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  1. #1
    dangerous floater Winehole23's Avatar
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    A gold-plated burden
    Hard-pressed American states face a crushing pensions bill






    CHUCK REED is the Democratic mayor of San Jose, California. You might expect him to be an ally of public-sector workers, a powerful lobby in the Golden State. But last month, at a hearing on pension reform held by the Little Hoover Commission, which monitors the state’s government, Mr Reed lamented his crippling public-pensions bill. “City payments for retirement benefits have tripled over the last ten years even though our workforce has declined dramatically, and we have billions of dollars in unfunded liabilities that the taxpayers must pay,” he said.


    Mr Reed estimated that the average cost to his city of employing a police officer or firefighter was $180,000 a year. Not only can such workers retire at 50, but some enjoy annual pension payments greater than their salaries. They are also entitled to cost-of-living increases of 3% a year, health and dental insurance for life and lump-sum payments for unused sick leave that could reach hundreds of thousands of dollars.


    Plenty of similar bills are looming in America’s public sector: in municipalities, in the federal government, and especially at state level. Defined-benefit pensions, which link retirement income to salary, are expensive promises to keep. The private sector has been switching to defined-contribution plans, in which employees bear the investment risk. But the public sector has barely begun to adjust, and has built up a huge liability to its staff. Worse, it has not funded the promises properly.





    Joshua Rauh, of the Kellogg School of Management at Northwestern University, and Robert Novy-Marx, of the University of Rochester, estimate that the states’ pension shortfall may be as much as $3.4 trillion and that municipalities have a hole of $574 billion. Mr Rauh calculates that seven states will have exhausted their pension assets by 2020—even if they make a return of 8%, a common assumption that looks wildly optimistic. Half will run out of money by 2027. If pension promises are to be kept, this will place immense strain on taxes. Several have promised annual payments that will absorb more than 30% of their tax revenues after their pension funds are exhausted (see chart 1).



    The severity of states’ pension woes was disguised for years, because asset markets were so strong and because of the way states accounted for the cost of pension provision. But the 21st century has been dismal for stockmarkets, where most pension money has been put. State budgets came under huge pressure as a result of the 2008-09 recession, which caused tax revenues to plunge. Meredith Whitney, an analyst who made her name forecasting the banking crisis, believes the states could be the next source of systemic financial risk.


    Now the problem is making headlines, especially in California, where taxpayer groups have been highlighting the generous pensions of some former employees. More than 9,000 beneficiaries of CalPERS, the largest state retirement plan, receive more than $100,000 a year.



    The stage is set for conflict between public-sector workers and taxpayers. Because almost all states are required to balance their budgets, any extra pension contributions they make to mend a deficit will come at the expense of other citizens. Utah has calculated it will have to commit 10% of its general fund for 25 years to pay for the effects of the 2008 stockmarket crash. But attempts to reduce the cost of pensions are being challenged in court and will be opposed by trade unions, which still have plenty of members in the public sector.


    A pension plan is a promise to pay employees after they retire. Most liabilities fall due well into the future, once those now working retire and receive payments until they die perhaps 20 or 30 years later. Such future liabilities have to be valued, using a discount rate to reflect what they are worth in today’s money. The higher the discount rate, the lower the present value.


    States use the expected return on the assets in their pension funds as a discount rate. This is often around 8%, and reflects the performance of the past 20-30 years. However, such returns will be hard to come by in future. As Bill Gross of Pimco, a giant fund-management firm, pointed out recently, given current bond yields of 2% and a typical portfolio with 60% in equities and 40% in bonds, a total return of 8% requires a return of 12% on equities. And with American equities yielding just 2-2.5%, that in turn would require dividends to grow by 9-10% a year. Dividends grow roughly in line with the whole economy—and 9-10% is just not plausible.


    This reliance on returns as the basis of the discount rate is extraordinary, when you stop to consider it. The more risk the pension fund takes (for example, by buying high-yielding bonds of companies with poor credit ratings), the lower its liabilities appear to be.



    “Funding the liability with risky assets doesn’t make the liability any smaller,” says Andrew Biggs, of the American Enterprise Institute, a conservative think-tank. A state pension fund may achieve the desired returns by investing in the stockmarket. But if that does not work out, the state must still pay its pensioners.


    David Crane, an adviser to Arnold Schwarzenegger, the governor of California, describes the treatment of state pension funds as “Alice-in-Wonderland accounting”. Suppose, he says, that a state had to pay a bondholder $30,000 a year for 25 years and to pay a pensioner the same sum for the same period. The bond obligation would have a present value of $425,000 in its accounts but the pension liability, with the same cashflows, would be valued at just $320,000.


