All the good Joshua Rauh and Robert Novy-Marx have done in spotlighting the real unfunded liabilities public pension systems are accruing (albeit through a fallacious riskless rate theory) could be undone as the two professors, in a recent book of essays edited by Aaron S. Edlin and Joseph E. Stiglitz, offer their solution – more debt and a Defined Contribution Plan for future employees – that would be even more disastrous if taken seriously.
Their essay is titled ‘Pension Security Bonds: A New Plan to Address the State Pension Crisis’ wherein they propose allowing states to use a variant of Pension Obligation Bonds (nontaxable this time) to pay off past liabilities in exchange for being required to pay in their annual ARC and to put new employees into a Defined Contribution plan as well as the Social Security system. They admit:
Our plan shifts $75 billion of pension costs for existing workers onto the federal government, but it would prevent a much larger future bailout…….Indeed, the federal government would almost certainly come to the rescue rather than watching a state fail.
So what’s the problem?
- More debt; what could go wrong?
- There is no more ARC for funding. What’s to keep a state from hiring an actuary who, for the right price, sees 20% investment earnings and a plague component in the mortality table as reasonable?
- Defined Contribution plans are likely to cost more assuming the new employees would be younger. It’s those current older participants accruing 40% of their salaries while funding sources come up with about 10% who are the problem.
- Is the American Social Security (ponzi) system really the paradigm here?
- A federal bailout inevitable? Tell that to retirees in Prichard, Alabama and Central Falls, RI. The template to deal with failed public pensions has been set.
Outside of that Rauh and Nowy-Marx got it right. There needs to be a plan to address the state pension crisis……..though not theirs.