State and local government hiring will never recover
Throughout the recovery, public-sector employment figures have been dismal. Even though recent data suggests that government job losses might have peaked, there is an ugly accounting change looming that could prove a permanent deterrent to a large rebound in government hiring.
The accounting change is being driven by the Government Accounting Standards Board (GASB) and relates to pension liabilities. Governments will soon be required to report their pension liabilities alongside their other liabilities, like long-term debt, on their financial statements. Currently governments are allowed to bury their unfunded pension liabilities in the footnotes of their financial statements. When they calculate their financial ratios, they are also not required to include future liabilities owed to retirees.
With pension costs expected to take up larger and larger amounts of tax revenues, politicians will have no excuse to ignore their ballooning pension problems. What has long been an unpleasant fact for budget officers will soon become a very visible sign to government officials, the public and investors that pension burdens are very heavy and that adding employees means long-term fiscal burdens that many governments don’t have the fiscal space to take on.
Bloomberg has a good overview of the state and local government employment picture:
After four years of shuttering fire houses, cutting school budgets and firing teachers and police, these governments are starting to steady as tax revenues rebound. Public employment at all levels declined by just 7,000 in the first two months of this year, well down from the 22,000 monthly average in 2011, according to Labor Department data.
“We’re at a point where we’re nearing the bottom,” said Christopher Hoene, director of research with the National League of Cities in Washington. While some cities still are shrinking staffs, others are “not that far off from some of them hiring again. In the sense of the business cycle for local governments, the curve is starting to change.”
There certainly will be hiring to augment police forces and teaching staffs in places that can afford it, but the resources needed to make new hires will increasingly be crowded out by the costs for retired public workers. Retirements will likely increase as employees who first joined state and local government workforces in the early 1980s meet their 30-year service requirement.
With a handful of exceptions, public pension plans across the country are underfunded. In some instances, they are projected to exhaust the assets in their plans as soon as 2020. Forty states and many cities have enacted changes to get their pension plans on more solid footing, but it will take decades in some cases to restore them to full health. The states with the biggest unfunded pension liabilities, such as Illinois, are just now grappling with the legal and legislative changes necessary to prevent their pension commitments from swallowing larger and larger amounts of their annual budgets.
Greece is not Germany, and California is not Vermont
Last week Gillian Tett of the Financial Times picked up Meredith Whitney’s municipal bond doomsday flag and started waving it for an international audience. Her article, entitled “Pension gap spells trouble for muni bonds,” broadly painted the entire municipal bond market as having unacknowledged, long-term issues. Her closing line seemed to be a call for investors to shift their concerns from European sovereign debt to the debt of muniland:
Fiscal woes, in other words, are not just a matter for the eurozone; investors had better keep watching that American periphery too.
I agree with Ms. Tett that it is important for investors to dig down into the affairs of municipal bond issuers. Like the nations of the European Union, the quality of fiscal management varies by state. The U.S. has a number of well-run Germanys and we also have a handful of Greeces.
The problem with Tett’s piece is that it both used some less-than-credible sources to assert that unfunded public pension liabilities are an enormous problem and failed to distinguish California from Vermont. For example, this graph shows the combined state and local pension fund expenditures of the country overall and the nine states that devote the highest share of their annual budgets to their pension plans (source: U.S. Census Bureau via the National Association of State Retirement Administrators, page 3):
According to the National Association of State Retirement Administrators (NASRA), the national average for state and local government pension contributions is 3 percent:
Based on the most recent information provided by the U.S. Census Bureau, approximately three percent of all state and local government spending is used to fund pension benefits for employees of state and local government… pension costs since 1980 have been reliably stable, declining from around four percent to nearly three percent in 2009.
The comment by Mr Brainard highlights the main points on which financial economists disagree with GASB and NASRA.
Municipal bankruptcies do happen. Even sovereign countries become insolvent and require bailouts. The thinking that financial analysis does not apply because governments can roll over their debts indefinitely contributes to these events. Even if a state is not going out of business, the debts of today’s taxpayers will still at some point have to be paid back by tomorrow’s taxpayers if the cost of servicing the debts are not going to swallow the whole budget.
