August 21, 2013 1:04 PM
The bankruptcy of Detroit is an unusual event, but its uniqueness lies mainly in its severity. Municipal governments across the nation are struggling to bring their own finances under control, and for many of them, unfunded pension obligations are a huge driver of deficits. If other municipalities want to avoid a similar fate (even if in milder form), they first need to get a handle on the size of the problem.
The good news is that this is possible. The bad news is that efforts to clarify the pension obligations picture will meet stiff resistance from government employee unions. Yet, the union can only kick against fiscal reality for so long.
In Detroit, a major point of dispute between public pension funds and the city's state-appointed emergency manager is just how large is the pension gap -- specifically, how it is calculated. Pension officials have argued that they are adequately funded, but those claims appear based on overly optimistic projections of future investment returns.
In July, emergency manager Kevyn Orr argued that the city's pensions face a shortfall of at least $3.5 billion -- five times the figure of previous estimates, according to The Wall Street Journal. But the shortfall is likely much greater.
August 16, 2013 12:32 PM
Public awareness of the scope of the state public pension crisis seems to be growing every day. That's a welcome development, in that it has led to state officials to look for ways to reform their underfunded pension systems. The question they face is: How?
For ideas for reform, they should look to a new report by former Utah state Senator Dan Liljenquist, who led his state's wide-ranging and successful pension reform. The report, published this week by the American Legislative Exchange Council (ALEC), puts forth ideas for reform based on some basic principles. First, all new employees should join a defined contribution (DC) system. Second, payments that are due under state's current pension systems must be paid and reasonable adjustments to current benefits should be made, as courts allow.
For specific reforms, the study offers three basic options: 1) defined contribution plans, such as 401(k) plans; 2) cash balance (CB) plans, which have aspects of both defined benefit (DB) and defined contribution plans; and 3) hybrid plans, in which the employer makes a fixed contribution, as in a defined contribution plan, and employees have the option of joining with other employees to create a defined benefit option.
August 13, 2013 10:17 AM
A recent item in The Washington Post explains "how Georgetown Law gets Uncle Sam to pay its students’ bills," averaging $158,888 over three years, taking advantage of perverse incentives in a federal student-loan program. A federal income-based repayment plan forgives the student loan debt of law students who go to work for the government or a "public interest" law firm 10 years after they graduate, as long as they pay a small percentage of their income in the first ten years after graduation towards paying off part of their student loans. Typically, much of those law students' loans are not paid off by the end of 10 years, and thus are forgiven at taxpayer expense. But Georgetown has figured out a way to take things even further and make taxpayers pick up the entire tab through creative accounting. Under its Loan Repayment Assistance Program, a student can get his law degree "absolutely free of charge," and entirely on the taxpayer's tab. As the Post notes,
Georgetown has found a very clever way to exploit recent reforms to federal student loan programs so as to greatly reduce the price of law school for students without costing the school anything either. Georgetown Law students who use LRAP use loans from Grad PLUS — the federal government’s student loan program for grad students — to fund the entire cost of going to law school. That includes not only tuition and fees but living expenses like housing and food. Grad PLUS has no upper limit on the amount you can borrow, so there isn’t any constraint on how much you take out.
Once out of school, the students enroll in an income-based repayment program, in which, if they’re working for a nonprofit, the federal government forgives all loans after 10 years. For that 10-year period, however, the borrower has to pay a share of their income. But under LRAP, Georgetown commits to covering all of those payments.
Upon first glance, it looks like what’s happening is that Georgetown is paying for part of the cost of law school and the federal government is forgiving the rest. But as Jason Delisle and Alex Holt at the New America Foundation discovered, Georgetown’s cleverer than that. The tuition paid by new students — tuition they’re often paying with federal loans — includes the cost of covering the previous students’ loan payments.
So Georgetown is ultimately paying its share with money its students borrow from the federal government. The feds are paying back themselves. At no step in the process does Georgetown actually have to pay anything. The feds are picking up the entire bill.
August 9, 2013 2:55 PM
In explaining my policy positions, I often find myself pointing out I am neither pro-business nor pro-bank, but pro-market. My Competitive Enterprise Institute colleagues and I might have a position that lines up with a particular industry group on one issue but opposes it on another. The only guide we have is which policies further consumer choice and the free market, and which restrict it.
