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Can States Escape Pension Obligations Through Bankruptcy?

A number of states face major unfunded liabilities in their public employee pension plans, including those covering teachers. But getting out of those obligations isn't easy. As we've reported, plans for currently enrolled employees have been shielded by state constitutions and regarded by the courts as contracts between the state and employees, which can't be broken.

But apparently there's some interest in Congress in offering states an escape route: allowing them to declare bankruptcy in federal court, according to a new story in The New York Times.

The story points out that states currently are prevented from seeking protection in federal bankruptcy court because they're considered sovereign entities, unlike cities. Any effort to change that status could face serious constitutional hurdles, the article explains.

Yet federal lawmakers have grown increasingly worried that states could soon seek federal bailouts to resolve their budget woes, a la General Motors. House Republicans have shown an interest in changing the law to allow states to declare bankruptcy, and senators from both parties also have become curious about federal options, the Times reports. By declaring bankruptcy, the expectation is that states could get out contractual pension obligations with their employees.

Yet even as they explore the topic, lawmakers seem to be tip-toeing around it for fear that talk of state bailouts and bankruptcy would roil municipal bond markets.

This isn't the first time Congress has shown an interest in wading into state pension issues. As we reported, Republicans introduced a measure bill last year designed to require states to be more transparent about the unfunded obligations of their plans.

In the states, numerous governors and lawmakers have raised concerns about the costs of teachers' pension programs, and have pledged to cut those expenses by reducing benefits and raising required payments for future employees, if they're legally barred from changing benefits for those who are currently enrolled.

Critics of efforts to cut back state pension programs have said that state officials have the money to cover their obligations—they just don't want to pay them. That's because it's politically more appealing to promise to cut spending, they say, and to criticize public pension systems as overly generous, at a time when many private-sector workers' retirement plans are still recovering from the recession's wreckage.

A recent report by the Pew Center on the States noted that some states have tended to skimp on the yearly actuarially-recommended payments to pension plans, when they deemed the costs too high. (In New Jersey, Republican Gov. Chris Christie has called for cuts to the state's pension system, while the Democratic leader of the state senate has said the governor needs to guarantee the state will make the necessary yearly contribution to the plan, first.)

Pew also pointed out that state' pensions burdens are not uniformly bad; some states have kept up with yearly costs—and those states are in relatively good shape.

In fact, the Times cites a analysis by the Center on Budget and Policy Priorities, which says much of the public and media reporting on states' budget woes in confusing states current fiscal woes—created largely by the recession, with questions about longer-term debt and pension obligations. This creates "the mistaken impression that drastic and immediate measures are needed to avoid an imminent fiscal meltdown," the report says. The center goes on to explain:

"Some observers claim that states and localities have $3 trillion in unfunded pension liabilities and that pension obligations are unmanageable, may cause localities to declare bankruptcy, and are a reason to enact a federal law allowing states to declare bankruptcy. Some also are calling for a federal law to force states and localities to change the way they calculate their pension liabilities (and possibly to change the way they fund those liabilities as well). Such claims overstate the fiscal problem, fail to acknowledge that severe problems are concentrated in a small number of states, and often promote extreme actions rather than more appropriate solutions. ... State and local shortfalls in funding pensions for future retirees have gradually emerged over the last decade principally because of the two most recent recessions, which reduced the value of assets in those funds and made it difficult for some jurisdictions to find sufficient revenues to make required deposits into the trust funds. Before these two recessions, state and local pensions were, in the aggregate, funded at 100 percent of future liabilities."

As states face new pressure to cut spending and reduce deficits in the months ahead, expect more scrutiny of state pension systems, and higher-decibel debates about how to pay for them.

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