Don't Ignore Public Pensions

With Americans understandably preoccupied with high unemployment and a modest outlook for economic recovery, another worrisome problem has been building, all but unnoticed.

The unfunded pension liabilities of state and local governments have been rising. By law, these pensions will have to be paid to the 20 million men and women who work in the state-local public sector. They will have to be paid chiefly by the taxpayers, either of the respective states or-possibly-by all of us if Congress decides to ride to the rescue.

The latest estimate of unfunded pension obligations for state and local government is $2 trillion. It comes from Orin Kramer, chairman of New Jersey’s Investment Council, reported in an interview with the Financial Times.

Last year Mr. Kramer estimated $1 trillion in unfunded liabilities, based on projected investment returns of 8%. Now he believes that 8% is too optimistic, and that current investments are performing worse than anticipated. In either case, cities and states will not have adequate revenues to meet their obligations.

For many years a growing economy propelled increases in stock prices, enhancing the coverage of many pension plans, public and private. But stocks have not yet fully recovered from the market’s collapse. Prudent planning cannot assume that stocks will resume their prior course, and so the problem must be examined.

One reason for the unfunded liabilities is the increase in the financial power of public sector unions, such as the American Federation of State, County, and Municipal Employees and the Service Employees International Union. They contribute to the election campaigns of state legislators and governors and encourage them to raise public pensions.

This is easy to do because payouts come decades later, when the elected officials voting now also will be retired. Public sector unions gave $7 million in New York and $38 million in California in 2008.

Take the California Public Employees’ Retirement System and its sister agency, the California State Teachers’ Retirement System. They lost $100 billion in the last fiscal year. In 2008, over 6,000 California public retirees received pension benefits of at least $100,000, with the most richly rewarded, the former city administrator of Vernon, near Los Angeles, receiving almost $500,000.

California already seeks help from Washington-meaning all of us taxpayers. As Governor Schwarzenegger said yesterday in his State of the State Address, “Federal funds have to be part of our budget solution because the federal government is part of our budget problem. When President Clinton was in office, California got back 94 cents on the dollar from the federal government. Today we only get 78 cents back.”

An increase in unfunded liabilities could not have come at a worse time for state and local governments already staggering financially. Many states not only face record operating deficits from the recession, but they are looking at a potential expansion of Medicaid obligations if health “reform” is signed into law by President Obama.

Further, many states accepted stimulus funds on condition that they expand programs for low-income or unemployed residents. The federal stimulus funding for expansion of unemployment insurance, Medicaid, and Temporary Assistance for Needy Families, among others, will expire at the end of 2010, leaving programs to continue without federal aid even as state revenues remain below pre-recession levels.

Pension plans for employees of state and local governments are not governed by the U.S. Labor Department-administered Employee Retirement Income Security Act, which specifies investments that can be made by private employer pension plans and minimum levels of funding. Rather, public pension funds operate under guidelines of the Government Accounting Standards Board, which has different criteria.

Whereas gains and losses from private pension funds must be smoothed over seven years under the Pension Protection Act of 2006-ten years upon request-gains and losses for public plans only have to be smoothed over a 30-year period. This means that public funds can incur greater deficits than private plans, because projected gains 30 years hence can be used to offset near-term losses.

Although private plans can reduce employee benefits and increase contributions to bring under-funded plans into financial health, many public sector plans have been prohibited by the courts from doing this. New employees can be charged a higher contribution rate for lower benefits, but not current employees who were hired under more favorable terms.

Underfunded public pension plans are legal obligations of the state, and have to be paid either with taxpayers’ dollars, or with increased contributions from new state employees, or both. State and local tax rates will have to rise to pay for this.

Many states are hoping that the Federal government will bail out their pension plans. In fact, legislation has been proposed to bail out union-sponsored multi-employer plans in the private sector, which are also in trouble. Representative Earl Pomeroy’s Preserve Benefits and Jobs Act would set up a fund within the Pension Benefit Guaranty Corporation to pay multi-employer pension plan benefits - without limits. It’s not hard to envision similar legislation to rescue states.

At the state or federal level, someone is going to pick up the tab for underfunded pensions. Who? Take a look in the nearest mirror for the answer, because the bill will be footed by taxpayers - either through state and local tax increases, or by a federal bailout.

This piece originally appeared in RealClearMarkets

This piece originally appeared in RealClearMarkets