Two events that have arisen over the past couple weeks illustrate this principle. Banks and retailers often are at opposite ends of a policy fight, and this is reflected in some high-profile provisions of the 2,500-page Dodd-Frank financial "reform" legislation. I find myself siding with bankers against retailers in one instance and with retailers against bankers in another.
In one instance, the Durbin Amendment controls prices on debit card processing fees for retailers. On this, I line up with the banks – and credit unions and community banks for that matter.
Retailers like the increased sales debit and credit cards provide as well as the lessened risk of fraud and theft when compared to cash and checks. But they want the government to put caps on what the banks and credit unions that issue the cards can charge them. The Durbin price controls within Dodd-Frank already have shifted the costs of debit-card processing from big retailers, such as Wal-Mart, to consumers, who have seen free checking virtually disappear from low-balance accounts.
July 31, 2013 4:05 PM
For people watching it from afar, the bankruptcy of Detroit -- the biggest municipal bankruptcy in American history -- may have brought a sense of relief in the fact that they live somewhere else. But it's also brought needed public attention to the state of city finances around the nation. While Detroit is an egregious case of municipal incompetence, corruption, and mismanagement, its problems are not unique.
In fact, one of the drivers of debt that brought the Motor City to its knees is common among states and cities: defined benefit pension plans, which guarantee payments independently of the level of the plan's funding. This week's cover story in The Economist brings some needed attention to the problem:
Most public-sector workers can expect a pension linked to their final salary. Only 20% of private-sector workers benefit from such a promise. Companies have almost entirely stopped offering such benefits, because they have proved too expensive. In the public sector, however, the full cost of final-salary pensions has been disguised by iffy accounting.
Pension accounting is complicated. What is the cost today of a promise to pay a benefit in 2020 or 2030? The states have been allowed to discount that future liability at an annual rate of 7.5%-8% on the assumption that they can earn such returns on their investment portfolios. The higher the discount rate, the lower the liability appears to be and the less the states have to contribute upfront.
Even when this dubious approach is used, the Centre for Retirement Research (CRR) at Boston College reckons that states’ pensions are 27% underfunded. That adds up to a shortfall of $1 trillion. What is more, they are paying only about four-fifths of their required annual contribution.
July 22, 2013 12:15 PM
Over the weekend, President Obama hailed the third anniversary of the enactment of the Dodd-Frank "financial reform." In his weekly radio address, the president also hailed the confirmation of Consumer Financial Protection Bureau Director Richard Cordray, which occurred last week after Senate Republicans caved to Majority Leader Harry Reid's "nuclear option" threat to end the filibuster.
The president began his address, "Three years ago this weekend, we put in place tough new rules of the road for the financial sector so that irresponsible behavior on the part of the few could never again cause a crisis that harms millions of middle-class families." And he concluded, "If we keep moving forward with our eyes fixed on that North Star of a growing middle class, I’m confident we’ll get to where we need to go."
Sorry, Mr. President, but just the opposite is true. Dodd-Frank has declared certain large financial institutions to be "Systemically Important Financial Institutions," enshrining too-big-to-fail in law. And the volumes of regulations emanating from the law's 2,500-plus pages have harmed community banks, credit unions, small businesses, farms and manufacturers that had nothing to do with the crisis.
Here are some articles my colleagues and I have written on Dodd-Frank's devastating toll as well as some its just plain silly, but still destructive, provisions:
July 22, 2013 12:11 PM
The government has spent vast sums of money promoting homeownership through subsidies, tax exemptions, and bailouts. For example, in prosperous Alexandria, Virginia, certain people who never saved up enough money for a down payment received interest-free loans from the federal government to enable them to make a down payment. They do not have to repay those loans until they sell their home. Thrifty people with savings were not eligible for such a handout, penalizing them for their thrift.
