The Norris Group Blog

James Spiotto Head of the Special Litigation, Bankruptcy and Workout Group (Full Bio)

This week Bruce Norris is joined again by James Spiotto. Off-air Bruce and James were talking about the trustees’ responsibility and mandate. One of the things Bruce read about was the Board of Trustees Responsibility had to do with CalPERS, and from reading it he realized it boxed them into something that seemed so confining they might not be able to make the right decision. The article said, “The trustees’ primary duty of loyalty is to the beneficiaries of the trust. The trustee is under a duty to the beneficiary to administer solely and to the interest of the beneficiary. The trustee must not be guided by the interest of any third party. The unwavering duty of complete loyalty to the beneficiary of the trust must be to the exclusion of the interest of all other parties. When Bruce read this he thought he could be a trustee; and he had been involved in running partnerships for people’s money where the sole decision was his. There are times where he has made decisions that cut losses but created a loss at the same time, and it was the best decision.

Bruce said in a way this is what he is looking at. He wonders if the math will not work for a lot of what has been promised. If this is a fact, then duty of the trustees is to take into account the best interest of the beneficiary and make a decision that they think might be breaking their promise as a trustee. James said sometimes we forget that we view ourselves more as advocates for a position than the responsible adult in the room. In the true sense of a fiduciary, it may be better to do what is sustainable and affordable over time than to buy into promises that can never be fulfilled. One of the biggest challenges of people in connection with workers and their pension and their future is that if you cost a municipality too much, you ultimately see fewer employees and fewer benefits long-term. If you work with the municipality to maximize its value and its taxpayers with good services, you will wind up with more people coming and more potential for the fulfillment of any promise that is made.

Sometimes, especially for the younger workers, asking for too much now will lead to less for everyone later. Everything has to be balanced. Aristotle used to say, “Virtue was nothing in excess.” That is truly a guiding principle for fiduciaries. One of the things to keep in mind is being a true supervising adult, both on the municipal and the pension side, means working together with the other party to make sure the long-term goals are met, not just the present or near-term payments. When you have a 3-year process+ for Vallejo, it seems like that probably did not occur. One of the problems, unfortunately, was Chapter 9. That is why it is the last resort and has been used so sparingly. It is complicated, time-consuming, and is very costly. It is also not predictable, so you may go in saying you’re going to do one thing, but the pushes, shoves, and demands may come out entirely differently.

If you have a city employee, it seems once a promise is in place it is in place permanently for a specific person. Now if a new employee is hired under a completely different set of circumstances, possibly not having a defined benefit plan but another person in the company does, Bruce wondered if there would be any ramifications for that. James said long-term the municipality, just like the state, is a sub-sovereign. It can pay, or it can choose not to pay. However, you can be sued for not paying. However, if it does not have money to pay, then it cannot pay. Everybody has a vested interest, not only in their pension, but in another sense of the word vested, have a vested interest in making sure the municipality prospers and grows. If you charge too much, we all know what happens, no matter what business or municipality it is. If the prices are not sustainable and affordable, there will be less and there will be pain.

It is the younger worker and future workers that are important to the future of the municipality. If you really want your pension paid and the promises kept to the degree possible, the best thing to do is help that municipality be very sustainable and affordable, and sometimes less may mean more. By asking for everything now, you may get far less, and others may get nothing. The key phrase here is “promises kept to the degree possible.” Bruce wondered if the promises in place can be kept. James said depending upon the various calculations, if you look at state and local governments various studies by various individuals say under-funding could be $1-$3 trillion. It is unknown if this is accurate because investments and other rules may make it hard to calculate, but it could be a very large number. If you stop making a house payment, the lender probably has the recourse of going after the property, and they will sell it for a certain amount of money. When you have the arrangement, like with CalPERS, it seems like it is a superior lien where even if you cannot pay it now, it will hang around in first position forever.

James said first, no one likes to see any worker shorted because it is not fair. At the same time, if we don’t make the promises realistic, sustainable, and affordable, we are really doing a graver injustice. If we cost too much, the municipality will raise taxes, and we know from the city of Bridgeport in 1991 that they had to raise taxes to balance their budget because of state law. You raise taxes, and tax payers, corporate and individuals leave. You then have less tax revenue. If you raise taxes more, more leave, and you create a death spiral. This is why things need to be restructured. We talk about the rights of sovereigns, and everyone recognizes that at times certain rights have to give way to the corporate or public good. The public good here is to maintain the municipality in the essential governmental services. Sometimes, we may have to adjust those, not because we want to cause pain to anyone, but we actually want to make sure that they get the most of the benefit of the bargain rather than asking for too much now, which causes people to leave the municipality and there is less to pay in the future.

