December 3, 2014 3:25 PM
“I’ll gladly pay you Tuesday for a hamburger today” was the trademark utterance of J. Wellington Wimpy, the mooching character from the old Popeye cartoons. These days, he might find work to pay for his burgers managing a public pension fund—while playing bingo after hours.
In recent years, state and local governments’ pension shortfalls have gained greater public attention, due in part to the 2008 financial crisis, which left many in even worse shape. But the financial crisis isn’t alone to blame.
For years, public pension managers have been contributing less than the actuarially recommended contribution, essentially eating the proverbial burger today while leaving a future patron to pay the bill. Then, as the burger bill grows larger and our friend Wimpy gets more worried about ever paying it back, he turns to playing bingo, making ever larger wagers in the hope of clawing his way out of the hole he’s dug for himself.
At that point, as the American Enterprise Institute’s Andrew Biggs explains in The Wall Street Journal:
[P]ublic-plan managers may see little option other than to double down on risk. In 2013 nearly half of state and local plan sponsors failed to make their full pension contribution. Moving from the 7.5% return currently assumed by Calpers [the California Public Employee Retirement System] to the roughly 5% yield on a 38%-62% stock-bond portfolio would increase annual contributions by around 50%—an additional $4 billion—making funding even more challenging.
But the fundamental misunderstanding afflicting practically the entire public-pension community is that taking more investment risk does not make a plan less expensive. It merely makes it less expensive today, by reducing contributions on the assumption that high investment returns will make up the difference. Risky investments shift the costs onto future generations who must make up for shortfalls if investments don’t pay off as assumed.
October 7, 2014 9:41 AM
“Heads I win; tails you lose.” That essentially sums up the relationship the California Public Employee Retirement System (CalPERS) has long enjoyed vis-à-vis the Golden State’s elected officials. Now it is finally facing a serious challenge.
Last week, a federal bankruptcy judge ruled that cities must treat bondholders and pensions in like fashion. Judge Christopher Klein of the Eastern District of California said he would decide by the end of October how to apply the ruling to the bankruptcy of the City of Stockton, but it seems unlikely that pensions will escape cuts altogether, while bondholders are forced to take haircuts.
As The New York Times reported on the case:
Calpers is a powerful arm of the state, with statutory powers that include liens allowing it to foreclose on the assets of a city that fails to pay its pension bills.
Calpers had argued that if Stockton stopped making payments and dropped out of the state pension system, the lien would let it claim $1.6 billion of its assets. But Judge Klein said those statutory powers were suspended once a California city received federal bankruptcy protection.
“Why should I take that lien seriously?” he asked a lawyer for Calpers, Michael Gearin. “I may avoid it as a black-letter matter of bankruptcy law,” he said, referring to well-established legal principles.
He did not dispute that Stockton would be billed $1.6 billion to leave Calpers and said such a termination fee “can be seen as a golden handcuff.” But in bankruptcy, he said, Stockton could legally refuse to pay the bill because it arose from the city’s contract with Calpers, and contracts are broken routinely in bankruptcy.
“The bankruptcy code provides that the lien can be avoided and be treated as an unsecured claim,” Judge Klein said.
Judge Klein also said that Stockton had many options other than Calpers for retirement benefits: a private provider, like an insurance company; a multiemployer pension plan affiliated with a union; one of California’s county-run pension plans; or it could even offer no pensions at all.
Moody’s $2 Trillion Public Pension Shortfall Estimate Highlights Need for Better Pension Accounting PracticesOctober 1, 2014 11:12 AM
In a new report, Moody’s estimates the nation’s largest pension funds face a $2 trillion taken together. That’s a lot of money. But as significant as the size of the deficit is Moody’s criticism of how many pension funds have been managed, and pension fund’s reporting of their own liabilities. Bloomberg reports:
“Despite the robust investment returns since 2004, annual growth in unfunded pension liabilities has outstripped these returns,” Moody’s said. “This growth is due to inadequate pension contributions, stemming from a variety of actuarial and funding practices, as well as the sheer growth of pension liabilities as benefit accruals accelerate with the passage of time, salary increases and additional years of service.”
In other words, for years, many public pension plans have determined their contribution levels using discount rates based on overly optimistic projection on investment returns. That in turn, has led to pension plans using riskier investment strategies in search of higher yields—a strategy the California Public Employee Retirement System recently abandoned in the case of hedge funds.
September 22, 2014 2:12 PM
CalPERS knows when to fold ‘em. The California Public Employee Retirement System, the nation’s largest public pension fund (and one of the world’s largest), announced last week that it would no longer invest in hedge funds, where it had sought larger returns in the hopes of gaining greater investment returns. It’s the right move. But it’s really only correcting a mistake, for CalPERS should have never held ‘em in the first place.
July 28, 2014 9:55 AM
Coauthored with Alex Bolt.
President Barack Obama spuriously claimed, "These so-called right-to-work [RTW] laws, they don't have anything to do with economics," when he futilely attempted to thwart Michigan’s enactment of a right-to-work law.
A new study by the Competitive Enterprise Institute demolishes Obama’s spurious claim by showing how RTW laws, which free workers from a mandate to join a union in order to be employed, benefit states. RTW laws produce better income, population, and job growth than in forced-unionism states.
July 9, 2014 11:32 AM
Today, the Competitive Enterprise Institute released the first installment of CEI’s new three-part series, The High Cost of Big Labor, which looks at the economic impact of labor policies on U.S. states.
In “Understanding Public Pensions: A State-by-State Comparison,” economist Robert Sarvis ranks the states based on their pension debt. This debt burdens labor markets and worsens the business climate. To get a clear picture of the extent of this effect around the nation, this paper amalgamates six studies of states’ pension debts and ranks them from worst to best. Today, many states face budget crunches due to massive pension debts that have accumulated over the past two decades, often in the billions of dollars. There are several reasons.
One reason is legal. In many states, pension payments have stronger legal protections than other kinds of debt. This has made reform extremely difficult, as government employee unions can sue to block any scaling back of generous pension packages.
Second, there is the politics. For years, government employee unions have effectively opposed efforts to control the costs of generous pension benefits. Meanwhile, politicians who rely on government unions for electoral support have been reluctant to pursue reform, as they find it easier to pass the bill to future generations than to anger their union allies.
A third contributing factor has been math—or rather, bad math. For years, state governments have understated the underfunding of their pensions through the use of dubious accounting methods using a discount rate—the interest rate used to determine the present value of future cash flows—that is too high. This affects the valuation of liabilities and the level of governments’ contributions into their pension funds.