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detroitdestruction

There’s nothing surprising about last week’s news that Detroit’s main city government joined the likes of Vallejo, Calif., and Jefferson County, Ala., in filing bankruptcy. Six decades of fiscal and operational fecklessness by Motor City officials such as the abysmal Coleman Young and notorious (and now-incarcerated) Kwame Kilpatrick have led to mounting fiscal burdens that have rendered the city so insolvent that by May, the Michigan state government took over its finances and handed control of the city to an emergency financial manager. Weighing heaviest on the books are the array of retirement deals between Motown and public sector union locals that have proven to be far costlier than generations of politicians have wanted to admit. This includes pension deficits of $3.1 billion as determined by Moody’s Investors Service in its review of the city’s finances — or $2.1 billion more than the 977 million in pension deficits officially reported by Motown (which as its state-appointed financial manager Kevyn Orr, noted in his analysis released in June is higher than the $644 million the city reports in other financial statements), as well as $5.7 billion in unfunded retired civil servant healthcare costs and $1.43 billion in pension-obligation bonds outstanding. In fact, Detroit’s pensions have paid out $3 billion more in benefits over the past five years than it has generated in investment income and pension contributions.

hollywoodmodellogoBut soon, Motown and its fellow municipalities won’t be the only ones in bankruptcy courts. The very fiscal fecklessness besetting these municipalities are now hitting traditional districts, forcing them to pay dearly for the high costs of building booms and retirement deals they made with states, and affiliates of the National Education Association and American Federation of Teachers. This, along with the woeful performance of many districts in improving student achievement, is another reminder that the traditional district model, already proven to be ineffective and obsolete in providing high-quality education to children, is even less useful in encouraging fiscal prudence.

As Dropout Nation has reported for the past few years, the full cost of traditional teacher compensation (including defined-benefit pensions, near-lifetime employment, and low-cost healthcare in retirement) have been coming home to roost as some time. The retirement of Baby Boomers in the teaching ranks, along with the current economic malaise, increasing costs of Medicaid driven in part by the Affordable Care Act, and decisions by states, districts and NEA and AFT affiliates to contribute as little as possible to pensions, has led to a perfect storm of sorts. Another decade of deal-making between districts and teachers’ union affiliates has led to generous benefits for teachers, but at a high cost to districts (and ultimately, taxpayers). Districts and states spent $73 billion on benefits in 2011-2012, a 74 percent increase over 2001-2002, according to a Dropout Nation analysis of U.S. Census Bureau data; the average district now spends 34 cents on benefits for every dollar of teacher salary, an increase from the 29 cents per dollar of salary spent a decade earlier.

Exacerbating the problem for states and districts are shoddy pension accounting and actuarial rules that obscure the true levels of the pension and retiree healthcare liabilities on their books. As a result, districts and states are likely understating their pension shortfalls by 35 percent or more. Chicago Public Schools likely faces a pension shortfall of between $11 billion and $15 billion, (depending on the exclusion and exclusion of $3.3 billion in unrealized investment losses), between 36 percent and 96 percent greater than its officially-stated shortfall of $8 billion. The pension deficit, which Chicago exacerbated with the help of Illinois state officials (who have granted the district a pension contribution “holiday” that allows it to pour less into the pension than it should), and the AFT local there (through is control of seats on the pension), is one reason why the district moved last Friday to lay off 2,000 teachers and other staff.

These issues, along with the evidence that traditional teacher compensation is ineffective in improving student achievement and rewarding high-quality teachers for their work, is why school reformers and cost-cutting governors are attempting to overhaul how teachers are compensated — including replacing defined-benefit pensions with hybrid retirement plans that have elements of defined-contribution plans — and sparring with NEA and AFT (both of which derive their influence from their promise to rank-and-file Baby Boomers members in classrooms that they will make sure that teaching is the best-compensated profession in the public sector).

At the same time, busted pensions aren’t the only problem weighing heavily on traditional districts. During the last decade, districts spent little on bolstering information technology infrastructure or developing data systems that would provide the information teachers and school leaders need for improving student achievement. Instead, they spent profligately on new and restorative construction –including high school stadiums and fixing up aging buildings — even when enrollment numbers were in decline. New buses were bought as well even when districts were operating them to full capacity only two-thirds of the time. By 2007-2008 (or at the beginning of the financial meltdown that led to the current economic malaise), districts had spent $53 billion on school construction, 35 percent more than in 2001-2002, according to the U.S. Census Bureau. Construction, along with moves by districts with their own pensions to float bonds in the hope of growing the proceeds (and reducing pension shortfalls) during that era’s bull market, are among the reasons why the nation’s districts had $407 billion in debt outstanding in 2010-2011, a 80 percent increase over the debt levels in 2001-2002, according to an analysis of U.S. Census Bureau data, while having a mere $177 billion in cash and investments on hand, a 46 percent increase in the same period.

Because so many districts floated variable-rate bonds with interest rates that could increase or decline, they used interest rate swaps — investment derivatives — to offset increases in rates on those bonds. Both moves have burned districts, with high levels of debt on the books and swaps they must continue pay for as long as 30 years even as interest rates have declined. These burdens, along with reverse-seniority layoff rules that restrict districts from reducing staff based on teacher performance and the obsolete scale-focused structure inherent within the traditional district model, have made it even harder for districts to deal sensibly with reductions in tax revenues, state dollars, and federal funding. Closing schools, as some big-city districts have done in order to stave off fiscal trouble, won’t be enough to overcome decades of bad decision-making.

