RETIREE NIGHTMARE: Major Pension Funds Going Bust?

From the New York Times, we read this:

Picture the next major American city to go bankrupt. What springs to mind? Probably not the swagger and sprawl of Dallas.

But there was Dallas’s mayor, Michael S. Rawlings, testifying this month to a state oversight board that his city appeared to be “walking into the fan blades” of municipal bankruptcy.

…Under its glittering surface, Dallas has a problem that could bring it to its knees, and that could be an early test of America’s postelection commitment to safe streets and tax relief: The city’s pension fund for its police officers and firefighters is near collapse and seeking an immense bailout.

Over six recent weeks, panicked Dallas retirees have pulled $220 million out of the fund. What set off the run was a recommendation in July that the retirees no longer be allowed to take out big blocks of money. Even before that, though, there were reports that the fund’s investments — some placed in highly risky and speculative ventures — were worth less than previously stated.

What is happening in Dallas is an extreme example of what’s happening in many other places around the country. Elected officials promised workers solid pensions years ago, on the basis of wishful thinking rather than realistic expectations. Dallas’s troubles have become more urgent because its plan rules let some retirees take big withdrawals.

Now, the Dallas Police and Fire Pension System has asked the city for a one-time infusion of $1.1 billion, an amount roughly equal to Dallas’s entire general fund budget but not even close to what the pension fund needs to be fully funded. Nothing would be left for fighting endemic poverty south of the Trinity River, for public libraries, or for giving current police officers and firefighters a raise.

Dallas is a relatively nice city. I live in North Dallas. The low cost of doing business has done wonders for development and employment. But politicians here are not very different from anywhere else: Promises are made that cannot possibly be kept. Cans are kicked until they explode.

How will Dallas manage to pay the unfunded liabilities? Not through property tax increases. Texas homeowners are protected under state law by a 10% annual cap on property tax increases. And the city cannot borrow enough money to cover this; they do not have the capacity. Retirees will not accept a cut in benefits willingly; the litigation would be monumental.

As a city, they have a way out: bankruptcy. They can stiff the retirees. “Sorry. You lose. Good day.” Politically, this is suicide. It is the great game of hot potato. No politician wants to be the one left holding the hot potato. But when all else fails, the option is there.

What happens when a state-run retirement program is underfunded? Cities and counties can declare bankruptcy, but not states. This is the problem currently facing CalPERS, California’s enormous public sector retirement fund.

From the Sacramento Bee, we read this ominous report:

Ron Seeling, the California Public Employees Retirement System’s chief actuary, believed he was speaking to a closed-door seminar in 2009 when he warned that public employee pension costs were becoming “unsustainable.”

However, Ed Mendel, a veteran reporter who writes a blog on pensions, was there, and later published Seeling’s dire warning.

“I don’t want to sugarcoat anything,” Seeling said. “We are facing decades without any significant turnarounds in assets, decades of — what I, in my personal words, nobody else’s — unsustainable pension costs of between 25 percent of pay for a miscellaneous plan and 40 to 50 percent of pay for a safety plan (police and firefighters) … unsustainable pension costs. We’ve got to find some other solutions.”

It was all wine and roses until the Great Recession:

By the time Seeling delivered his dark appraisal in 2009, the state was being hammered by an ultra-severe recession, and the CalPERS trust fund was losing what turned out to be nearly $100 billion in value.

Seven years later, CalPERS and other pension funds still haven’t fully recovered, and they’re sharply raising mandatory “contributions” from state and local governments to cover the gaps left by meager investment earnings.

…Validating Seeling’s 2009 projection, state and local governments are now routinely paying 40 to 50 percent of payroll for “safety system” employees. The California Highway Patrol, for example, is paying 50.08 percent to CalPERS — nearly four times its 1999 level — and several cities are paying even more.

So the state government is leaning back on funding from city and county governments. But this input is declining:

Local governments, particularly cities, have a bigger pension problem than the state, because they devote much of their budgets to costly police and fire services.

Pension costs figured prominently in the bankruptcies of three cities. In one case, Stockton, the federal bankruptcy judge declared that it could legally reduce pension benefits, challenging the long-held assumption that pensions are legally untouchable. However, Stockton opted to not reduce benefits, so the issue remains untested.

If the present pension situation is dim, the future may be even darker.

The bad news for CalPERS doesn’t end there:

Another year, another mess with California’s public employee pensions. The California Public Employees’ Retirement System (CalPERS) announced this week that the rate of return for its investments for the fiscal year ending on June 30 was less than one percent. It was .61 percent. As the Los Angeles Times notes, this is the worst returns it has logged since 2009, when the housing bubble burst and hit California particularly hard.

The next recession, which I think will arrive soon, is going to wipe out the stock market. Bond yields are already low. They are going to sink even lower. The ability of pension fund managers to generate returns will be severely curtailed. The pension shortfalls will spiral out of control.

Local governments with heavy unfunded liabilities will get pummeled. Retirees for city and county level governments should be concerned. They can be legally stiffed if the local government declares bankruptcy.

State-level retirees are the big winners. The state cannot declare bankruptcy. Retirees who were state employees are required by law to get paid.

But current state employees – especially in California or Illinois – should be scared. The retirees have first dibs on funding. When the recession hits, it will be difficult for states to keep funding current programs. So to meet state pension obligations, they will have to fire state employees. There will be a mad dash between competing state government agencies and programs for funding. A large number of state employees will get the pink slip. A lot of government programs will lose funding.

If I were a state employee – especially in California  or Illinois – I’d have a backup plan.

CONCLUSION

The unfunded liabilities are the Achilles’ heel of the modern welfare state. The retirement benefits have been codified into priority by law. Furthermore, these are liabilities that continue to grow. Short of outright default, the government cannot do anything about it. There is no escape.

There is a silver lining to this: it restricts the growth of the welfare state. Social Security and Medicare already account for over half the federal budget. Mostly untouchable military spending accounts for another quarter. There is simply no more room for major welfare programs. We got Obamacare in 2010, but I think that may be the last major welfare program that the federal government ever enacts, and parts of its will probably be repealed anyway.

Raising taxes will not get around this. The unfunded liabilities of Social Security and Medicare are over $222 trillion. Any new revenue is already claimed by these programs.

Meanwhile, most voters are oblivious to all of this. They will not pay attention until they feel the pinch in their wallets. They have forgotten the most important proverb relating to the welfare state: “Things that can’t go on forever… won’t.”

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