MuniLand: Telenovela – A Government Against Itself

Along the Colorado River, deep in the gorges of The Grand Canyon, a dramatic municipal credit story is developing. Eclipsed by the headlines out of Illinois and New Jersey, you don’t hear much about it, but the twists and turns are worthy of a telenovela. You don’t hear much about this drama because, at AA- by S&P, Arizona is rather highly rated credit. Pension funding levels are relatively healthy, at about 77% as of fiscal year 2014, and Arizona is doing a fine job of making 100% of its annual required contribution to its retirement system. So what’s the story? Well, back in 2011, Arizona enacted pension reforms that suspended retiree’s cost of living adjustment (COLA). The law limited the benefit payout and effectively forced participants to contribute about 4% more from each paycheck to fund the pension plan. Fast forward four years, and the Arizona Supreme court knocked down the law and restored the COLA, which added about $1.5 billion to the system’s unfunded liability. Jump to present day, and a new case is on Arizona Supreme Court docket challenging the contribution increases. Moreover, this case would force the state to refund the additional contributions made into the system or award plan participants about $175 million. Now, here is where the story gets really interesting. The case is being brought by two active judges. What you have is a situation in which the government is fighting itself, and because the Arizona Supreme Court justices are part of the pension plan, they have an incentive to roll back the law. So far, four out of the five Arizona Supreme Court justices have recused themselves because they would benefit from the refund. The one remaining justice was hired after the pension fund closed to new participants, and now a special five-judge panel will be appointed to hear the case. As with any good telenovela, there is an additional complicating factor. Back in 1998, the voters of Arizona approved a constitutional amendment stating that “public retirement benefits shall not be diminished or impaired.”  This is the exact same language found in the Illinois State Constitution. The Illinois State Supreme Court found their constitutional language to be unambiguous, and struck down a law reducing state retiree benefits. Interestingly enough, none of the Illinois Supreme Court judges recused themselves from the hearing. The moral of our telenovela is that at times the government undermines itself. The consequences of ignoring and pushing off liabilities into the future are higher costs over the long run, or being willing to accept a diminished level of service or higher rates of interest on state debt.