The financial logic that increases in interest rates improve pension funding is certainly recognized in financial accounting for corporations, and it should be recognized in government accounting as well. A non-defaultable promise of, say, $1000 in 10 years time is much less costly to meet by setting aside resources today when interest rates are 5% than when they are 0%. If interest rates on low-risk securities were to rise, then public pension funding would improve – unless of course the rise was due to a spike in inflation in which case COLA increases would likely undo much of this effect.
Finally, I am not sure how much citizens will allow themselves to be overcharged for the provision of specific public services in order to pay for legacy pension liabilities. That is why we present the figures both as a share of total revenue and as a share of tax revenue. Regardless, each year that the contributions continue to be far below these levels, the needed contributions to catch up become larger.
Tapping the brakes on Illinois debt?
Illinois, the state in the weakest fiscal position, is planning two big bond deals in the first quarter of 2012. Next week they plan to raise $800 million in general obligation bonds to finance various transportation projects, followed by another $750 million later this winter in long-term bonds to fund construction projects.
Although the state is drowning in debt, unfunded pension liabilities and unpaid bills, these debt offerings are very restrained compared to the last two years when it borrowed to make obligatory payments to its heavily underwater pension system.
The State Treasurer, Dan Rutherford, had opposed issuing debt to fund pension obligations and managed to raise the alarm among his former colleagues in the Illinois legislature about the dangers of endless borrowing. Rutherford’s actions may have reversed the momentum of Illinois’s debt issuance. He is certainly the first fiscal officer that I have heard of who threatened to call the rating agencies to slow his state’s bond issuance.
In another important step for the cash-strapped state, Illinois raised the personal income tax last year:
An income tax hike enacted in early 2011 that will raise $6.8 billion in new revenue annually helped ease the state’s cash flow and budget woes, but its unfunded pension obligations still pose a daunting challenge to efforts to stabilize its fiscal house. The state’s funded ratios were the lowest among states last year based on fiscal 2010 results.
The latest review based on fiscal 2011 figures shows Illinois’ unfunded [pension] liabilities rose to $82.9 billion for a funded ratio of 43.4% from $75.7 billion for a funded ratio of 45.4% in fiscal 2010.
The need to fund pension liabilities is crushing Illinois. Reform must be pretty radical to move the system to a more sustainable level of pension funding, but the state government seems to be dithering:
MMD believes that current 10yr IL GO spreads +160bps to AAA GOs will move to the 12mnth average of 176.5bps this week.
Rhode Island’s awful investment returns
It’s getting a little tiresome to hear all the adulation that’s being heaped on Gina Raimondo, the Rhode Island General Treasurer. She’s been praised in the Wall Street Journal, Time, and now CNBC as some sort of fiscal Joan of Arc who rescued the state’s public pension system from insolvency. I’ll give Raimondo credit for leading the charge to reduce benefits to Rhode Island public workers and increasing their retirement age, but she’s far from a pioneer in making tweaks to state pension plans – 17 other states have also made changes recently.
More importantly, the problems Raimondo addressed were not the biggest that the state faced. The main problem with Rhode Island’s pension system is that it has very poor investment returns on its $6.5 billion portfolio of assets. Over the past ten years the state’s investments returned 2.47 percent compared with the national median of 3.4 percent (page 6). These returns are in the lowest tier of state pension plans, and this chronic underperformance is causing a substantial shortage of assets to pay retirees.
A national clearinghouse for public pension fund data, the Public Fund Survey, wrote in its report for FY2010:
Over time, investment earnings have a major effect on the cost and funding condition of a public pension plan: from 1982 through 2009, investment earnings accounted for 60 percent of all public pension revenue.
