MuniLand

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:

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.

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.

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.

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:

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.

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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.

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.

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.

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.