MuniLand

Numerous public pension plans across America are in horrendous shape. The employee plan of the Commonwealth of Puerto Rico, funded at an alleged 7 percent of assets, is functionally broke. Other public plans, like that of Charleston, West Virginia, have 24 percent of the assets needed to meet future promises to retirees.

There is little to no regulatory oversight of public pensions. And what little there is comes in a roundabout way. For example, the sanction that the Securities and Exchange Commission administered to the state of Illinois for not adequately disclosing to bond investors that it was not properly funding its system.

The core of the SEC complaint says:

The state omitted to disclose in preliminary and final official statements material information regarding the structural underfunding of its pension systems and the resulting risks to the state’s financial condition.

So the SEC says to a state, “You were not telling investors, who bought your bonds, all the facts.” And then essentially says, “Don’t do it again.” Of course, the SEC could have fined Illinois, but taxpayers would just foot the bill for this. There must have been dozens of people involved in the preparation of the state’s bond offering documents. Was there a mastermind behind it? Probably not. If there had been, the SEC would have charged that individual as it did in the case of San Diego officials who misrepresented the city’s pension. Those charges were eventually dismissed.

Now all the media is filled will howls of indignation at the SEC for the lame treatment of Illinois. This was capped with Bloomberg’s Jonathan Weil’s piece, “And the SEC Wonders Why Investors Think It’s Spineless.” This is not quite fair. There is some kind of a heist of pension assets taking place in Illinois, but neither the SEC nor any other federal agency has the power do anything about it. Here is why, from the SEC complaint:

Muniland ground rule number one: Never use the state of Rhode Island as example of national issues. The state has been poorly managed and dominated by union interests for decades. Rhode Island is a high school dropout when it comes to fiscal management. The underfunding of its public pensions is exhibit one.

Josh Barro of Bloomberg has broken muniland’s number one rule and used Rhode Island’s public pension system to argue about systems nationwide. He writes:

This lack of attention has meant that local plans are much more likely than statewide plans to have become deeply underfunded. Of the 110 statewide pension systems covered by the Public Funds Survey, the worst-funded is the Illinois State Employees’ Retirement System, with a funding ratio of 35.5 percent. Sixteen of Rhode Island’s 36 local plans are worse funded than Illinois SERS.

Texas Watchdog.org explains how Texas is mounting the transparency pony:

A quartet of the most powerful legislators in Texas filed bills Thursday to make available to the public detailed financial information from most local taxing entities and pension systems across the state.

Senate bills 14 and 13 and their identical House counterparts establish, at the request of state Comptroller Susan Combs, new requirements for the posting of public debt, unfunded liabilities, borrowing and project costs on websites maintained by state and local agencies.

This new legislation, if passed and signed by the governor, has the potential to set the gold standard for public accounting of spending and taxpayer liabilities. The legislation would require the posting of all tax rate information:

There have been hundreds of articles written about how a number of U.S. states have unfunded pension liabilities. These massive shortfalls have been researched by numerous groups, and although they differ on the size of the shortfalls, they all agree that pension liabilities are creating a troublesome drag on many state budgets. The Pew Center on the States is one of the first groups to dig down and analyze the condition of city pension funds and the promises made for retiree health benefits. Their new study, A Widening Gap in Cities, reports a mixed picture.

Cities such as Milwaukee, Wi. and Washington D.C. are prepared to meet their financial commitments to retirees (see above). Others, such as Chicago and Portland, Or. have seriously neglected their pension funds. Almost universally, cities have failed to pre-fund the commitments they have made for retiree health care. In total, cities have pre-funded only 6 percent of their healthcare promises, leaving a shortfall of $118 billion, according to Pew. In contrast, cities have funded 74 percent of pension liabilities, leaving an unpaid balance of $99 billion. In fact, 22 cities face larger unpaid bills for retiree health care than for pensions (page 16).

There are many approaches to increasing the funding for pension and retiree benefits. Pew discusses some of these approaches (page 22):

Although the national media has always been a fan of Rhode Island State Treasurer Gina Raimondo, I’ve personally been lukewarm on her performance. She built a case for draconian changes in pension benefits for current workers by inflating the portion of the state pension plan that was unfunded. This led the State Assembly to adjust pension benefits in a way that seemed to go against the law. Unions sued the state and State Superior Court Associate Justice Sarah Taft-Carter has just ordered the case to undergo federal mediation. But I’ve always thought the bigger issue for Rhode Island was that its pension fund had horrible investment returns; some of the lowest in the country. And Treasurer Raimondo has only taken steps this week to change the fund’s management.

