Public Pensions and City Solvency

From the amazon.com description:

Richard Ravitch, former lieutenant governor of New York, writes the Foreword and Robert P. Inman and Susan M. Wachter provide the Conclusion. The book’s three chapters examine the issue from different key perspectives: Joshua D. Rauh, a leading scholar in the study of unfunded pension liabilities, provides an economist’s perspective; Amy B. Monahan, a renowned authority in public employee benefits law, illuminates the legal framework; and D. Roderick Kiewiet and Mathew D. McCubbins, visionary political scientists, put the crisis and its economic and legal implications into context and lay out the necessary framework for reform.

Some useful excerpts:

1) Why City Pension Problems Have Not Improved – Joshua D. Rauh

Furthermore, an often-cited cost of closing DB plans to new employees is the claim that the plan’s existing unfunded liability will have to be paid down more quickly. As detailed in Costrell (2012), GASB accounting standards require a change in the ARC calculation method if the plan is closed to new members, and that change generally results in an accelerated amortization schedule. The acceleration occurs because the ARC for the unfunded liability in a closed plan must, under GASB rules, be measured assuming a “level dollar” method as opposed to a “level percent of pay” method.   The ARC does not determine mandatory funding policy, which is set by state statutory authorities. Pension systems that determine their own funding policy could therefore close plans to new workers and choose to pay down the unfunded liability under the same schedule as they otherwise would have. However, cities may face real constraints in switching to DC plans if legislatures or state authorities mandate that all systems in the state must make the ARC. Then the GASB accounting requirements could in fact require cities to accelerate the paying down of unfunded liabilities when they close plans to new workers, as the ARC under GASB rules would increase. (pages 31-2)

The Pension Benefit Guaranty Corporation (2014), in its projection report for the 2013 fiscal year, highlights a net deficit of $27.4 billion in the single-employer plan and a projection of the deficit of $7.6 billion as of 2023. However, these calculation do not use market valuation. Van Binsbergen, Novy-Marx, and Rauh (2014) estimate, using MVL approaches, that the PBGC’s insurance of unfunded corporate liabilities has grown to a net debt with a value of $358 billion. (page 39)

In sum, the pressure to deal with the pension crisis has to date simply not been strong enough from interested parties. The groups most likely to exert that pressure are citizens who feel their services squeezed, taxpayers who rebel against tax increases without improvements in services, bondholders who are concerned that their debts will be impaired to pay pensions, and pension recipients who become concerned that they will not receive their full benefits. Until now, each of these groups either has not had the collective will to act or has assumed that the other groups will bear the brunt of the cuts. Until discipline comes strongly from these groups, politicians will likely fight battles around the first-step reforms rather than badly needed structural changes. (page 40)

2) The Law and Politics of Municipal Pensions – Amy B. Monahan

The answer, I argue, is that political economic forces strongly favor systemic underfunding, and the law that applies to public pension plans has done nothing to stem such political inclinations – in some cases arguably exacerbating them. (page 42)

Often, when politicians face incentives to spend money in suboptimal ways, there are other political or market forces to push back against the inclination. This tends not to be true in the pension funding context, since employees (the obvious counterpressure to the political inclination to underfund) are often better off if pension costs are kept artificially low. If employees were to pressure politicians to fully fund annual pension costs, there would be less money left for other forms of employee compensation such as salary and health benefits. Alternatively, if employees pressure politicians to fully fund pension plans, it might create pressure to make pension benefits less generous. (page 43)

Essentially what courts hold is that a plaintiff who complains about a government failing to make an annual pension contribution does not have a “ripe” claim, because we will not know whether the failure to fund the pension in a given year actually harms a plaintiff until that plaintiff’s benefits come due. (page 44)

There is little to no evidence that annual funding requirements can be effectively enforced through the court. These funding requirements typically cannot be enforced by courts because  (1) they are sufficiently vague that courts have nothing concrete to enforce and (2) courts often lack the ability to direct state funds, either because of constitutional limitations on the ability to allocate funds from the state treasury, or because potentially allocated funds simply do not exist.  A recent New Jersey Supreme Court case struck down a statutory funding requirement on different grounds, finding that the funding requirement was an unconstitutional form of debt under the state constitution because it placed a binding financial obligation on future legislatures (Burgos v. State, 2015 WL 3551326[N.J.2015]). (pages 48-9)

Because of the serious separation-of-powers issues that could arise if a court were to find a legislature unable to change laws based on the finding that a law is contractual, the Supreme Court has required that the intent of a legislature to bind itself in the future, through the creation of a contract, must be abundantly clear (National Railroad Passenger Corp. v. Atchison, Topeka, and Santa Fe Railway Co., 470 U.S. 451, 465-66 [1985]). (pages 51-2)