So the major source of pension plan funding, investment returns on plan assets, has been terrible in Rhode Island. I’m not aware of any discussion or changes in the law to address this issue. Instead, state workers and retirees are carrying the load of getting the pension plan in better shape. The latest pension reform only addressed state worker conditions. Check out this list from WPRI.com:
Dear Ms Long,
Thanks so much for providing this information as well as your analysis. The Treasurer’s response to these dismal returns was that she’s “keeping an eye on risk.” Even with a risk averse portfolio, I find it hard to believe that she can’t do better for the state retirees, especially given her expertise in investing.
Please continue to monitor the situation.
Washington’s misguided pension panic
Many state and local pension funds are still struggling from the financial crisis. Between 2007 and 2008, they recorded a loss of 27 percent. Pension assets have bounced back some – they stood at $2.664 trillion at the end of Q3 2011 – but are still approximately 17 percent below their 2007 high. Although many state legislatures and city councils have taken steps to shore up their pension funds, including the elimination of cost-of-living adjustments and requirements for higher contributions from employees and taxpayers as well as later retirement ages, there are still struggles ahead.
There is less money to investment management companies from public pension funds and social security than there is from 401K/IRA plans. Structurally, individuals are much better off in a collaborative plan which can stay fully invested in the market forever, but the management fees are better for individual plans. As to the rest, find me any time or place in history when at least some government officials could not be bought and sold.
As markets become increasingly efficient, as the margins earned by management companies become increasingly compressed, expect the desperation to dismember public plans to increase.
When the golden cake is not passed around anymore, it is very hard to scrape crumbs from it, and a great many people on Wall Street and Washington cannot see themselves eating bread.
New Jersey’s battering ram
Chris Christie rode to national prominence when he publicly excoriated a New Jersey teacher and other citizens over differences in opinion in town hall meetings. In contrast to the plain vanilla politispeak of most public officials, his blunt, confrontational style of governing was seen as a breath of fresh air. Christie either has a naturally combative governing style or believes that choosing a new target will get the national spotlight back on him. Or maybe he just wants to create a legacy as New Jersey’s most powerful battering ram.
Christie’s latest target is New Jersey state judges. Since no federal law other than IRS statutes has jurisdiction over public pensions, state judges are the chief interpreters of what is owed to public-sector retirees. A New Jersey judge recently overturned a pension reform that Christie spearheaded and that the state legislature passed in the spring. This new law would have required state judges to increase their pension payments from 3 percent of their salary to 12 percent over seven years and make a much bigger contribution to towards their health care costs.
Now, New Jersey’s constitution prohibits the governor or the legislature from reducing the salaries of state judges. The framers included this provision to insulate the judiciary from the types of political attacks that Christie is making on them.
It’s important to note that there are sound legal disagreements about the judge’s ruling and the attorney general has filed an appeal to the state supreme court. That said, Christie’s response to the court ruling was confrontational and condescending:
The governor, instead, turned venomous. He attacked [the judge]’s integrity and accused her of “protecting her own pocketbook and those of her colleagues.” He called her the reason “why the public has grown to have such little faith in the objectivity of the judiciary.”
Later, after you’d think he had a chance to calm down, he went at her again: “Judge Feinberg made a decision that is, on its face, self-interested and outrageous,” Christie said. “This is a blatant attempt to exact for themselves special treatment because they have the power to do so.”
The head of the state bar association and many others in the legal profession in New Jersey have berated him for his attacks. From the Star Ledger Statehouse Bureau staff (emphasis mine):
Not only does the hypocrisy on the right never cease to amaze me, but it frightens me because I know what a destructive force it can be. A lot of folks on the right accuse Obama of being a tyrant of sorts. I’ve heard this again most recently with Obama’s issuing of executive orders on things he can’t get Congress to pass. I find it ironic and frustrating because if anything Obama doesn’t fight hard ENOUGH for his proposals.
