Are public pension shortfalls self-inflicted wounds?
A new white paper by Chris Tobe, a chartered financial analyst and a former trustee for the Kentucky Retirement System, asks: “Did the SEC and S&P let 14 states destroy their Pensions?” Tobe’s question shifts the blame for public pension shortfalls from generously compensated public workers to legislators, the credit-rating agencies and the SEC. His thesis is that some states’ legislators knowingly failed to make required annual payments to the pension fund and instead spent the money on current services such as teachers’ salaries and new roads. Tobe further alleges that credit-rating agencies and the SEC were asleep at the wheel about the problem and bear some of the blame.
State pension funds have an estimated $900 million shortfall, according to the Center for Budget Research. I think Tobe is looking in the right corners for the culprits. Public workers do have generous retirement plans, and the financial crisis certainly created enormous losses for pension funds. But these losses, in many cases, were layered on top of plans that were already poorly funded. From Tobe’s white paper:
The current political rhetoric on public pensions that blames gold plated benefits and high investment assumptions misses the most basic fundamental problem. The dirty little secret of at least 14 states is that politicians have misled the public as both political parties have conspired to secretly borrow $100’s of billions from their pensions.
Public pensions are exempt from ERISA, so there is no direct federal regulation, and state regulation of public pensions has proven itself ineffective at best in most states. As states borrow money through the municipal bond market there are regulators and independent reviewers who are supposed to provide investors with an honest view of state finances. These are the only watchdogs. This paper asks why both the SEC and S&P and Moody’s fell down on this job.
Tobe then gets into the dirty details of the nation’s most poorly funded pensions:
The vast majority of the lowest funded plans have made subpar ARC [annual required contribution] payments. This lack of ARC funding is the most direct reason for the lowest funding ratios of:
- Illinois SERS 23%
- Oklahoma Teachers 27%
- Rhode Island Employees 29%
- Connecticut Teachers 32%
- Colorado PERS 34%
- Alaska Teachers 37%
- Minnesota PERF 37%
- New Jersey Teachers 38%
- Kansas 38%
- New Mexico Teachers 38%. viii
(Note this source may be combining pension and retiree health ratios in some calculations.)
Tobe’s point about the credit-rating agencies is spot-on – they only began to include pensions in their liability calculations in 2011. From a January 2011 article in the New York Times:
States do not now show their pension obligations – funded or not – on their audited financial statements. The board that issues accounting rules does not require them to. And while it has been working on possible changes to the pension accounting rules, investors have grown increasingly nervous about municipal bonds.
Moody’s new approach may now turn the tide in favor of more disclosure. The ratings agency said that in the future, it will add states’ unfunded pension obligations together with the value of their bonds, and consider the totals when rating their credit.
Tobe’s allegation about the SEC not enforcing pension liability disclosure is not entirely true as they sanctioned New Jersey in 2010 for securities fraud in misrepresenting pension liabilities. This followed a settlement between the SEC and San Diego in 2006 for concealing its pension fund deficit. From the SEC on New Jersey:
According to the SEC’s order, New Jersey offered and sold more than $26 billion worth of municipal bonds in 79 offerings between August 2001 and April 2007. The offering documents for these securities created the false impression that the Teachers’ Pension and Annuity Fund (TPAF) and the Public Employees’ Retirement System (PERS) were being adequately funded, masking the fact that New Jersey was unable to make contributions to TPAF and PERS without raising taxes, cutting other services or otherwise affecting its budget. As a result, investors were not provided adequate information to evaluate the state’s ability to fund the pensions or assess their impact on the state’s financial condition.
New Jersey is the first state ever charged by the SEC for violations of the federal securities laws. New Jersey agreed to settle the case without admitting or denying the SEC’s findings.
The main culprit in this story is all the politicians who looked the other way when their budget analysts suggested that required pension payments should be made annually. Tobe’s on the right track. Pension shortfalls are a big problem, and lots of government and market participants have been blind.