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).
If you are a fan of New Jersey’s Gov. Chris Christie, and I certainly am one of them, then this video is a must-see. The video is part of story from the The Washington Examiner and here is what they had to say:
Well, this might be the best Chris Christie-tells-off-pubic-employees video yet. In part because in this case the poor policeman doesn’t come off as arrogant, and also because Christie does his best to level with the guy and respect him. But that doesn’t keep Christie from flinching when it comes to leveling with the guy. Money quote: ““Here’s the thing: You’re getting a paycheck. And there are 9% of the people in the state of New Jersey who are not.”:
Read more, and view video, at the Washington Examiner: http://washingtonexaminer.com/blogs/beltway-confidential/2011/01/gov-christie-public-employees-dont-be-angry-first-guy-came-here-a?bctid=763052194001#ixzz1COPB9wfm
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.
Most public pension systems assume their assets will return around 8% annually, and the lowest assumption among major public pension systems is 7%. According to the article, only a handful of funds have reduced their return assumptions, despite an environment where such returns seem unlikely . . . This entire system effectively treats the expected return on the pension fund assets as achievable without any risk. When a state assumes, say, 7% instead of 8%, it sets a little more money aside and does a little less gambling on behalf of future taxpayers (our kids and our elderly selves) . . . In sum, systems that use 7% are being more responsible than those using 8% — but even 7% is a flagrant violation of the principal that states should run balanced budgets. Already this system has led to state pension debt that when properly measured amounts to $3 trillion across the 50 states, since unfunded pensions were the way that politicians could borrow money out of the view of taxpayers and outside of budgetary requirements.
If going forward we want to actually return to the principal that states should run balanced budgets, there are only two routes for future retirement benefits: 1.) defined benefit (DB) pensions funded at risk-free rates and invested in bonds that match the profile of benefit payouts; or 2.) 401(k)-type defined contribution (DC) pensions like the private sector. Anything else is simply borrowing in disguise.