    Private-sector companies are no longer allowed to use assumed returns when calculating their pension-fund liabilities on their balance-sheets. They have to use corporate-bond yields. The contrast makes it appear as if public-sector pensions can be delivered on the cheap. “The accounting suggests that governments can provide pension benefits at half the cost of a private-sector fund,” says Mr Biggs.


    A more prudent way of measuring the liability is to regard a pension as a debt that the state owes its employees. So one possible discount rate is the state’s cost of borrowing, the yield on its municipal bonds. Some argue that pensioners have even greater rights than bondholders and that points to using a “risk-free” rate like the Treasury-bond yield. Both rates make the present value of pensions liabilities much higher than that declared by the states.


    Using Treasury bond yields as the basis for discounting, Mr Rauh and Mr Novy-Marx calculate that states’ pension liabilities are as much as $5.3 trillion. That is 68% more than reported by the states, and produces the authors’ figure of $3.4 trillion for the gap between liabilities and assets.



    In their defence, the states say that they are following the Governmental Accounting Standards Board (GASB), which recommends discounting liabilities by assumed returns. Even on that optimistic basis, states are not putting enough aside. According to the Centre for Retirement Research, their average funding ratio, using the GASB approach, fell from 103% in 2000 to 78% last year (see chart 2); with a risk-free rate underfunding would be much worse. Despite this shortfall, 21 states failed to make their full contribution to their pension funds over the past five years, according to Eileen Norcross of George Mason University in Washington, DC.

    Trouble in Trenton

    New Jersey provides a prime example of America’s pension difficulties. In August the Securities and Exchange Commission (SEC) charged the state with fraud for misrepresenting the underfunding of its pension plans to municipal-bond investors. This was the first time a state had been charged with violating federal securities laws. It settled the case without admitting or denying the SEC’s findings.


    A study by Ms Norcross and Mr Biggs outlines, using the Treasury yield as a discount rate, how New Jersey has run up a pensions deficit of $174 billion. That is equivalent to 44% of the state’s GDP, or more than three times its official debt.





    The problems started in 1992 when the then governor, Jim Florio, increased the assumed return on pension assets from 7% to 8.75%. That allowed contributions to be reduced and helped the state balance its budget. Further reforms in 1994 and 1995 eased the accounting assumptions, allowing Mr Florio’s successor, Christie Whitman, both to cut taxes and to balance the budget. In the late 1990s the fund bet heavily on technology stocks, giving a brief boost to asset values. Employees’ contributions were cut from 5% of payroll to 3%. New Jersey also increased benefits, giving pension rights to surviving spouses in 1999 and a boost of 9.1%, in effect, to scheme members in 2001, just as the dotcom bubble was bursting and the fund’s assets were falling in value. The effect of this chronic underfunding on the pension scheme for the police and firefighters is shown in chart 3.


    In March Chris Christie, the Republican governor elected in November 2009, reduced the pension benefits of new state employees. Last month he unveiled a more ambitious plan with several measures that affect existing workers. These include an increase in their contributions to 8.5%, raising the qualification for early retirement from 25 to 30 years of service, moving the normal retirement age to 65 and ending future inflation adjustments. It is too soon to tell whether Mr Christie will get this plan through. Not surprisingly, the unions oppose it. “Once again, it’s an attack on the middle class,” said Hetty Rosenstein, who heads the state chapter of the Communication Workers of America.



    Other states have also started on reform, but have focused mainly on restricting the benefits of new employees. Michigan closed its defined-benefit scheme to entrants back in 1997 and Alaska moved to a defined-contribution plan for new staff in 2006. Utah is closing its defined-benefit plan to new employees next June.


    But this makes only a small dent in a huge problem. The bulk of liabilities consist of promises to people already working or retired, which are often legally protected. Reducing this bill will take a much bigger reform. Mr Rauh and Mr Novy-Marx estimate that raising the retirement age by a year would trim the cost by 2-4%; a cut of a percentage point in inflation-linking would slash it by 9-11%. But states that have tried to adjust existing promises, such as Colorado, Minnesota and South Dakota, which have frozen cost-of-living adjustments, have faced challenges in court.
    States will have to make difficult choices. A change to the rights of existing scheme members is sure to have an adverse effect on people on low pay, nearing the end of their careers or already in retirement. A cap on the cost-of-living adjustment, for example, would be a nightmare for pensioners were inflation to flare up, because they would have no way of making up the loss in their purchasing power.



    But after years of neglecting the problem, such changes will be hard to avoid. In the words of Dan Liljenquist, a state senator in Utah and an architect of its reforms: “This is not a conservative-versus-liberal issue, this is a reality issue.”

  2. #2
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    I read an article last week that said while pension obligations are necessarily on the city/county/state books, their obligations for retirees' medical care aren't, and that's many 10s of $Bs more.

    America is so fucked, so fraudulent, and there's no unfucking it.

