Pension Plans Could Lead More Cities To Bankruptcy

Recently Vallejo, California became the largest city in the state's history to declare bankruptcy, and while they have the headlines now, there will likely be more cities to follow. A few weeks, ago I did a post about Vallejo’s bankruptcy. Specifically, I talked about how the housing crisis had hurt the city, but I didn’t do enough justice for one of the major factors in the decision for the city to declare bankruptcy, which was the city’s bloated pension plans.

To explain how ridiculous the pension plans in Vallejo had become, I simply need to tell you what they were offering. The following is an excerpt from an article by CNNMoney

“But the real nail in Vallejo's coffin was the city's labor costs. Under the current labor agreement, the average police officer walking the beat in Vallejo will be paid $122,000 this year before overtime, according to city documents. An average sergeant will make $151,000; a captain, $231,000. The average firefighter, meanwhile, will bring in $130,000 before overtime.

That's just the salaries, though. The final budget-crusher was the city's pension plan. Thanks to retroactive benefit enhancements approved by the city council in 2000, police officers and firefighters can now retire at age 50 and receive an annual pension equal to 90% of their final pay (assuming 30 years on the job), an amount that gets increased every year to help keep pace with inflation. The old plan had given the workers a pension equal to 60% of their final pay at age 50.”

As CNNMoney goes on to point out in their article, Vallejo is not the only city to increase pension benefits, either: “ironically, just a few hours south of Vallejo, the city of Rialto, Calif., recently approved a similar retroactive pension increase that will give police officers a pension equal to 90% of their salaries at age 50.” And there are many other cities in the same boat. Flush with cash thinks to higher property values and taxes, many cities made the same mistake Vallejo did--and just might end up with the same fate.

Government pension plans are protected by constitutional and legal guarantees, according to the article, so pretty much the only way out from under these burdensome arrangements is for the cities to declare bankruptcy.

With city revenues declining, a population aging and budgets going further and further in the red, it seems like we almost have a perfect storm brewing. In my post yesterday, I talked about how cities were slated to make major budgetary cuts, but those cities that elected for these bloated pension plan arrangements might need more than some budget cuts to save them.

Once again, as an investor, I would strongly suggest that you take some time to analyze a city’s financial strength and longevity before you buy. A city in bankruptcy is a city that is going to be short on services and on the decline.