Eggheads’ Cracked Reasoning

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?

  1. More debt; what could go wrong?
  2. 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?
  3. 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.
  4. Is the American Social Security (ponzi) system really the paradigm here?
  5. 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.

10 responses to this post.

  1. Posted by Tough Love on November 3, 2012 at 12:57 am

    No bailouts, no shifting. REDUCE the pensions of CURRENT (not just new) Public Sector workers to a level (expressed as a % of pay) no greater than that of the average Private Sector Taxpayer. Per the Us Gov’t BLS, Public Sector workers earn no less in “cash pay”. They therefore no NOT deserve no greater Taxpayer-funded pensions or benefits.


  2. Posted by Anonymous on November 3, 2012 at 1:06 am

    Wait until the state take over Fema the way Romney wants. Even rich people who lose everything in a hurricane wont be bailed out by the Feds when the Insurance companies go under from the burden of Billions of dollar in damage. You know darn well the state wont put any money aside for disasters.


    • Posted by Tough Love on November 3, 2012 at 10:58 am

      As a recent commentator stated, to put it in perspective, the huge concern over even $50 Billion dollars in damages from Superstorm Sandy is just 1/60-th of the current underfunding of Public Sector pension Plans.

      Your pissing on the wrong tree.


  3. Posted by Eric on November 3, 2012 at 10:39 pm

    If Obama wins, the states will be bailed out, pensions and all… in monopoly money of course. If Romney wins, with the additional wars, our money will still be like monopoly money, but I would not build a hotel on Boardwalk.


  4. Posted by Captain on November 4, 2012 at 6:20 am

    We need to quit looking for solutions (?) that punish the responsibe states while rewarding the irresponsible; which is irresponsible. How about we let the feds worry about the federal government debt and let the states do the same. Bailouts do NOT fix the problem.


    • Posted by Tough Love on November 4, 2012 at 1:27 pm

      Yes, and that State/City “fix”, is to REDUCE THE PENSION BENEFIT LEVELS PROMISED to that which can be fully funded with existing tax revenues.


  5. Posted by twins on November 4, 2012 at 6:07 pm

    Imagine half the people are employed by government at any level. That is teachers, nurses, firefighters, policemen, bus drivers and other public transport, mail workers, garbage collection, military, bureaucracies, etc., and in some place, also doctors, paramedics, state TV, airlines, airport workers, etc. Imagine one of them contributes $5K per year to their pension for 30 years and gets $50K per year for 30 years payout. The contributed amount is the fruits of their own labor and rightfully theirs. The additional amounts paid out as pensions are taken from others, by government as intermediary, and are the fruits of another’s labor. This is the definition of slavery in modern form


    • Posted by Tough Love on November 4, 2012 at 7:02 pm

      Typically 10-20% of the total cost of Public Sector pensions are paid for by contributions from the employees (INCLUDING the investment earnings thereon). The 80-90% balance is the responsibility of the Taxpayers.

      Of course Taxpayers have not been putting in enough contributions such that together with investment earnings on those contributions plus the workers’ contributions and investment income thereon, the Plans could be fully funded (over the working careers of the workers)….. but That’s BECAUSE the 80-90-% balance allocated to THEM is too high, BECAUSE the promised pensions are too generous … far greater than those of Private Sector taxpayer.

      Taxpayers should refuse to fund any Public Sector pensions that are (as a % of pay) greater than their own.


  6. Posted by Willy on November 5, 2012 at 10:23 am

    I’ll read the piece in detail later. If stiglitz is proposing a shift toward a defined contribution plan, that is a key part of a solution going forward. This will gradually shrink the long term burden. The traditional plans could sunset sooner and caps put in place as parts of trade offs.


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