  3. #3
    Veteran DarrinS's Avatar
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    Oh well, they'll just have to save for their own retirement like the rest of us private sector folks.

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    Cold-Ass Honkie RandomGuy's Avatar
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    Oh well, they'll just have to save for their own retirement like the rest of us private sector folks.
    Most are forced to contribute to the funds anyways. They are saving. The smart ones know that what they have been promised will probably be cut and have other vehicles of saving as well.

    This ticking time bomb is in addition to SS and Medicare liabilities.

    Anyone who thinks taxes aren't going up is kidding themselves.
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    Cold-Ass Honkie RandomGuy's Avatar
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    But after years of neglecting the problem, such changes will be hard to avoid. In the words of Dan Liljenquist, a state senator in Utah and an architect of its reforms: “This is not a conservative-versus-liberal issue, this is a reality issue.”
    Wonder what the tea party crowd will make of the tax increases, speaking of politics.

    The grown-ups in the room know that you have to raise taxes and lower benefits to get the problem under control, because doing one without the other will be next to politically impossible.

  6. #6
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    The Repugs had to have their guns-for-oil, so the people get deprived of butter.

  7. #7
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    Defined benefit pension plans simply do not work. They all need to be scrapped.

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    Cold-Ass Honkie RandomGuy's Avatar
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    Defined benefit pension plans simply do not work. They all need to be scrapped.
    I agree.

  9. #9
    Mr. John Wayne CosmicCowboy's Avatar
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    Defined benefit pension plans simply do not work. They all need to be scrapped.
    X2... The public sector retirement plans are absolutely obscene when compared to what the private sector can afford to offer.

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    Veteran Wild Cobra's Avatar
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    Wonder what the tea party crowd will make of the tax increases, speaking of politics.

    The grown-ups in the room know that you have to raise taxes and lower benefits to get the problem under control, because doing one without the other will be next to politically impossible.
    The grown-ups know we need more tax payers and less tax revenue users. Deficit spending is OK as long as we are on a path to make that real, and when times are good, pay down the debt rather than fining more programs to spend it on.

    Why did we have so much deficit spending in the 90's when the economy was good? That should be criminal.
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    Why did we have so much deficit spending in the 90's when the economy was good? That should be criminal.
    Lemme guess, all that defecit spending from the 80s was okay though..........

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    "deficit spending in the 90's when the economy was good"

    Clinton used the increased tax revenues for The Longest Peace Time Economic Expansion to pay down the national debt.

    dubya and St Ronnie increased the national debt. dubya dubbled it, $5T to $10T, while GDP was growing and tax revenues were up.

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    Veteran Wild Cobra's Avatar
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    Lemme guess, all that defecit spending from the 80s was okay though..........
    At least you can assign a reason for it.

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    Veteran Wild Cobra's Avatar
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    Clinton used the increased tax revenues for The Longest Peace Time Economic Expansion to pay down the national debt.
    Are you high?

    The debt increased under every budget approved by president Clinton.

    He did not pay down the debt. That is my point. During good times, the debt should be paid down. Not go up.

  15. #15
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    Clinton paid down the national debt.

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    Scrumtrulescent
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    Veteran Wild Cobra's Avatar
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    Clinton paid down the national debt.
    Please...

    Don't tell me you are that dumb.

    from Table 7.1—Federal Debt at the End of Year: 1940–2015

    Year Debt in $ millions
    1989 2,867,800
    1990 3,206,290
    1991 3,598,178
    1992 4,001,787
    1993 4,351,044
    1994 4,643,307
    1995 4,920,586
    1996 5,181,465
    1997 5,369,206
    1998 5,478,189
    1999 5,605,523
    2000 5,628,700
    2001 5,769,881
    2002 6,198,401

    Where is the debt reduction please.

  18. #18

  19. #19
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    debt still went up under clinton, gdp just happened to outpace it. that being said, clinton & co do deserve credit IMO for curtailing the growth in defecits we saw under reagan and Bush I.
    Last edited by coyotes_geek; 10-20-2010 at 10:47 PM.

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    Mr. John Wayne CosmicCowboy's Avatar
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    debt still went up under clinton, gdp just happened to outpace it. that being said, clinton & co do deserve credit IMO for curtailing the growth in defecits we saw under reagan and Bush I.
    Gingrich and crew should get equal credit with Clinton. They had Clinton by the balls and were a good balance for each other. It basically created a spending gridlock.

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    ^^^ true.

  22. #22
    🏆🏆🏆🏆🏆 ElNono's Avatar
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    You have to take GDP into account though. And I'm not saying this to defend Clinton.
    Just throwing around currency numbers alone doesn't really tell you much, because the currency value over time does change. You have to have a reference value, and most everyone uses the country's GDP at that given point in time to draw a ratio.