Supporters of taxpayer subsidies for homeownership falsely claim it promotes political stability and prosperity. But As George Mason University's Michael Greve notes, "there’s actually very little support that home ownership correlates with—let alone promotes—democratic stability. If anything, the data suggest that ownership rates are inversely correlated with political stability and the rule of law." Bankrupt, unstable Greece has a much higher homeownership rate than does the United States. Stable, prosperous Germany and Switzerland have much lower homeownership rates than the U.S. does. European countries facing fiscal crises, like Italy, Spain, and Portugal, have higher homeownership rates.
Similarly, The Washington Post reports that a recent study found that "higher levels of homeownership can kill jobs":
Andrew Oswald and Dartmouth’s David G. Blanchflower have a brand new working paper (pdf) suggesting that homeownership has an even bigger and wider effect on unemployment than anyone has realized. Here are the key points:
"We find that rises in the home-ownership rate in a US state are a precursor to eventual sharp rises in unemployment in that state. …A doubling of the rate of home-ownership in a US state is followed in the long-run by more than a doubling of the later unemployment rate."
. . .the authors argue that homeownership has a much broader — and negative — impact on the labor market as a whole.
Why is that? The authors find that higher levels of homeownership in a state appear to be associated with lower levels of labor mobility, higher commute times, and fewer new businesses created. Taken together, those three factors tend to increase the unemployment rate.
Anti-Business and Anti-Freedom: The United Nations Convention on the Rights of Persons with DisabilitiesMay 23, 2013 12:38 PM
In the American Spectator, CEI Vice President for Strategy Iain Murray and Geoffrey McLatchey explain why the Senate should be skeptical of the United Nations Convention on the Rights of Persons with Disabilities, which fell six votes short of the 67 needed for ratification last December. As they note, "the treaty would enable an enormous increase in the potential power of UN bureaucrats over the American people and undermine national sovereignty." Moreover, although "CRPD proponents argue that it merely reiterates existing U.S. disability law," this is simply false, based on the treaty's plain language.
It also delegates authority to a UN committee, they note, resulting in a "loss of U.S. sovereignty." UN committees like to define free speech as discrimination against minority groups in violation of international treaties, making it dangerous to ratify such treaties. For example, the U.N. Committee on the Elimination of Racial Discrimination has ruled Germany violated international law by not prosecuting a former legislator for remarks to a scholarly journal about Turkish-immigrant welfare recipients that were deemed racially offensive. The UN committee ruled Germany's failure to prosecute the speaker violated the International Convention on the Elimination of All Forms of Racial Discrimination.
May 9, 2013 2:46 PM
As state governments across the nation struggle to address a public pension underfunding crisis they can no longer deny, The Economist is the latest major news outlet to turn its gaze on the ongoing debacle. In the current issue, the magazine's "Buttonwood" column draws a sketch of U.S. public pension accounting that is not only dysfunctional, but that runs against plain common sense.
American public-sector schemes discount their liabilities by the expected return on their assets. The riskier the asset mix, the higher the assumed return—and the lower the bill appears to be.
This is an odd way of thinking. Suppose a car company borrowed $10 billion in the form of a 20-year bond to build a manufacturing plant and planned to pay off the debt with the profits from running the plant. The car company will assume a higher return on capital than its financing cost (otherwise it should not build the plant). But it still has to recognise the $10 billion bond liability on its balance-sheet. It cannot say it owes only $2 billion because it expects a very high return.
The reason is clear. If the plant fails to earn a high return, the firm will still be liable to repay the bond. Similarly, if pension schemes fail to earn a high return on their assets, they still have to pay benefits. Final-salary pensions are a debt-like liability.
The Buttonwood columnist (currently Philip Coggan) notes recent changes to the nation's largest public pension plan, the California Public Employee Retirement System (CalPERS), that would require greater employer contributions. But such changes will be ineffective in the long run unless they were to be accompanied by major reforms that address some of the structural factors that have made public pension shortfalls severe and chronic: payouts based on final-year pay, negotiation of benefits through collective bargaining, benefit increases through binding arbitration, politicized pension fund boards, and flawed accounting standards.
May 6, 2013 1:20 PM
In the Daily Caller, historian and presidential biographer Charles C. Johnson writes that "Housing nominee Mel Watt helped create the subcrime crisis.” Watt has been nominated by President Obama to be director of the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac. As John Berlau discussed earlier, Watt's record also flunks privacy, transparency and government-accountability tests.