Some districts have already gone bust. The Buena Vista district in Michigan near the state capital of Lansing attracted national attention in May when it shut down its operations for two weeks before the state provided emergency aid in order for its graduating class to complete their studies. But the district’s fiscal condition had been in deterioration for some time thanks in part to bad decisions such as striking a three-year contract with the NEA affiliate that required the district to pay all the costs of healthcare instead of requiring teachers to pay 20 percent of the tab. Between 2007-2008 and 2011-2012, Buena Vista’s deficits increased from $395,041 to $948,300, (according to Dropout Nation‘s analysis of Wolverine State financial data for the district. Buena Vista is one of 50 districts in the Wolverine State that are in dire financial conditions. By tonight, Buena Vista and another district, Inkster, may shut down for good if it cannot meet a state mandate to obtain a loan to finance operations for the upcoming school year.

But it isn’t just small districts that could end up filing for bankruptcy or dissolved altogether. There’s Detroit Public Schools, which like the city government, is already under state receivership. The district’s new state-appointed financial czar, Jack Martin, must deal with more than just systemic academic failures and declining enrollment. Detroit is on the hook for part of the Michigan Public School Employees Retirement System’s official pension deficit of $22.4 billion (and more like  $30.4 billion, or 36 percent more than officially reported, according to a Dropout Nation analysis of the pension using a calculation developed by Moody’s) as well as $26 billion in unfunded retired teacher healthcare liabilities. If Michigan adopted more-realistic accounting for the teachers’ pension than it does now, Detroit Public Schools would have to pay $138 million, or 35.6 percent more than it contributed to the pension in 2011-2012, the latest year reported, just to make up its share of the underfunding. Considering that Detroit’s revenue declined by 15 percent — or $187 million — between 2010-2011 and 2011-2012 (from $1.27 billion to $1.07 billion), there’s no way the district could handle any kind of double-digit hike.

But pensions aren’t the only woes weighing on the Motor City district. A successful move by the district four years ago to float $507 million in bonds (with interest rates as high as 7 percent) to fix existing buildings now seems particularly senseless given the shutdown of  91 schools during the tenure of recently-departed financial czar Roy Roberts and his predecessor, Robert Bobb. Even more infamous spending sprees — including the acquisition of 160 BlackBerry smartphones and 11 motorcycles on the taxpayers’ dime, as well as the purchase of five floors in the landmark Fisher Building for $24 million (or $3 million more than its owner had paid for the entire building) — have also been costly. Although a series of bond refinance efforts have helped reduce interest payments, the district still spent $190.2 million –or 18 percent of its revenues — to service $2.2 billion in debt outstanding. Add in the missteps by Roberts during his tenure (including the reversal of staffing reductions predecessor Bobb made during his tenure, as well as striking a new deal with the Motor City’s AFT local that will make it even harder to control payroll costs), and one can see that Detroit Public Schools is virtually insolvent. A bankruptcy filing of its own is likely.

Another big-city district that is a bankruptcy candidate is Philadelphia, whose fiscal woes have been chronicled by Dropout Nation over the past two years. Last month, the financially-strapped district announced that it would lay off 676 teachers and other staff in order to address a $304 million budget shortfall for its upcoming fiscal year. As with Detroit, the City of Brotherly Love district must also bear part of the burden for Pennsylvania’s Public School Employees’ Retirement System, which like the district is virtually insolvent. A Dropout Nation analysis earlier this year determined that  PSERS’ deficit is likely $33.5 billion, or 27 percent higher than it reported for its 2010-2011 fiscal year. Philadelphia would likely have to pay an additional 81 percent in contributions — or an additional $76 million on top of the $93 million in paid out in 2011-2012 — over the next 17 years, a burden it couldn’t sustain given that revenues declined by $201 million (or 7 percent) between 2010-2011 and 2011-2012.

As with so many districts, the woes Philadelphia faces have been years in the making. A string of deals with the AFT’s City of Brotherly Love local, along with increases in pension contributions, led to a 41 percent increase in spending on teachers’ benefits between 2001-2002 and 2010-2011. Philadelphia’s $1.5 billion school construction program, which began in 2004, added 20 new schools (in addition to rehabbing additional buildings) even as enrollment was in decline; the move by the district in March to shut down 23 schools proves how big a mistake the district made in launching a school building program in the first place. Meanwhile Philadelphia’s fiscal mismanagement would wreak havoc on its balance sheet and operations. The district’s decision in 2004 to float $871 million in variable-rate interest bonds led it to strike a series of interest rate swaps to offset any sudden increases in interest rate payments. That decision would ultimately cost the district $72 million by 2011, according to a report by the Pennsylvania Budget and Policy Center. These missteps, along with the more than a decade of bungled school overhaul efforts and a continuing failure to provide children in its care with high-quality education, has led the district to its current state of insolvency.

Detroit and Philadelphia may be the biggest names on the list of bankruptcy candidates. But they won’t be alone. More districts will end up having to face their insolvencies (if not forced into bankruptcy or dissolved altogether) before this decade is over.

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