    I do agree that you have to give credit to guys like Clinton and the opposing Congress though. It's hard to get to balance that budget, specially since there's normally a fair amount of obligations that they inherit from before they were in charge.
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    The grown-ups know we need more tax payers and less tax revenue users. Deficit spending is OK as long as we are on a path to make that real, and when times are good, pay down the debt rather than fining more programs to spend it on.

    Why did we have so much deficit spending in the 90's when the economy was good? That should be criminal.
    So do you consider the years of Republican control of the White House and both Houses of Congress equally criminal?

    If not, why not?

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    Veteran Wild Cobra's Avatar
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  25. #25
    Veteran Wild Cobra's Avatar
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    debt still went up under clinton, gdp just happened to outpace it. that being said, clinton & co do deserve credit IMO for curtailing the growth in defecits we saw under reagan and Bush I.
    I would give him credit if it was with a democrat congress. Opposing powers seem to be best for our national health.

  26. #26
    Veteran Wild Cobra's Avatar
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    So do you consider the years of Republican control of the White House and both Houses of Congress equally criminal?

    If not, why not?
    My God. No. I cannot consider that unless we were to remove 9/11 and our military deployment.

    I have explained that several times one way or another in past posts.

    I have always been consistent that the debt should always be paid down except in time of war or recession. We can include large scale national disasters and large scale projects like Hoover Dam, building the interstate system, Our quest to the moon, etc. I don't thing we have had any large scale projects that warrant large scale spending since we went to the Moon, and I don't thing we can afford such things any longer since we have such a social services burden now.

    What did president Clinton have? No recession, no large scale national disasters, a booming economy from both the tech boost and Y2K threat.

    There was absolutely no excuse not to pay down the debt in the fantastic economy that we had under president Clinton.

    President Bush inherited to bursting of the tech boom and loss of Y2K threat. We had 9/11 leading to a large scale utilization of our military. We had the largest scare in maybe 20 years of a congress threatening anything to raise taxes, leading to a slow down in capital investment into the economy.

    Government likes to use the good times to justify more increases in government spending. Then when the economy goes downhill, we are hurting worse than before. there is no excuse for this, and this cycle must end.

  27. #27
    dangerous floater Winehole23's Avatar
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    with lower interest rates, the (projected) shortfall is now $4.4 trillion
    The states are essentially autonomous. Congress does not regulate their pension operations. The Employee Retirement Income Security Act, enacted in 1974, applies only to private-sector pensions.

    Rather, state and local pension funds operate under guidelines of the Government Accounting Standards Board. It is essentially a federally-sponsored, private-sector advisory body, without enforcement power.


    In the private sector, gains and losses of pension funds must be smoothed over seven years under the Pension Protection Act of 2006-ten years when requested by the plan's administrators. By contrast, in the public sector, gains and losses may be smoothed over 30 years.
    This means that public funds can incur greater near-term deficits than private plans, because projected gains 30 years hence can be used to offset near-term losses, at least on paper.


    The disparity raises a question as to whether the states and cities need to be held to a stronger discipline, according to the Hatch report.
    http://www.realclearmarkets.com/arti...sis_99520.html

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    I'm still sticking with this a year and a half later.......

    Defined benefit pension plans simply do not work. They all need to be scrapped.

  29. #29
    dangerous floater Winehole23's Avatar
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    states borrowing to cover shortfalls:
    Debt-burdened U.S. states and municipalities were grappling with about $900 billion in long-term unfunded pension liabilities as of 2011, according to a Boston College analysis of 126 plans. The solution for some local governments from California to Florida: Take on more debt.



    State financial authorities are betting the pension assets they now manage will get better returns as the U.S. economy recovers and stock and bond markets improve. If so, states can take advantage of today’s ultralow borrowing costs to strengthen their retirement plans now—and pay off the debt later when pension funds generate returns robust enough to more than cover their annual payouts.



    Local governments sold $4.96 billion of pension bonds in 2011, the most since 2008, according to data compiled by Bloomberg. In California, Pasadena issued pension bonds in March. Oakland, Calif., and Fort Lauderdale are among issuers considering a bond sale later this year. Illinois, which has one of the country’s most poorly funded public pension funds, borrowed a total of $7.2 billion in 2010 and 2011.



    This strategy could backfire if state retirement fund returns don’t rebound. Recent history isn’t encouraging: In the decade through June 2010, the nation’s biggest state retirement systems earned less than half of what they needed to keep up with pension obligations, according to a Bloomberg survey. Borrowing to pay pension benefits “is risky for a government,” says Douglas Wood, Fort Lauderdale’s director of finance. “If the market stays down and the pension systems don’t earn their fair share on their return, then over time the city has to make that up” from its general budget.
    http://www.businessweek.com/articles...und-shortfalls

  30. #30
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    So state and local governments are borrowing money to pay people to not work. Certainly nothing bad is going to come from this..........

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