This, Too, Should Be Called Default

With all of the S&P hoopla, we've heard a lot about 'default'--that the U.S. government can't (false) or won't (with the teahadists, who knows?) pay the money owed on its debt. Well, there's another kind of default that's slipping under the radar (italics mine):

When the small, beleaguered city of Central Falls, R.I., filed for bankruptcy this month, it sought to cut the pension checks it has been sending its retired police officers, firefighters and other workers by as much as half. All the city promises now is that its retirees, many of whom do not get Social Security, will not have their benefits cut to less than $10,000 a year.

But investors who bought the city's bonds could do much better: Rhode Island recently passed a law intended to make sure that they would be paid in full, even in bankruptcy.

Retirees are wondering how the city can cut what they believed was a guaranteed benefit. "We put our time in, we put our money in," said Walter Trembley, 74, a retired Central Falls police officer. "And the city, through their callousness and everything else, just blew it. They were supposed to put money in and they didn't."

Cities and local governments make lots of promises: to their citizens, workers, vendors and investors. But when the money starts to run out, as it has in Central Falls, some promises prove more binding than others.

While Central Falls, RI is a basket case on many different levels, lots of state and local governments aren't meeting their obligations:

Teachers in New Jersey likewise got a cold shoulder when they tried to make the state comply with a law that it contribute a required amount to their pension fund each year. A judge ruled that their plan was not yet unsound, despite the state's failures to make the payments. The teachers, who argued that by the time the plan qualified as "unsound" it would have collapsed, lost on appeal last year. But the state always sets aside enough money to pay bondholders.

Keep in mind that many state and local employees are not eligible for Social Security benefits as a cost-cutting measure for those governments, so the pension is often all these retireed employees have. And this is the reality:

After going 20 months without their pension checks, the 141 retirees of Prichard decided a third of a loaf was better than nothing and settled with the city. Their average benefit, which had been $1,000 a month, is now about $350. But they also get Social Security. Ms. Berg, the retired clerk, said she worried about the retirees of Central Falls, many of whom do not.

"I can't imagine telling them that they have to take this 50 percent cut," she said. "These are retirees, elderly people. They can't go out and get new jobs."

So wealthy bondholders taking a haircut equals default, while making Grandma eat catfood is fiscal responsibility. Good to know.

An aside: For those who want to argue the 'overpaid government employee' canard, read this.

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It is a default. And there's absolutely nothing that keeps a company or city from defaulting. Even on guaranteed bonds. Workers should be very leery of any pension arrangement, other than with the federal government, that removes their social security benefit.

Yes, because those city workers are the ones who need to take responsibility and own this default.

@2 Nobody said that the city workers need to own the default or take responsibility. But it's wise for people to "trust, but verify".

There's a big gap between how systems and people *should* behave and how they do. There are a lot of scammers out there, as well as a lot of irresponsible city planning. If we want to protect retirees, we can work to fix bad planning by cities.. but in the meantime, we can also teach people how to watch out for dangerous situations.

By Windchasers (not verified) on 15 Aug 2011 #permalink