So along comes Gov. Christie, a governor with true tyrannical tendencies, and the right see in him the future of their party. Oh, the irony. I think…correction, I KNOW that the combination of a major political party that has embraced a my-way-or-the-highway mentality as the Republicans have–as with their handling of the debt ceiling debate; their threat to end Bush’s tax cuts for ALL Americans rather than end them for the wealthy only; the voter suppression laws Republicans are passing around the country; or, simply their lock-stop refusal to support ANYTHING proposed by Obama or the Democrats–led by a governor like Christie, who embodies that same governing style, would be a disaster at a time when we have enough disaster on our plate. Yet, it is this battering-ram characteristic in Christie which may one day propel him to the top of the US political food chain. No wonder Americans are losing hope and feeling like they no longer have a say in their democracy. Tyranny seems to be what half the country wants and the other half feels powerless to do anything about. I feel this confluence of currents coming together and to say it will be bad for this country is a gross understatement.
Mary Williams Walsh, asleep in Rhode Island
In her 2,500 word feature on the pension reform process in Rhode Island, New York Times reporter Mary Williams Walsh seems to have found more color than facts. The piece reads more like a campaign profile of Treasurer Gina Raimondo than an assessment of the gritty fight over public pensions in the nation’s sixth smallest state:
Ms. Raimondo also learned early on about economic forces at work in her state. When she was in sixth grade, the Bulova watch factory, where her father worked, shut its doors. He was forced to retire early, on a sharply reduced pension; he then juggled part-time jobs.
“You can’t let people think that something’s going to be there if it’s not,” Ms. Raimondo said in an interview in her office in the pillared Statehouse, atop a hill in Providence. No one should be blindsided, she said. If pensions are in trouble, it’s better to deliver the news and give people time to make other plans.
Treasurer Raimondo did not initiate Rhode Island’s pension reform fight. We can give her credit for being a politician who is doing her job to rein in a plan that, for structural reasons, will consume a growing portion of state general fund revenues. But this fight began under the administration that preceded Raimondo and Governor Lincoln Chafee. Walsh buries this deep in the article when she says:
Rhode Island has been trying to fix its pension system for years; it has announced four “reform” plans since 2005, each of which has claimed to reduce costs for the state and cities.
Moreover, the numbers reported in the article seem inflated and poorly sourced. The article says that pension costs will grow very rapidly to consume 20 cents of every tax dollar. Moody’s, however, published a report yesterday showing that pension payments would not consume 20 percent of the budget until 2021, and even that assumes that general revenues remain at the 2011 level. This fiscal hysteria is overblown.
Mary Williams Walsh and the NY Times are poor sources for financial information. Walsh seems more motivated to write stories which capture imaginations more than facts. She has misrepresented the municipal bond issues for a couple of years now and helped publicize that hack Meredith Whitney and her special form of mythology.
The Dummies Guide to the Pension Crisis
Hat tip to Ted Nesi of WPRI.com for pointing out this excellent union sponsored video that discusses the problems for the public pensions of Rhode Island. Although the details are specific to that state the structural problems apply to almost every state because public pensions across America are underfunded. Every state faces problems that are politically or financially difficult. Either taxpayers will be paying more to top pension plans or retirees will be receiving smaller pension payments. Pension reform is a complex topic and I hope we see more educational efforts like this video.
Further:
WPRI.com Judge Taft-Carter issues decision in pivotal RI pension case
Desperation costs are steep
Harrisburg, the state capital of Pennsylvania, has narrowly averted filing for Chapter 9 bankruptcy as their independent city Parking Authority has secured a loan to advance future payments to the city for use of city land. Unfortunately the unnamed lender will be charging the Authority 10.75% interest. The costs of desperation are steep. This one-off lease payment from the Parking Authority allows the city to make their September 15th bond payment on their crushing incinerator debt and avoid Chapter 9, but what about the next bond payment in 2012? They don’t seem to have any more assets to borrow against. So they’ve postponed the problem but not solved it. From Bloomberg:
The Parking Authority will borrow to make the payment, and some on the council balked at the interest rate of as much as 10.75 percent on the loan. About a third of the city’s 49,500 residents live below the federal poverty level. The lease covers land under several garages, and the loan costs may reduce the authority’s income, which provides revenue to the city.
