The Public Policy

Governments’ Bad Investments

Final proof that the ongoing financial crisis is not a crisis of free markets.

By 10.1.10

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The Wall Street Journal reports that municipalities all over the nation are teetering on the verge of bankruptcy ("Local Debts Defy Easy Solution," September 23). This may be the final proof that the ongoing financial crisis is not a crisis of free markets, as populist politicians and media have characterized it. The municipal debt crisis is a political crisis, one created by politicians making bad decisions with taxpayer money in order to funnel it to their cronies and supporters. 

Why are municipalities in so bad a position? For the most part, because of deals cut with public employee unions. One of the prime benefits a labor union brings to its members is a fat pension plan that, in theory, is generously funded by the citizens of the municipality the union members work for. 

For union-friendly politicians, this was a sweet deal. They could reward their labor supporters with generous benefits, while passing the buck of raising taxes to pay for those benefits on to their successors years into the future. Now those bills are coming due. As the Journal says, state and local pension plans "have promised over $3 trillion in retirement benefits," while their pensions assets "are at least $1 trillion shy of that." California's pension shortfall is larger than the GDP of Saudi Arabia, oil riches and all.

This massive liability puts state and local governments in a bind. They simply cannot balance the needs and wants of workers, creditors, taxpayers and retirees. Someone, somewhere, will have to suffer, unless state and local can fob the problem off onto the federal government. 

Sen. Robert Casey (D., Pa.) and Rep. Earl Pomeroy (D., N.D.) are sponsoring legislation to allow the Pension Benefit Guaranty Corporation (PBGC) to engineer a taxpayer-funded bailout of the Teamsters' pension fund. If enacted, the Casey-Pomeroy bill could set a precedent to have federal taxpayers bail out the states.

That would be a disaster. It will turn the PBGC into a pension fund variant of Fannie Mae and Freddie Mac, the two government entities most to blame for the original financial crisis. Unions and local governments simply have to be held to account for their bad investments. Furthermore, members of these underfunded pension schemes should be able to opt out and put their funds into defined contribution 401(k) plans or other retirement vehicles.

States and municipalities should recognize their deals with labor unions as bad investments and take steps to end those agreements. The federal government should not bail them out. However, Congress has made it difficult for local governments to go into bankruptcy. If America is to break the vicious cycle of bad public investment, that needs to change.

That is what should have happened with General Motors. Bankruptcy would have allowed GM to rebuild itself as a company that sold cars to meet the needs of drivers, rather than to fund its pension plan. But the political clout of the United Auto Workers prevented that from happening. Instead, the federal government poured massive amounts of taxpayer money into the firm to keep its failed business model going. Now, as the car companies' re-privatization approaches, the nation's Inspector General says that shares will have to be priced at $134 each for taxpayers to recoup their investment.

If there is a silver lining in this situation, it is the public revulsion at the bailouts -- something to which Congress should pay heed. The new Congress will need to recognize that streamlined bankruptcy procedures for states and municipalities are badly needed, and to pass such procedures within its first 100 days.

With such procedures in place, state and local governments will be able to take the steps necessary to restore themselves to fiscal health. Of all the bad investments governments have made over the years, the overly generous deals given to unionized public sector employees are perhaps the worst. If bankruptcy brings an end to those unwarranted privileges, the rest of us will have a shot at a much fairer deal from government in the future.

Mr. Murray is a recovering former unionized public sector employee.

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About the Author
Iain Murray heads the Center for Economic Freedom at the Competitive Enterprise Institute and is the author of Stealing You Blind: How Government Fatcats Are Getting Rich Off of You.