Bethany McLean

Where is the political accountability for America’s pension disasters?

Bethany McLean
Dec 11, 2013 22:03 UTC

Five years after the financial crisis, there’s still a hue and cry about sending people to jail. After all, financiers were, at best, self-servingly optimistic about the future. At worst, they said things that weren’t true, and made promises they couldn’t keep. Investigations are still ongoing, and although it’s doubtful, maybe some big guys will go to jail. But there’s another group of people who have injured, and are continuing to injure, millions of Americans with purposefully blind optimism and false promises. Those are politicians in every city and state that is facing a pension shortfall.

You can’t read the news without hearing about the pension problem. Last week, federal judge Steven Rhodes ruled that Detroit can proceed with the largest municipal bankruptcy in history, thereby allowing the city to cut billions of dollars in payments that are owed to city employees, retirees, investors and other creditors. In Illinois, Governor Pat Quinn signed into law a plan that will trim Illinois’s pension hole, which is viewed as being one of the deepest and darkest in the country. (Labor unions say they will challenge the plan in the courts; credit rating agencies have pointed out that the legal protection of pension benefits is particularly strong in Illinois, so it remains to be seen what will happen.)

Inevitably, there is more to come. Rhodes’s ruling could have implications for California cities, like San Bernardino and Vallejo, that are wrestling with bankruptcies. In Chicago, the pension hole is estimated at $20 billion, and according to the New York Times, payments to the local pension fund are expected to increase by $590 million in 2015 to a total annual contribution of almost $1.4 billion. “Should Chicago fail to get pension relief soon, we will be faced with a 2015 budget that will either double city property taxes or eliminate the vital services that people rely on,” Mayor Rahm Emanuel told the Times.

There is disagreement about the size of the problem — it depends on how optimistic you are about the future, and how you truly account for pension liabilities — but most people agree that a problem exists. Estimates of the size of the hole range from almost $1 trillion to well over $4 trillion, according to a 2012 paper by the Kennedy School. In a recent report, the credit rating agency Moody’s, which calculates the pension hole using something called adjusted net pension liability — basically, the difference between the value of a pension plan’s assets and its future benefit payments adjusted for a present-value calculation — wrote that “several large local governments have pension burdens large enough to cause material financial strain.” For instance, in Chicago, the adjusted net pension liability is 678 percent of its annual revenue; 28 other local governments in Moody’s list of the top 50 (based on the amount of debt outstanding and whether or not Moody’s rates them) have an adjusted net pension liability that is greater than their annual revenue. Four of the top 50 local governments have actuarial contribution requirements in excess of 15 percent of operating revenues. In fiscal 2011, 33 of the top 50 local governments contributed less than what was actuarially required. And so on.

The argument generally centers on whose fault it is. You can pick your villain: Labor unions, Wall Street, the rich, the recession, an uncooperative market that can’t deliver the ridiculous 8 percent returns that many plans have counted on, the politicians. In simple terms, the right wing generally blames the unions for negotiating what some view as overly generous packages, while the unions have mostly argued that their benefits are legally protected by the state, and therefore cannot be cut back. Both miss the point. The unions should be angry about the underfunding of their pension benefits, while no one should be angry at the unions: it was their job to get the absolute best deal for their constituents that they could, and so they did. It doesn’t really matter if the promises were too generous or not generous enough: they were promises, and people relied on them.

The Pension Destabilization Act

Bethany McLean
Aug 13, 2012 16:19 UTC

From the wonder of the Olympics to the horror of Libor, there’s been plenty of news this summer. So maybe it’s not surprising that a 1,676-page bill called Moving Ahead for Progress in the 21st Century, which President Obama signed into law on July 6, has escaped attention. (Really? You’d rather watch Gabby Douglas win the all-around gold than read this bill? Shocking.) But buried within the bill, which is also known as the Highway Act, is a provision that matters to many Americans, a provision that sums up a lot of what’s wrong with Washington today, a provision that is not just bad finance but also reeks of the cronyism we should all fear.

The provision is called the Pension Stabilization Act, and really, it should be renamed the Pension Destabilization Act. Pensions are fairly unstable already, relying on markets of the future that smart prognosticators doubt are going to be as generous as the markets of the past. And yet, many pension plans are counting on similar rates of return anyway. In his August letter, Pimco’s Bill Gross pointed out that one of the country’s largest state pension funds says it will earn what sounds like a modest real rate of 4.75 percent. But as Gross notes, assuming a portion of that is in bonds yielding 1 to 2 percent, the pension would need stocks to return 7 to 8 percent after adjusting for inflation to hit its target. That is, as Gross writes, “very heavy lifting.” Nor are we heading into tough times with a cushion. Different sources put the funding deficit for large corporate pension plans at somewhere between $475 billion and $500 billion as of the end of 2011.

Given that, and given that corporate profit margins and cash balances are near all-time highs, you might think, or hope, that Congress would be cracking the whip. And it did, sort of, by passing the Pension Protection Act in 2006, which among other things generally required companies to fund their pension shortfalls over seven years.  But then the financial crisis hit, and companies begged for relief, and now, in 2012, we have the Pension Stabilization Act. While the math is complicated – Jim Moore, a managing director at Pimco, calls it a “Rube Goldberg contraption”– most people who have looked at it say that the overall effect is going to be, as JPMorgan put it in a recent piece, to “significantly reduce” the cash that companies are required to contribute to their pension plans in the next few years.  It does so, in essence, by increasing the discount rate that companies use to calculate their pension liabilities when they’re determining how much money they need to put in. Using a higher discount rate makes the liability look smaller, thereby decreasing the funding requirement.