Central Falls, a densely populated and impoverished city of nearly 20,000 in Rhode Island, filed for Chapter 9 bankruptcy on August 1, citing unaffordable pension and retiree health care liabilities. The city said it had no choice after retirees refused to accept any cuts. A retired state Supreme Court judge now oversees their finances, and the city is asking him to impose “a prudent plan” which would lower what pensioners are paid.

The California city of Vallejo is just now emerging out of bankruptcy, which it filed in 2008. Part of its plan includes lowering what it pays to banks for interest and reducing benefits to retirees.  Clearly, there are two powerful forces that do not want municipalities to file for bankruptcy: bondholders and public worker unions. The usual rules no longer apply when a city files.  For example, Central Falls has now voided all public worker contracts and said retirees must immediately pay 20% of their medical coverage. Vallejo is now allowed to pay less interest on the bonds iy sold. In the parlance of finance, this is known as taking a haircut, and bondholders hate haircuts as much as public workers hate it when told their pensions are in jeopardy.

Sure, Vallejo’s finances cratered when the housing market did and Central Falls has been an “economic basket case” for years. But they are not isolated instances.  Cities across the country, including many in California (as well as the state itself), have public pension and health care obligations they are struggling to meet.  The problem nationwide is getting worse and more obvious. Years of neglect and hiding public pension problems are increasingly and painfully obvious.

At this point it doesn’t really matter how it happened or who was responsible. Public pension reform is coming and it will prove painful for many. Is it fair? No. If you paid into your pension fund for decades, retired, then learned the benefits will be slashed, well, it could be catastrophic. Sure, there are a few who get big cushy pensions and are the targets of rage. But many pensioners are just getting by. A cut in their benefits might mean they’ll need to start checking the price of cat food or take their meds every other day instead of once a day.

Ordinarily, cities in such a predicament could call on the state or federal government to help them out financially. But given the current recession, budget reductions, and stock market correction, no one has much in the way of extra money. They can’t borrow either, because no one will lend to them, except perhaps at steep rates. That’s no solution at all.

The State of California has massive unfunded public pension liabilities. Even worse, from a financial standpoint, the public pension by law can force the state to make up any funding shortfall they may have. So while such liabilities are not actually carried on the balance sheet of California, it is still ultimately responsible for them.  This kind of financial shifting of liabilities can certainly make a balance sheet seem far healthier than it actually is.

There will be more municipal bankruptcies triggered by pension liabilities. How will we handle them?