Using June 2009 data, Robert Novy-Marx and I measured a $3.1 trillion gap in state and local pension systems, arising from $2.3 trillion in assets and $5.4 trillion in liabilities.
Since then, the situation has evolved in several ways. First of all, the stock market continued to recover from the financial crisis . . .
More importantly, the true financial value of the liabilities that have been promised have grown substantially due to much lower bond yields . . .
the total unfunded liability is $4.4 trillion.
And folks are wondering why consumers aren’t spending?! Until policymakers come up with definitive solutions to these massive unfunded liabilities (that don’t involve raising taxes), then the uncertainty it creates will force consumers to pay down their own debt (or save) and restrain consumption.
These are structural issues that can not be fixed by monetary policy actions from the Federal Reserve. Ironically, as pointed out by Rauh, loose monetary policy is worsening the situation by keeping interest rates low and ballooning these unfunded liabilities. The Fed needs to stop babying politicians with cheap money and let them take their Castor Oil (via higher interest rates).
We all know that Uncle Sam is drowning in red ink–if you need a humorous reminder check out Remy’s “Raise the Debt Ceiling.” Well, it turns out that states are not in much better shape. According to a new study by Harvard Economist Jeffrey Miron, for the Mercatus Center, states will reach dangerous debt levels in 20 to 30 years. From the study “The Fiscal Health of the U.S. States” (pdf):
This paper examines the fiscal health of the 50 U.S. states and reaches five conclusions. First, state government finances are not on a stable path; if spending patterns continue to follow those of recent decades, the ratio of state debt to output will increase without bound. Second, the key driver of increasing state and local expenditures is heath-care costs, especially Medicaid and subsidies for health-insurance exchanges under the Patient Protection and Affordable Care Act of 2009. Third, states have large implicit debts for unfunded pension liabilities, making their net debt positions substantially worse than official debt statistics indicate. Fourth, if spending trends continue and tax revenues remain near their historical levels relative to output, most states will reach dangerous ratios of debt to GDP within 20 to 30 years. Fifth, states differ in their degrees of fiscal imbalance, but the overriding fact is that all states face fiscal meltdown in the foreseeable future.
Check out this video to see when your state reaches the danger zone.
I’m so sick of this debt ceiling debate because it is all a ruse. The federal debt, as defined by the debt sold by the U.S. Treasury, is only a small fraction of all the obligations that the federal government owes. Thankfully, I just found this nifty debt clock (in the sidebar) from the good folks at the Institute for Truth in Accounting. Here is how they derive their higher estimate:
The Institute’s Debt Clock is an estimate of the nation’s publicly-held federal debt, intergovernmental debt held by the various branches of the government, the unfunded obligations related to social insurance programs as well as the pensions and retirement benefits promised to military veterans and government workers.The debt represented by notes, bonds and bills are known to the penny and can be seen here.
Estimates of the unfunded portion of America’s obligations are not so precise.Unfunded obligations include Social Security, Medicare, pensions, etc, and the components of the estimate come from several agencies, the most important of which are from the Social Security Administration’s trustees.
Typically, the trustees make their actuarial estimate and release it on April 1st, each year.This figure represents the trustees’ best estimate of the demographic factors that will affect the receipts and payments that the system will pay for old age and medical benefits for the many Americans receiving benefits. This year, the trustees have deferred issuing their estimate because they want to have more time to calculate the effect of the new health care law.Their estimate must cover the next 75 years rather than the 10 years of taxes and the six years of benefits the Congress used to estimate reform’s costs.We expect that their estimate will be released in June, at which time we will reset the Institute’s Debt Clock.
I’ve never been satisfied with Ben Bernanke’s rationale for Quantitative Easing as a way to save the economy. Did he totally forget the 1970’s where economists had to invent a new term for recessionary inflation now known as stagflation. To me, Quantitative Easing is a recipe for stagflation.
But, what is the direct transmittal mechanism for higher interest rates leading to higher interest payments? That would ultimately be determined by the term schedule on federal bonds, i.e., how much debt is short-term needing to immediately rolled-over versus debt that is long-term with no immediate need for roll-over. The shorter the term schedule, then the more at-risk is the federal budget to a higher interest rate.
Unfortunately, I did not know where to find the data on the term schedule for federal bonds. So today I found over at No Money, No Worries a blog post with the term schedule of federal bonds. And here we find the smoking gun. Nearly 38 percent of the $9 trillion in marketable federal debt must be rolled-over this year and the next year (2011 and 2012)! If interest rates were to spike over the next 18 months, it could make the Mercatus chart look downright rosy.
So for all the folks wondering if there will be a QE III they should not be looking at the health of economy. Rather, they should be looking at factors that would otherwise force the Federal Reserve to raise interest rates . . . like a plummeting dollar for instance. Ironically, failure to get a grip on the ballooning federal deficit is exactly the kind of event that could trigger a falling dollar . . . which would then spark QE III to lower interest rates to keep interest costs from further ballooning the federal deficit. Does anyone see anyway off this hamster wheel? Argh!
Moody’s Investors Service has begun to recalculate the states’ debt burdens in a way that includes unfunded pensions, something states and others have ardently resisted until now.
States do not now show their pension obligations — funded or not — on their audited financial statements. The board that issues accounting rules does not require them to. And while it has been working on possible changes to the pension accounting rules, investors have grown increasingly nervous about municipal bonds.
Moody’s new approach may now turn the tide in favor of more disclosure. The ratings agency said that in the future, it will add states’ unfunded pension obligations together with the value of their bonds, and consider the totals when rating their credit. The new approach will be more comparable to how the agency rates corporate debt and sovereign debt. Moody’s did not indicate whether states’ credit ratings may rise or fall.
In making the change, Moody’s sidestepped a bitter, continuing debate about whether states and cities were accurately measuring their total pension obligations in the first place. In adding together the value of the states’ bonds and their unfunded pensions, Moody’s is using the pension values reported by the states. The shortfalls reported by the states greatly understate the scale of the problem, according to a number of independent researchers.
“Analysts and investors have to work with the information we have and draw their own conclusions about what the information shows,” Mr. Kurtter said.
In a report that is being made available to clients on Thursday, Moody’s acknowledges the controversy, pointing out that governments and corporations use very different methods to measure their total pension obligations. The government method allows public pension funds to credit themselves for the investment income, and the contributions, that they expect to receive in the future. It has come under intense criticism since 2008 because the expected investment returns have not materialized. Some states have not made the required contributions either.
Moody’s noted in its report that it was going to keep using the states’ own numbers, but said that if they were calculated differently, it “would likely lead to higher underfunded liabilities than are currently disclosed.”
So, they’re only partially lifting their heads out of the sand. See chart below from the NYT on how the debt burden picture changes for select states.