WASHINGTON — The top Democrat on a House panel that plans to hold a hearing Wednesday on “State and Municipal Debt: The Coming Crisis,” believes states and localities need to reform their pension systems, but is uncertain about whether states in severe fiscal distress should be permitted to file for bankruptcy protection.

In an interview Monday, Rep. Mike Quigley, D-Ill., the ranking minority member of the TARP and financial services subcommittee of the House Oversight and Government Reform Committee, talked about his concerns and what he hopes to learn from witnesses scheduled to testify at the panel’s hearing.

The witnesses are: David Skeel, a professor of corporate law at the University of Pennsylvania Law School who supports the idea of states declaring bankruptcy; Eileen Norcross, a senior research fellow at George Mason University’s Mercatus Center, who has written about the crisis in public sector pension plans and needed reforms; and Nicole Gelinas, a fellow at the Manhattan Institute and contributing editor of City Journal, who does not believe bankruptcy would help states.

Quigley, a former Cook County, Ill., commissioner, said he is very concerned that some governments, facing severe financial distress, may collapse or default on their bonds. In particular, he sees states’ unfunded pension liabilities — which he pegged at $3 trillion — as a major problem for state governments, enhancing their fiscal distress. Quigley hopes to find some “middle ground” between two extremes: federal bailouts, which would encourage moral hazards, and telling the states they are on their own.

“The middle ground is: we can force [pension] reform,” he said. “This is more of a tough love.”

Quigley, who remains committed to defined benefit pension plans for public-sector employees and opposed to defined contribution or 401(k)-type plans, thinks state and local governments need to consider a range of reforms, including asking employees to contribute more to plans, hiking the minimum retirement age and paring cost-of-living adjustments. He cited recent reforms in Illinois, which restructured its pension plans for new employees, but not for existing workers.

“They did the right thing, but they made it apply to almost no one,” he said.

 Quigley also said the pension bill introduced by three Republicans in December was “a good idea,” but that he cannot commit to the revised bill they are expected to introduce Wednesday until he examines the changes. The bill, sponsored by Reps. Paul Ryan from Wisconsin and Devin Nunes and Darrell Issa, both from California, would have required state and local governments to determine pension-funding levels based on a more conservative set of benchmarks linked to Treasury bond rates. It also would have prohibited states and localities from issuing new tax-exempt debt or receiving federal subsidies for taxable debt if they did not file annual reports on their pension plans to the Treasury Department.

Norcross said Monday that she will testify about growing unfunded pension liabilities and the need for reform in the pension area. In a recent paper,  “The Crisis in Public Sector Pension Plans,” she said that while some reports estimate state pension plans are underfunded by $452 billion, she believes that figure is actually about $3 trillion, using accounting methods required for private-sector pensions. Another $500 billion should be added to the $3 trillion figure to account for the unfunded pension liabilities of localities, according to other researchers.

One of Norcross’ biggest complaints is that most governments use a discount rate of around 8% to value their pension plan liabilities, based on the rate of return they expect from their investments. That kind of rate encourages governments that have halted contributions to plans or suffered investment losses to invest in riskier securities that pay higher rates, she said.  A more realistic discounted rate would be that of a government-guaranteed investment, such as a Treasury bond, at 4%, she said. Some researchers contend that rate could be higher, at 5%, to reflect a liquidity premium for Treasuries.

While some economists warn that pensions — unlike short-term budget gaps — are long-term problems, Norcross said governments need to start reforming pension plans now. Pension plan costs currently account for about 3.8% of governmental budgets, but are expected to rise to between 5% and 9% of budgets by 2014, she said.

Norcross also plans to talk about some of the structural problems underlying state budget gaps, such as the rising cost of Medicaid. 

Asked whether states should be permitted to file for bankruptcy protection, she said: “I’m not sure that’s the way to go. Bankruptcy doesn’t get to structural problems.”

Gelinas, a chartered financial analyst, echoes that view, suggesting bankruptcy is not a silver bullet for financially troubled state governments. “You can’t liquidate a state,” she said. “It’s not a failed corporation.”

Instead, Gelinas suggests, Congress, with its control of federal education, transportation and Medicare funding, could induce states to reform, rewarding them for saving money rather than for spending it. “There are other things they can try before using the nuclear option,” she said.

Still, state bankruptcy has its advocates, including Skeel, who in a Wall Street Journal op-ed piece published last month urged Congress to enact a law enabling states to seek bankruptcy protection. Such a measure, he said, would enable states to reduce the burden of underfunded public-employee pensions and reduce their bond debt, and could even permit restructuring of the “Cadillac pension benefits” that some have promised their employees. 

Meanwhile, the House Judiciary Committee panel on courts, commercial and administrative law, chaired by Rep. Howard Coble, R-N.C., plans to hold a ­hearing, “The Role of Public Employee Pensions in Contributing to State Insolvency and the Possibility of a State Bankruptcy Chapter,” at 4:00 p.m. on Monday, Feb. 14.

A number of House lawmakers have been concerned that states’ growing unfunded pension liabilities would trigger major financial problems and lead to requests for federal bailouts.

Last month, Rep. Jason Chaffetz, ­R-Utah, introduced a resolution under which the House would express opposition to any federal government bailouts of ­governmental pension plans or other post-employment benefits provided to governmental retirees. The measure has been referred to the House Committee on Education and Workforce.

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