreement settling the terms for terminating the plan. The termination did not produce litigation; it implemented default priorities contained in the plan and divided the participants into three groups: 3,600 retirees and active workers who had already reached the permitted age of 60; approximately 4,000 employees, aged 40 to 59, who had at least ten years of service with Studebaker and whose pension benefits had therefore vested; and a residual group of 2,900 workers who had no vested rights.

Persons in the first group had the first claim on the pension assets; they received full lifetime annuities. The cost of the annuities purchased for this group was about $21.5 million. After the annuities, only $2.5 million remained in the pension fund, less than the amount necessary to cover the benefits of the members of the second group who received approximately 15% of the personal value of their earned pension benefits. The third group received “zip.”

There’s your scenario for Detroit retirees with possibly a few tweaks (I don’t see current retirees getting anywhere near 100% of their benefits) and for the rest of us maybe, by 2024 – using the Studebaker timetable – we will have  PERISA – which primarily exists these days as a hopeful acronym just waiting for implementation.

19 responses to this post.

  1. Posted by Tough Love on July 19, 2013 at 2:21 am

    John , I believe the Detroit distributions will be far from the 100%, 15%, 0% you described for Studebaker. I believe so because that split was essentially “Union-negotiated” and since the company wasn’t kicking in any money beyond what was already in the Plan, why would it care much anyway (as to how it was divvied up). And we all know that the Unions always favor the most senior members.

    The Detroit bankruptcy must be approved by the Bankruptcy Court, and while those already retired (especially those with the smallest pensions) may get some preferential treatment I doubt that the % of vested benefits they get to keep will be much greater than those of vested actives … and I see little justification why it should be.

    Reply

  2. Posted by Al Moncrief on July 19, 2013 at 3:44 pm

    Detroit owns 60,000 works of art valued at $20 to 30 Billion, the city can afford to pay its debts.

    Support public pension contractual rights and the rule of law in the USA. Contribute at saveperacola.com, Friend Save Pera Cola on Facebook!

    Reply

    • Posted by Anonymous on July 19, 2013 at 4:20 pm

      The problnis that the city never could afford an artwork collection anyone than they could afford the unrealistic salaries, pensions and health benefits . The result speaks for itself.

      Reply

      • Posted by Al Moncrief on July 19, 2013 at 6:49 pm

        How is having $20 to $30 Billion in assets that could be liquidated by Sothebys over the next couple of years a “problem”?

        Reply

        • Posted by Anonymous on July 19, 2013 at 7:26 pm

          Would you sell your house to pay off your creditors? Where would you live? There isn’t anything wrong with having 30B in assets if one can afford it. Detroit clearly could not afford it any more than they could afford the excessive public pensions salaries and benefits. Hence, they are now reaping the consequences of their greed and financial ineptness. Coming soon to a city or town near you

          Reply

          • Posted by Al Moncrief on July 21, 2013 at 12:16 am

            You wouldn’t have to sell your house, your creditors would simply take it in court. Agreed, we will see dozens of muni bankruptcies among the thousands, some of these dozens will be near me, perhaps in neighboring states.

        • Al,

          There are questions about whether they can sell the art. They’re trying to pass a law barring those type of art sales in Michigan:
          http://www.cnn.com/2013/05/31/us/michigan-detroit-art
          plus if some of the pieces came from donations their might be a stipulation against selling them.

          If they sold them they could be breaking either a law or a contract and they may have reached their limit on how many of those they can break.

          Reply

          • Posted by Al Moncrief on July 21, 2013 at 1:18 pm

            Hey John, I’ll look at the article, of course, taking accrued pension benefits would be in violation of the Michigan state Constitution (law), and in violation of the Contract Clause of the US Constitution.

          • Posted by Al Moncrief on July 21, 2013 at 2:07 pm

            “‘They basically let us know that the collection was not off the table,’ said museum director Graham Beal.”

            “Nowling conceded that while the city has not made any plans to sell assets, ‘it is possible that the city’s creditors could demand the city use its assets to settle its debts.’ Beal maintains that DIA’s collection is among the top six in the Western Hemisphere. While he could not specify a value, Beal said it would likely be in the billions of dollars.”

            “Laura Bartell, a bankruptcy law professor at Wayne State University in Detroit, said she believes Orr is just doing his job and that it would be irresponsible for him not to consider what assets Detroit has and what they are worth. ‘I don’t think anyone argues that Detroit does not have the legal authority to sell something that Detroit owns. It’s a question of whether Detroit will — and if Detroit should,’ said Bartell.”

