The recent blow-up of the Dallas Police and Fire Pension System was entirely predictable.
It is tempting to blame unusual circumstances for the recent lock-up of redemptions and likely substantial reductions to pensions in Dallas for those still in the fund. However, many other American pension funds are heading down the same road. Dozens of US local and state government pension plans will end up in the same situation.
In the late 1990’s, returns in financial markets had been strong for years. This lead many to believe that exceptional returns would continue. In this environment, the board that ran the Dallas plan decided that more generous pension terms could be offered to employees. These benefits, it was thought, could be funded by the higher expected returns without needing greater contributions from the Dallas municipality and its taxpayers. These changes meant that pension liabilities were guaranteed to skyrocket in future years. However, there was no guarantee that investment returns and inflation levels would also be high. Dallas police and fire personnel were being offered the equivalent of a free lunch. As a result, they took full advantage.
The playbook from the Detroit bankruptcy is likely to be used repeatedly in the coming decade. When a bankruptcy occurs and an administrator is appointed a very clear order of priority emerges. Firstly, services must be provided otherwise voters/taxpayers will leave or revolt. If there is no police force, water or waste collection the city will cease to function.
Secondly, pensions will be reduced to match the available assets quarantined to meet pension obligations. If the budget doesn’t have capacity or the legal obligation to contribute more to pension funding, pensioners should expect their payments to be cut. For Dallas and the pension plans in Illinois this means payments cut by more than half.
Third in line are financial debtors. Bondholders and lenders don’t vote and they are seen as a bunch of faceless wealthy individuals and institutions who mostly reside out of state. They effectively rank behind pensioners. The pensioners are people who predominantly reside in the state and who vote. This is so even though the two groups technically might rank equally.