Pension Precipice

It is time to stare the brutal facts in the face. 

In Good to Great:  Why Some Companies Make The Leap…and Others Don’t, Jim Collins identified several business practices which enable a private-sector company to evolve and prosper.  One of the essential principles that leads to success is the habit of leaning into problems and facing the facts head-on, “infusing the process with the brutal facts of reality.”  The fact that the federal government, as well as a large number of state governments, are on the brink of financial ruin is directly attributable to the fact they have been sweeping the critical issue of pension liabilities under the proverbial rug.

As in so many thorny public policy areas, the states tend to feel fiscal pain before the federal government does and are usually forced to act first.  In the case of pension liabilities, there is wide variation, but many of the states facing massive budget deficits are also the states with the largest unfunded pension burden.  The first step is to quantify the problem. 

According to Andrew Biggs of the American Enterprise Institute (AEI), there are good reasons to believe that the unfunded pension liabilities being reported by some states do not fully reflect their actual obligations.  According to Biggs, state public employee pensions report unfunded pension liabilities of $438 billion, but the real liabilities could be more than $3 trillion.    

New Jersey, for example, reports a $32 billion unfunded public pension liability, a crushing burden by any standard in a state with a $29.4 billion annual budget.  But because of some arcane accounting rules, the tab is probably higher. 

When state public pension funds report their unfundedfuture liabilities, they are allowed to use the “rate of return they project for their portfolios of stocks and bonds – in New Jersey’s case, 8.25 percent per year.“But the markets have been in a slump over the last two years and the rate of return on those underlying assets has clearly been much lower than 8.25 percent.If New Jersey’s pension plans were to recalculate their unfunded liabilities using the same rules as do private pensions, the tab would be $145 billion, according to Biggs. 

Pension issues are also increasingly bearing down on the fiscal health of cities as well.  New York City Mayor Michael Bloomberg stated at an October 4, 2010 news briefing that the 8 percent estimates that New York City’s five pensions were using to calculate investment earnings was exceedingly rosy.  He said “It’s much too high an assumption for us, I think it should be lowered…That’s going to require the city to put in more money.  It’s very difficult to see where we could get the money to do that.”

And while the rate of return on those pension assets fluctuates, the fiscal promises made to state (and city) employees do not.  Most state pension plans are defined benefit plans, which means that recipients are promised a specific future payout regardless of whether or not the pension has made enough money over the years to cover those promises.

The Washington Postreported on October 6 that “In California, where an estimated 80 cents out of every government dollar goes to employee pay and benefits, Gov. Arnold Schwarzenegger (R) has proposed a two-tier system of pensions that offers new state workers reduced benefits with tighter retirement formulas. He also wants state workers to kick in higher pension contributions to help deal with California’s staggering deficit.

In a March 21, 2010 National Public Radio report by Tamara Keith on a pension study released by the Pew Center for the States, the Center said it had calculated statepension funds were 84 percent funded, with $452 billion in obligations unfunded. 

But Pew’s findings were questioned by Joshua Rauh, an associate professor of finance at the Kellogg School of Management at Northwestern University, who said his calculations are closer to $3 trillion underfunded. 

Keith’s report included a quote fromRobert Gentzel, policy director for the Pennsylvania State Employees’ Retirement System, saying “People say, ‘Well that’s ridiculous. We’re just not going to pay it. Let [the pension funds] go broke.’  That’s not what would happen. The taxpayers are ultimately going to have to pay the bill.”

In addition to not coming clean and accurately calculating losses to the plans due to the economic downturn, some states are cheating on their pension payments, skipping payments, making partial payments or pushing payments into the future, all in order to make their current budgets look better.With this fiscal debacle hanging over the states, recent bloating in state employee payrolls is an even more alarming trend when viewed through the prism of unfunded pension liability. 

Furthermore, it is an open question whether or not federal officials will allow the stimulus money to run out as originally planned, or whether they will be pressured by panic-stricken state budget officials and rapacious employee unions to pump even more federal tax dollars into state budgets.  Congress’s hasty move in August to approve another $26.1 billion in federal aid for state and local governments indicates how difficult it will be for Congress to turn offthat stimulus spigot.