Pension funds dragging down cities
In the 19th century, the city of Stockton, California, was a thriving Wild West gold rush town -- a destination for optimistic miners looking to strike it rich. Today, the bankrupt city is a cautionary tale of financial excess and a sobering reminder that the US economy is still struggling with the fallout of the 2008 housing market crash. (Justin Sullivan/Getty Images/AFP)
A few weeks ago, the city of Stockton, Calif., filed under Chapter 9 for bankruptcy protection, making it the largest municipal bankruptcy in the country's history. It was soon to be joined by other cities, such as San Bernardino.
These are not small cities: the population of Stockton and San Bernardino respectively stand at 229,000 and 210,000. The main cause of their financial difficulties is the overwhelming burden of their employees' pension fund deficits.
Although the situation is not as dire in Canada, it is a warning for municipal administrations across our country.
These Californian cities are declaring bankruptcy in a bid to either find an agreement with their creditors to cancel part of their debts or to get the public sector unions to accept a drastic reduction in benefits. But the fact of the matter is that they got into the mess they are in because they made promises to their workers that were too costly to keep.
At the heart of the problem is the system of defined-benefits pensions. Under this scheme, retirees are promised base benefits regardless of whether or not the contributions and investment returns are high enough to fund them. Although they still exist in some large unionized corporations, such schemes have been largely abandoned in the private sector - but not by governments.
The payments of employee benefits often represent the greatest financial burden borne by municipal governments. For example, in the city of Stockton, 76% of the budget last year went to employee services - pensions, health care benefits, and worker's compensation. Often, these promises were made during the boom years, when municipal administrations were hoping that housing prices would keep rising and that this would bring sufficient revenues from property taxes.
Moreover, some cities fudged the numbers so the unfunded promises they made would not appear too large. Hence, after the housing bubble burst, the city of Stockton had $800 million in unfunded promises to its workers.
So what about us in Canada? Should we be worried as well?
On the surface, the situation appears nowhere near as bad as that in the United States. For one thing, Canadian cities cannot declare bankruptcy. But that doesn't mean the problem does not exist.
In 2010, the cities of Montreal, Calgary and Vancouver had long-term debts larger than their annual revenues. The fiscal noose is tightening progressively as long-term debts and pension liabilities pile up.
More worryingly, many observers believe housing prices are in a bubble and will eventually decline, as they did in the United States, putting cities into a tighter fiscal spot. This could force provincial governments to step in, with taxpayers having to foot the bill.
Already, municipal administrations across Canada have begun to express unease regarding the increase in pension liabilities towards their employees. The numbers tell why.
Excluding Quebec's two largest cities, Montreal and Quebec City, the liabilities from that province's municipal employees' pension plans have jumped from $3.1 billion in 2010 to $4.8 billion in 2011. In New Brunswick, the pension deficit of the city of Saint John is estimated to be $193 million. Regina's employee pension plan has a $293-million deficit.
Cities cannot live beyond their means, any more than individuals. Something will have to give. Canadian municipalities should start implementing the necessary reforms, before they are looking down the abyss like their American counterparts.
- Michel Kelly-Gagnon is president of the Montreal Economic Institute (www.iedm.org). The views reflected in this column are his own.