James was just asked to testify regarding the ability or inability for a state to declare bankruptcy. Bruce wondered if at this point that is not possible for a state, and if he sees this is any way changing. James said since the late 1800s no state except for one has defaulted on their general obligation bond. Arkansas had a problem in the Depression in 1933, but they refunded it promptly thereafter. States have a long history of paying their debts. States are sovereigns, and if you tell a sovereign you can declare bankruptcy, that will create a perception in the market that states will pay their debts. They have traditionally, and they are a safe credit and can borrow money at a low cost. If you add bankruptcy to it, there is a fear that if they now can file bankruptcy then maybe the risks are far greater than they thought and they therefore need to charge more.

We are back to the three percentage points a year that is 90% more over the term and simple, and Bruce, James, and everyone listening are the taxpayers who pay this. We want to keep the borrowing costs low, keep the perception of credibility high, and therefore James does not think bankruptcy does anything. The ability to declare bankruptcy does not give you one more dollar in taxes. It may cause people to charge more because of the risk. The ability for a sovereign to say they can go into the proceeding is probably not as beneficial as having the sovereign deal with their problems responsibly and hopefully as true statesmen before you let it go beyond where it should be. We need to get back to doing some of the hard things that we need to do to make sure things are sustainable and affordable. We need to address the problems that need to be addressed and not tip over the situations that are beneficial.

James had mentioned a long-forgotten policy off the air when he talked to Bruce about a rainy day fund. It seems something like this would be common sense, but often the common sense things that we have done have been attacked with people asking why the funds need to be kept. They keep asking why they are taxing more than they should. The reason why is because revenues have always been choppy. We have had business cycles and economic cycles. Things go up and down. Municipality, state, and local governments have been driven away from rainy day funds because people felt there was evidence of over-taxing. However, it was actually good management. Bruce recalled former President Bush talking about us giving back people’s money when there was a surplus. Looking back at the end result of the tax cuts, this probably was not the best idea and we probably should have had some surpluses. James said the real call for everyone is we have to do the right thing. We don’t want to overtax, but we don’t want to under tax either because we want to pay our debts and make sure that the burdens and obligations that have been accumulated are not passed on to our children and grandchildren.

Bruce said when the state has a negative budget deficit like California does, it is really not employees of the counties or cities, but they have their own band of problems as far as promises for people that are working for the state. Bruce wondered if it is the same type of thing for CalPERS. James said yes and that you have state employees paid by the state taxes in California, education is the first priority, and there are general obligation bonds. They have a series of priorities by Constitution for the payment of their debt. If there are not enough funds, what unfortunately states do is they slow pay, which is sometimes very similar to not paying.

At one time we had an I.O.U, and the SEC said you have to respect the security. One could even question if the Federal Government SEC should be talking anything to the state, which is a co-sovereign. However, they were probably talking about the security laws, which they have jurisdiction over. Generally, the states can come up with creative ways of dealing with it. It all goes back to how you create benefits for your citizens, giving the best education that you can which would then attract employees with an educated work force looking for those opportunities. James said he thinks we have sometimes emphasized benefits without the meaning of the benefit. This means the benefit is better municipal services and better improvements. We get there by making sure we educate our citizens, provide job opportunities for them, and help them to help themselves get to the level that they want to in society. Often it is creating that education along with business and providing the educated workers for business that help communities grow and prosper. Once you start losing that benefit, you start losing taxpayers, business, and we really get into a difficult situation for municipality.

Wall Street has gone through the 1% episode, and in a smaller sense Bruce wonders if you are a citizen of a city and are looking at the benefit package of somebody who works for the city, would there be some resentment building in that sense where some have gotten a really good package while others are going to get less services than they thought they were deserving of. The cost is going to be greater for even those services. Bruce wondered if this sets up a little animosity against the people providing the services. James said to some degree asking for more than you should get is self-deceiving. If you are not going to provide the services but it is not going to be that energetic municipal body, state or local, that has provided the jobs, education, and stimulus to make people want to live and be there, then long-term you are not sustainable and affordable. It’s all going to fail, and the secret to success for a state or local government is maintaining and growing, not to reduce benefits and make it less attractive or raise costs beyond that which can be afforded.

