Bloomberg did a feature this week on the long-term outlook on pension funds for several major cities, and found that it is swiftly becoming a fiscal tsunami in several places. Part of this stems from severe under-funding of pension plans over many years, while the other part is accounting tricks.
As Bloomberg notes, “Moody’s, which in 2013 began using a lower rate than governments do to calculate future liabilities, has estimated that the 25 largest U.S. public pensions alone have $2 trillion less than they need.” This rate gimmick ultimately hides the true cost of retirement liabilities in municipalities. Additionally, “officials have been able to lower the size of the liability by counting on investment earnings of more than 7 percent a year, even after they expect to run out of cash. New rules from the Governmental Accounting Standards Board require a lower rate to be used after retirement plans go broke. Many reported shortfalls will grow as a result.”
Already, many U.S. cities each face billions in costs, resulting in trillions of dollars in municipal-bond market deficit. By now, many places have been downgraded — even down to junk — and thus face higher yield demands from investors.
Cincinnati and Minneapolis have already been lowered. Chicago was already downgraded to junk this past May as a result of a $20 billion pension deficit, and “was forced to pay yields of almost 8 percent on taxable bonds maturing in 2042, about twice what some homeowners can get on a 30-year mortgage.”
Houston was put on notice in early July by Moody’s that their bond rating was lowered to “negative” due to unfunded pensions costs. Houston’s revenue faces limitations from property tax caps, and thus funding the pension promises properly for three pension systems at this point has become increasingly difficult. It faces an unfunded liability of about $3.4 billion.
Likewise, in Dallas, the firefighters and police pension system deficit is poised to triple its shortfall “to $4.7 billion because of the accounting-rule shift.”
Perhaps the most egregious example is the California Public Employees’ Retirement System, the biggest pension system in the United States. They reported this week that “it earned just 2.4 percent last fiscal year, one-third of the annual return it projects. The California State Teachers’ Retirement System, the second-biggest fund, gained 4.5 percent, compared with its 7.5 percent goal.” Years of over-generous promises have resulted in an enormous and unsustainable debt that ultimately taxpayer will have to foot the bill for.
When the public sector and unions signed off on lavish pension provisions for the employee, they hoped there would be enough growth and investment returns to cover it way down the road. There were no provisions made to handle the possibility of a low-interest rate society or a fledgling economy like we’ve experienced the last six years; they took their chances and their fallback was always that they could suck money from the taxpayer by raising taxes to cover budgeting shortfalls. That is reckless and irresponsible.
Years of fiscal mismanagement in the public sector has resulted in this fiscal nightmare. Because the public sector does not have the economic forces of competition to keep compensation levels in check, as the public sector does, it was always incumbent upon public negotiators to manage contracts properly. Failing to properly negotiate, making cozy deals, and maintaining unsustainable defined-benefit plans has created the soaring budget and pension deficits we are experiencing.
And its only going to get worse.