BLOOMBERG - Further excitement in the saga of Detroit’s bankruptcy: Public-sector unions are challenging the city’s estimates of its pension underfunding. The actuaries hired by the city’s emergency manager say that the pensions are underfunded by 40 percent to 50 percent. The estimated shortfall, according to the Wall Street Journal, is more than five times higher than previous estimates.

The pensions are now fighting back, challenging this assessment.

Pension funds spokesman Bruce Babiarz said the report "was bought and paid for by the city, but it's not a true actuarial analysis of the funds." The funds, which say they have a total of about $5 billion in assets, estimate they are now underfunded by about $650 million.

Officials working for Mr. Orr said their estimates of a 7% rate of return on the funds' investments is more realistic than the 8% used by the funds, which they said was too high because it didn't account for demographic changes of pensionholders and the funds' investment mix. The emergency manager also estimates the funds' assets based on current market values rather than actuarial values over the life of the beneficiaries, reduces the impact of a "smoothing" process that can mask losses and cuts the amortization period for the liability by about half.

The first obvious question is: Who’s right? You can read the reports here and here, courtesy of the Detroit Free Press, which obtained them with a Freedom of Information Act request. The actuary calculates funding status for three scenarios: 7 percent (what the city requested); 7.5 percent (to show sensitivity or results to changes in investment returns) and 6.3 percent (what the actuarial consultant thinks is the most likely actual market return.) By contrast, the unions are projecting an average market return of 8.4 percent before expenses.

If you’ve followed my writing, you won’t be surprised to hear that I’m with the actuaries on this: The unions' expectations are far too optimistic, unless they’re reaching for yield by taking unacceptable risks with the pension funds. Simple demography means that growth is likely to slow down over the next few decades, which in turn means that you need to make more conservative assumptions about investment returns. As Joshua Rauh has exhaustively documented, most public-sector pension funds use excessively optimistic estimates of future investment yields, and they discount their future liabilities far too aggressively, resulting in rosy assessments of their funding status that are likely to result in fiscal crises down the road.

Here’s the really interesting question, however: Why is the pension fund arguing about this? Heading into the bankruptcy, a pension fund would normally try to inflate the underfunding estimates as high as possible, not minimize them. That’s because the unfunded pension liability is treated as an unsecured debt; it has to assemble with other unsecured creditors to collect whatever’s left over after the secured creditors have been paid. The bigger the claim, the larger the amount you’re likely to collect.

Chapter 9 bankruptcy is a little different, of course. Still, it doesn’t seem possible that transforming a $3.5 billion claim into a claim for less than $700 million could be in their interest. So why are they fighting this estimate so hard?

One possibility is that they’re trying to keep from triggering a Michigan law that lets Governor Rick Snyder fire and replace the board of a public pension whose funding status goes below 80 percent. Snyder could then, in theory, replace the board with one that is a better negotiating partner. But I’m not sure how convincing I find this, because we’re well beyond the negotiating stage at this point. Why would the pension funds fear Snyder more than the bankruptcy judge?

Because they’re trying to keep the city out of bankruptcy altogether, says the Wall Street Journal.

While pension shortfalls are only part of the city's $18 billion in estimated liabilities, any challenge to the city's calculations could give ammunition to those who question if Mr. Orr moved too quickly to seek bankruptcy protection for the city at the behest of Gov. Rick Snyder, who has insisted that Detroit is insolvent. A trial on whether Detroit is eligible for bankruptcy protection is scheduled for Oct. 23. The funds and others argued in their filings that cutting benefits earned by the city's employees and retirees would violate the state constitution. The city's largest public employee union, Michigan Council 25 of the American Federation of State, County and Municipal Employees, said in a court paper that the city's emergency manager "hastily commenced" the Chapter 9 filing to "slash pension and other post-employment benefit obligations."

This seems more delusionally optimistic than their projected investment returns. The city is running out of cash -- in fact, it already has run out of cash, which is why it is borrowing to pay pension contributions and running in arrears with vendors. Even the judge who stayed the bankruptcy didn’t try to argue that the city had the money to pay its obligations; she was reduced to the wistful hope that President Barack Obama would step in and use his healing powers, which is to say, taxpayer funds, to keep the pensions solvent.

Oh, perhaps Detroit could somehow stave off the inevitable for a while, but you can't easily envision a situation in which the city suddenly and for no apparent reason develops hundreds of millions of dollars of extra tax revenue. If it’s not this year, it will be the next, or the one after -- and the union pensions will take their haircuts, just the same.

The people who actually have good reason to fight this are the unsecured creditors, who are likely to see their share reduced if the city’s assessment stands. Although I’m sympathetic to their plight, I’m also sympathetic to the folks who worked for decades, and now face the possibility that the pensions they expected will be drastically cut -- in at least some cases without even Social Security to fall back on. Unfortunately, for Detroit’s creditors, there aren’t any happy options left -- just a reasonably fair allocation of the losses.

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