America's public sector pensions have been a scandal for years. It wasn't that long ago that they finally got around to doing their accounting the way that normal pensions do: by showing how likely their assets were to generate enough revenue to pay for future benefits. When they did, we found out what critics had long been claiming: many pension funds for state and local governments were disastrously underfunded. Politicians had gotten into the habit of promising generous pensions as a "cheap" giveaway to powerful unions.
With the holes laid bare, public pension funds scrambled to find some way to fill them without making politicians do something ridiculous, like raise taxes to pay for all the promises they'd made. Many of them seem to have hit on the notion of pulling the money out of boring old bonds and putting them in something that paid a nice, high return--not just equities, but hedge funds and exotic securities.
Since the public pension funds were rarely able to pay top dollar for financial wizards, and had a number of political constraints on both membership of the boards, and the investments they made, you can just about imagine what they look like now. But if you can't, the FT lays it out:
In the past year the funds, whose collective $2,000bn-plus in assets make them key investors in every asset class, have lost about 40 per cent of their value through investment losses.
The 2,600 pension plans provide retirement savings for 22m public employees in towns and cities across the US, and range in size from the giant Calpers, with $120bn (€91bn, £81bn) in assets, to tiny small town funds which pay pensions for local garbage collectors and police.
Phillip Silitschanu, a senior analyst at Aite Group, a consultancy, says the pensions "could face a cash flow collapse, they are liquidating assets to meet their monthly cash flow needs . . . instead of selling positions that are down 10 per cent, they are being forced to liquidate positions down 40 per cent. It is a firesale liquidation of assets to have the cash on hand to meet obligations".
Bill Atwood, the executive director of the Illinois State Board of Investments, says: "Right now it's very bad. For the full year 2009 (ending in June) we will have $270m negative cash flow on $8.5bn in assets."
State pension benefits are protected by law, and must be paid even if the fund is making a loss. Calpers, the largest fund, has lost $70bn in value in the past eight months, but still has to pay $11bn in benefits this year. Unless the fund starts recouping its losses soon, the California state government, which is already mired in a huge deficit, will have to lift contributions to Calpers starting from next year.
This is not, it should be emphasized, exclusively a problem of public sector pensions; private firms are also underfunded. But the scale is vastly different. According to the Pension Benefit Guaranty Corporation, which regulates and insures pensions, the total deficit in private plans covering about 34 million workers was a little over 10 billion as of September 2008. That's almost certainly multiplied quite a bit since then. But the current underfunding in public plans, which cover about 22 million workers, seems to be something north of a trillion dollars. And they're not insured.
The funds that are responsible are a different sort of headache; they'll be slapping heavy levies on local school districts and governments to shore up their capital. That will be a nasty burden on strapped local governments, particularly in places that are already in decline. My mother's hometown in Western New York now sees its local fiscal picture vary heavily with the financial industry 350 miles away because of teacher pensions. In good years, the market booms, tax revenue soars, and not only does their mandatory pension contribution fall, but the state often offers extra help out of the tax windfall. In bad years, the state aid disappears, their mandatory contribution goes up, and the senior citizens on fixed incomes start assembling pitchforks and torches for the march on city hall.
If that's not enough to worry you, keep an eye on Social Security. The trustee's report is due out in a few weeks, and I can virtually guarantee that the estimated date when the "trust fund" will be exhausted will move at least a year closer. In bad times, tax revenues fall, and age discrimination means that older displaced workers are prone to apply for early benefits rather than looking for another job--especially if their 401(k) has kind of evaporated. The release of the annual report used to feature a festival of complaining from bloggers that the Social Security Trustees were far, far too conservative in their estimates of future growth. I don't think we'll be hearing that this year.
Update: The PBGC emails
Actually, the PBGC was reporting on the shortfall in its own insurance
program. The private sector pension plans insured by the PBGC are in
reality underfunded by hundreds of billions of dollars. A recent
Milliman study for instance shows the shortfall among the largest 100
corporate pension plans to be $217 billion. Calculated on a
termination basis (that is assuming the pension plans were ending today)
the underfunding number is much higher.
So while the two systems (public and private pensions) are vastly
dissimilar (one with taxpayers as guarantors of last resort, the other
with the PBGC backstop), neither currently has assets sufficient to keep
its benefit promises.
The problem in the public funds is still bigger, but not as much bigger as I'd initially thought--which makes sense, since a bunch of funds, like the airlines, have been chronically underfunded since the 2000 stock market crash. It's hard for any entity to keep promises made forty years in the future.
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