Bruce wondered if there is a sovereign debt resolution or if it is only a suggestion right now. James said it does exist to some degree. One of the debates with the workers, taxpayers, and elected officials is agreement on what is sustainable and affordable. What are the essential services that need to be provided, and how much will it cost. This is what has to be paid first. The question is the cost, what can be paid to workers based on that level, and what can be paid in pension benefits based upon it, and finally what is sustainable and affordable. We don’t want to under tax people since that is unfair to the workers and to others, but we also don’t want to over tax them because people will move out. The first thing to do is come up with a quasi-judicial body that is going to determine the type of recovery plan and budget that is sustainable and affordable. Then, you go through appropriate discussions; negotiation, mediation, and arbitration that people come to voluntarily or enforce it as a determination and make it stick. At the end, you need an “or else.” Doing it voluntarily may be better for you, or else we will determine what it is and you have to live by it.

Bruce wondered if all James just said is in the power of the Chapter 9 Bankruptcy a it exists now. James said what you can do is you can turn the Chapter 9s into the prepackaged plan that we used to have for corporations. The “or else” determined by this quasi-judicial body, authority, government-protection authority makes those determinations and can enforce them through a Chapter 9. Corporations would use pre-packaged bankruptcies and could be done in 30, 60, or 90 days. The benefit of that is you don’t have to pay all the costs and expenses to go on three years.

There is a quarterly report that rates the debt of countries, showing which are in trouble. Greece is completely off of the bad list now; it’s not even in the top ten. Bruce thought this was interesting and wondered about Vallejo and if they have a credit hit their ratings down or their cost-to-credit up because of a bankruptcy. James said this is the biggest fear. The question is how you go back to the market and what you say to the market when you go back to it. There is a statement “backed by the full faith and credit,” and it has to mean something. It’s hard to say, “This time I mean it.” That is the unintended consequences of any of these actions not to pay people what they thought they had already earned. You cannot really afford to go down that road. We therefore have to figure out how to be as honorable as possible and pay people what they are supposed to get.

In the appendix of his report, James had one chart that showed bankruptcy filings over the course of a long period of time beginning in ’37 broken down. During the inflationary years, that was the cleanest time for any bankruptcies. It seemed cities did very well when interest rates were completely nuts and inflation was very high. Bruce wondered why this happened, and James said it was very countercyclical. When you are in an inflation period, revenues, income taxes, sales taxes, and real estate taxes are more. The tax revenues are coming in, and the municipalities are not having the problem. When you get to the time where people lose their job and businesses have a hard time paying their bills let alone their taxes along with values falling, you wind up getting less. Meanwhile, your costs keep going up at a somewhat standard rate. This is why you find municipalities in their troubles and problems follow economic downturns rather than our lead indicators. We could use a good bout of inflation.

As James and Bruce had talked about, a high tide raises all boats. Unfortunately, when we are trying to manage low to no inflation and very low interest rates, there are consequences not only to seniors and their investments, but elsewhere also. Inflation has ravages as we have seen in Germany in years gone by and in other countries. No one wants to create this kind. However, some inflation is not necessarily bad.

James has another chart that compares the Great Recession Years and the Great Depression years as far as ratio of state and local debt to GDP. If you look at the years we are in right now, we are definitely not where we were in the Great Depression and Recession, but Bruce wondered where we are now and if we are worse than we would have been, for example, in the ‘90s recession. James believes with our last downturn on a GDP basis, half of the problem was during the Great Depression even though people believed it was a lot closer. If you look at unemployment in the ‘80s and the ‘90s, we were not very dissimilar in the early ‘80s to where we are today. The filings for Chapter 9 were also very high in the early ‘80s. This was because we were suffering some of the pain. In the ‘80s you had rainy day funds, a lot of surplus, and you still had growth in communities. Today communities have aged even more and are less susceptible for growth, whether it is in the Rust Belt or elsewhere. Those are the types of problems where we need to recreate, regenerate, and hopefully renew so we come up with a very viable city or municipality going forward.

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