Pension funds derive 60% of their revenues from investment returns on a national basis. The other 40% of revenue comes from employee and government contributions. Rhode Island pension funds have had sub-par investment returns for years. The first thing that I would have done was change the pension fund manager before making legislative changes. One year ago I wrote this:

[…]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.

The crisis that public pensions face over funding shortfalls is becoming increasingly important in the media. Add to that some concerns about the generous benefits that some public retirees receive. As state after state struggles with new controls on benefits and takes steps to address plan shortfalls, the issues become mired in more and more complexity.

There is one issue in the pension storm that is easy to understand; that is the issue of “pension spiking,” or an employee taking sometimes illegal steps to inflate the final salary on which their pension is based. California State Controller John Chiang has gone so far as to call spiking a “form of public theft.”

The Federal Reserve Bank of Cleveland defines pension spiking as:

The practice of inflating employees’ salaries to increase their benefit base. This can be accomplished through a last-day “promotion,” where the employee receives a new title and a salary far above what he earned in the previous 364 days, or where an employee nearing retirement receives the lion’s share of available overtime.

Much as the Simpson-Bowles report aspired to be the foremost guide to reducing the federal deficit, the Volcker-Ravitch report on the state budget crisis that was released yesterday hopes to serve a similar purpose for state government spending. Paul Volcker, the former Fed chairman, and Richard Ravitch, who helped New York City work itself out of bankruptcy, led the State Budget Crisis Task Force, the group that produced this report. The task force also included two former U.S. Treasury Secretaries as members. The bottom line of the report is that there is less money to go around and that states should become better managers of the shrinking economic pie:

The United States Constitution leaves to states the responsibility for most domestic governmental functions: states and their localities largely finance and build public infrastructure, educate our children, maintain public safety, and implement the social safety net. State and local governments spend $2.5 trillion annually and employ over 19 million workers – 15 percent of the national total and 6 times as many workers as the federal government…

…States are grappling with unprecedented fiscal crises. Even before the 2008 financial collapse, many states faced long-term structural problems. Many economists believe that in the aftermath of the crisis, the economy will grow sluggishly for years as it works off the excesses of the credit and real estate bubbles and endures slow employment growth. Tax revenues are recovering slowly and remain well below their pre-crisis trends.

Some residents of Stockton, California are upset over the city’s decision to eliminate free healthcare benefits for public retirees. Michael Fitzgerald, a columnist for the Record, Stockton’s newspaper, wrote last week about the policy change:

The lavish perk that did the most to bankrupt Stockton is free lifetime medical care for some retired city employees and spouses. Now retirees are suing to keep it free.

And a commenter said in response:

You just wrote that retirees are the most responsible for the bankruptcy. The most? Really? Not an arena or a marina that has no fuel for boats or all the money the state raided to continue its programs, or……? About all that is left is retirees. And “unfunded liability.” Who even knew that arcane term before the City Manager started throwing it around, along with his other favorite, the Ponzi Scheme?

LA trader: “if stockton was a surprise, i dont know where you’ve been for the last 3 months.” Still, a LOT of stockton bonds put out to bid

— Taylor Riggs (@TaylorRiggs_BB) June 27, 2012

The City Council of Stockton, California voted this week to adopt a “pendency budget” in preparation for filing for Chapter 9 bankruptcy, which will place the city under the protection of the bankruptcy court and stay all legal actions against it. This maneuver gives the city some breathing room to come to an agreement with its creditors, especially bondholders and retirees, over how to reduce what the city owes them. This comes after months of Stockton being under a state-imposed “mediation period” in which these kinds of negotiations were voluntary.

Reuters’ Jim Christie reports on the background of the story:

Stockton’s city council voted six to one in favor of the 2012-2013 budget after a contentious five-hour meeting where angry retired city workers pressed council members to reject the $155 million spending plan. It proposes eliminating retirees’ medical benefits to help fill a $26 million budget deficit…

The Government Accounting Standards Board voted Monday to toughen pension reporting standards, a slight accounting change that has significant repercussions for muniland. Reuters’ Lisa Lambert reports how data that was formerly buried in the footnotes of financial statements will have to be made more prominent:

State and local governments will have to post their net pension liability – the difference between the projected benefit payments and the assets set aside to cover those payments – up front on financial statements, under the changes.

“The pension liability will appear on the face of the financial statements for the first time. That’s going to create the appearance of a weaker financial position,” said Robert H. Attmore, GASB chairman, who said the board intended to “peel back the veil so things are more transparent and there’s more information for policy makers.”