            “Gov. Snyder has been working with Orr to try to ward off the city’s bankruptcy and the sale of the DIA’s art. However, Snyder admitted that he is not legally empowered to declare the collection hands-off.”

            http://www.cnn.com/2013/05/31/us/michigan-detroit-art

            “If the city declares bankruptcy, the state-appointed emergency manager, Kevyn Orr, can sell off its assets to repay creditors—and artworks housed in the 128-year-old museum are not exempt. The city’s debt about equals the worth of the museum’s holdings.”

            “Senate Majority Leader Randy Richardville recently introduced a bill that would protect the museum’s collection from being sold off during bankruptcy proceedings. Even if that legislation passes, it may not help the museum: Federal bankruptcy laws tend to trump state laws in court.”

            http://www.businessweek.com/articles/2013-06-04/in-bankruptcy-detroit-could-sell-off-its-art-collection

            “A Metro Detroit bankruptcy expert already has indicated Schuette’s opinion may be for naught.

            ‘Federal law trumps state law’ in a Chapter 9 municipal bankruptcy, said Douglas Bernstein, a bankruptcy attorney at the Plunkett Cooney law firm in Bloomfield Hills, so DIA art would not be protected from sale to satisfy creditors.”

            http://www.detroitnews.com/article/20130613/METRO01/306130115

        • Posted by Tough Love on July 19, 2013 at 8:09 pm

          Al, The mantra of ALL museums has always been …. nothing can be sold other than to replace it with another similar item. the art cannot be sold to fund museum operations … and FAR below that would be to fund the city’s debt.

          Reply

        • Posted by Tough Love on July 19, 2013 at 8:17 pm

          The art is really no different than the City’s parks and libraries. They “belong” to the citizens of the city in perpetuity … not to be plundered to satisfy debt and obligations conjured up in back-room deals that knowingly screwed those very same citizens.

          Reply

          • Posted by MJ on July 19, 2013 at 8:46 pm

            Well said TL! Lets plunder all of our treasured assets to satisfy the ridiculous public pension debt. There’s an idea. Just goes to show the desperation of the situation.

          • Posted by Al Moncrief on July 21, 2013 at 1:25 pm

            MJ, earned, accrued, contracted public pension benefits (deferred compensation for work performed over decades) are also “treasured assets,” property protected by the Takings Clause. Works of art are relatively liquid assets of the city, and may very well be used to meet municipal debt obligations. The art could be sold to other public institutions where it would continue to be available to the public. Even if the art were to be sold to private individuals, much of it will eventually return to public institutions in coming decades.

          • Posted by Anonymous on July 23, 2013 at 2:55 pm

            Al. Only a public worker would think that their pensions are “treasured assets”. The pensions are more like balls and chains around slowly sinking cities towns and municipalities around the country. Can’t blame you for grasping at straws but the consequences of paying way too many to do way too little for so much is coming to an end called bsnkruptcy. Goes to show the short sightedness and desperation of those empty promises in exchange for votes.

  3. Just saw this article on NY Times: http://nyti.ms/132k6Zp

    The last paragraph was interesting:

    “Much of the theoretical argument for retaining current methods is based on the belief that states and cities, unlike companies, cannot go out of business. That means public pension systems have an infinite investment horizon and can pull out of down markets if given enough time.

    As Detroit has shown, that time can run out.”

    Do you agree, this “infinite time horizon” is the main differentiator in how public plans are valued and considered, compared to ones in the private sector? And do you think this Detroit bankruptcy now will change this? What would the change be, using a risk free interest rate assumption instead of 8% or so? If they do that, however, the plans will never catch up and are all screwed!

    Reply

    • Just saw the NYT article now and will likely have more on it later today but the “cannot go out of business” argument never made sense to me as a justification for a high interest rate. The funding rates should be low for public plans because of the need for liquidity. In NJ if you have to pay out $10 billion a year there’s a certain amount of your fund that you can’t invest long-term so the overall rate should be a lot lower.

      Reply

    • Posted by Tough Love on July 20, 2013 at 3:59 pm

      I agree with John, and taking it a step further, (where a Plan is fully funded and the annual outgo isn’t a large percentage of assets), ignoring the “risk” (AND the associated expected cost thereof) makes no financial sense. At some point such as strategy MUST trip up. ….. and appropriately INCLUDING the cost of that risk is equivalent to dropping the 7-8% liability discount assumption Public Sector Plans currently use AT LEAST down to the 5-ish % that Moody’s and Private Sector Plans use.

      Reply

  4. […] thought so too, once, but with Mr. Lowenstein’s imprimatur making it more likely and upon reflection I now see two […]

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  5. […] pension legislation will come (perhaps as early as 2024 if the Stubebaker timeline for federal action is adhered to) but it was needed in 1978 when the funding shortfalls emerging might have been […]

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