Dark times at the post office
One of America’s oldest institutions is facing default. The United States Post Office could be forced to stop delivering mail at the end of September. The rhetoric around the issue is beginning to sound like the potential default of U.S. government debt obligations during the debt ceiling debate. A report from the Government Accountability Office (GAO) tells the fiscal tale:
USPS has experienced a cumulative net loss of nearly $20 billion over the last 5 fiscal years. USPS does not now have—nor does it expect to have—sufficient revenue to cover its costs without legislative changes.
Every nation on earth has a postal service. Some countries have combined mail and phone services, although many have been privatized in recent decades. In Japan the post office is combined with the world’s largest deposit bank and mail carriers serve as bank tellers as they do their delivery rounds. Postal service is indispensable to an economy and society.
The next time you pick up your mail think about the role the postal service has played in shaping America. During colonial times postal riders carried newspapers and political treatises, as well as seeds, bills of tender and personal letters. Benjamin Franklin was appointed the first postmaster general when the Second Continental Congress decided it needed to replace King George’s postal business, which had begun with monthly postal deliveries between Boston and New York in 1672.
In 1788 John Jay wrote to George Washington:
The Direction of the Post Office, instead of being as hitherto, consigned chiefly to a committee, and managed without much System, should I think be regulated by Law, and put under the Superintendence, and in some Degree under the controul of the Executive.
Sorry, but we can’t afford to meet these obligations. It was risky for these employees to unionize and then force the US Postal Service to submit to their demands of unrealistic pay and benefits. They were told upfront that this would eventually be unsustainable. You stated that $150 billion, $150,000,000,000, over ten years would be money well spent. These retirees will not be dying in ten years. Most are just hiting retirement. Have you taken into account that this is happening to ALL State and Federal groups? We cannot fund SSI as it is. We cannot meet retirement promises for police, firemen, teachers, government employees. Why should we care about postal workers? They took a risk in picking their jobs. They took a risk in demanding ever increasing pay and benefits. Now, unfurtunately, they must meet the reality that has ever faced the private sector.
The unsustainability of public pensions
Public pensioners everywhere should be worried today. There is devastating news from Central Falls, Rhode Island as the city’s receiver has cut the monthly pension payments to retirees. From WPRI.com:
Central Falls slashed one in three of its retirees’ pension checks by more than half this month, with the majority of the city’s former public-safety workers set to lose tens of thousands of dollars a year.
Receiver Robert Flanders reduced 48 of the city’s 141 police and fire pensions by 50% or more, with all but three of those cut 55% from their original amount, according to financial records obtained by WPRI.com.
This is not a surprise as Central Falls had filed for bankruptcy on August 1st and the receiver for the city had announced he would be taking this action. He stated at the time that the city’s pension funds were far from funded but has never given a public account of their finances. There are also deeper issues for Central Falls and Rhode Island as they intend to pay bondholders 100 cents on the dollar while reducing pension benefits.
The plague of underfunded public pension plans is spread across America. Retirees and taxpayers everywhere should be worried. There are many reasons for widespread underfunding and they have been covered up by the opaque disclosure and accounting requirements pension funds have.
It’s easy for state and local treasurers to “smooth” results in a way that allows the legislative branch to postpone making the necessary contributions to bring the funds up to healthy levels. There have also been grants of benefits that are much too generous and many instances of rule-bending where employees have puffed up their benefits. Public worker unions have often used their influence to gain very favorable benefits and block changes. Benefits to workers were accrued over decades so it’s likely that it will take years to modify these benefits.
New Jersey passed legislation in June that raised worker pension contributions, lowered cost of living adjustments and adjusted eligibility requirements which would delay the time when qualified workers start receiving benefits. On Wednesday in reponse, twenty New Jersey unions filed suit against the state to block the changes. It’s understandable that unions would fight to retain as much as possible but many pension plans as currently established, especially New Jersey’s, are not sustainable. All sides must be realistic about what can be supported over time.
Thanks for checking in IrateSceptic.
Muniland covers state and local government issues with a nod to the federal government occasionally. I cover municipal bonds and fiscal issues. I’m Cate Long and my background is in the sidebar.
-
Resident Muniland expert
-