Municipal bankruptcy varies from corporate or individual bankruptcy in many ways, but a key distinguishing factor is that a court cannot force a bankruptcy plan on a municipality; the municipality itself must propose a plan. If there are creditors who object to the plan, it can nevertheless be approved by the court if at least one class of creditors accepts it and the court determines that it is fair, equitable, and in the best interest of the creditors.  (page 53)

Despite the fact that bankruptcy courts have appeared to give their blessing to pension adjustments, pension benefits have been only modestly adjusted (if at all) in recent municipal bankruptcies, namely those of Vallejo, Stockton, and Detroit. These bankruptcies began with significant talk of modifying pension benefits but, when the bankruptcy plan was negotiated, pension debt was, at most, modestly reduced, while other creditors took very significant haircuts. (page 54)

3) Erosion of the Foundations of Municipal Finance – D. Roderick Kiewiet and Mathew D. McCubbins

As such, there are numerous former government employees no longer contributing to the local economy that are still collecting money from the government itself, causing a net outflow of funds without even the minimal tax returns that might be seen if they still lived within the city’s limits. As a result, we have seen cities in these fiscally precarious positions seek to levy pension taxes on employees who live outside of their governmental jurisdiction. (page 68)

Caught up in the hubris that marked the period prior to the collapse of the dot-com bubble, state and local governments responded to the spectacular returns by increasing pension benefits without increasing contributions. In California, for example, the 1999 bill SB400 expanded pension benefits by an estimated 50 percent and applied the increases retroactively to all retired state employees. These increases were projected to require no additional contributions from the government or from employees despite the marked increase. (pages 72-3)

Some state and local governments have sought to cover unfunded pension obligations by issuing long-term bonds; about $64 billion of pension obligation bonds are currently outstanding. (page 75)

Local governments can provide more and better service at lower prices by bidding out garbage removal, ambulance services, and other tasks to private firms. Privatization, however, is anathema to public sector unions, and collective bargaining agreements typically include strong guarantees that any privatization of municipal services will be extremely limited. One should thus not expect too much from local government efforts to eliminate inefficiency (also known as waste, fraud, and abuse), assuming that they are motivated to do so. (pages 83-4)

Conclusion: A Call for Transparency – Robert P. Inman and Susan M. Wachter

All solutions required the costs to be paid by someone, and in none of the examples he [Rauh] cites, in fact, is the problem resolved. The costs are simply too high for policymakers to risk imposing them on the population, absent economic or political pressure to do so.  Such pressure will only exist when the underfunding is transparent enough for voters, pension recipients, bondholders, and new residents to see it in enough time to take action before a crisis is at hand. (page 87)

The most important aspect of providing information is that it comes from a credible source so that the recipients of the information believe it to be true…..Who will serve as that source?…..to date, there is no single source for this vital information for cities. (page 91)

19 responses to this post.

  1. Posted by S Moderation Douglas on April 22, 2016 at 12:47 am

    These excerpts look interesting, but there seem to be a lot of similar books on the market, and it’s difficult to decide which one, if any, is worth parting with your $24.95, plus tax and shipping. Even more disappointing if you find out it’s another biased screed.

    If I may recommend another source, free:

    Pension Reform Handbook:
    A Starter Guide for Reformers
    by Lance Christensen and Adrian Moore

    125 pages free download in my opinion, important reading no matter which side of the question you agree with.

    And Joshua Rauh:

    Hidden Debt, Hidden Deficits: How Pension Promises Are Consuming State and Local Budgets, b

    Available as a free PDF download, probably has as much (or more) information than the book.

    Please note, “someone who shall remain nameless” that by recommending these sources, I do not necessarily “support” them.

    Reply

  2. Posted by S Moderation Truth on April 22, 2016 at 1:18 am

    “Conclusion: A Call for Transparency…..”

    I don’t think there’s any doubt Defined Contribution pensions would be drastically more transparent that any Defined Benefit. That doesn’t automatically make them preferable, though. There are other considerations.
    It’s important to note too, that even if all present employees went to DC pensions for future service, the existing debt is still there, still growing, and still has to be paid.

    Reply

  3. Let’s refer to Defined Contribution plans by its accurate name: Investment Plans.

    Reply

  4. Posted by Javagold on April 22, 2016 at 10:24 am

    That’s a lot of words for Insolvency. Bankruptcy. Collapse.

    Reply

  5. In general the crimes — underfunding and retroactive benefit increases — were committed in the past, by Generation Greed.

    Facing up to the consequences in the short run means the link between what they had taken, and what those coming after had lost, would be clear, and Generation Greed would share in the consequences.

    Hiding and lying means that maybe Generation Greed can get to Florida and the grave without having to either share in the consequences or even face the reality of what it has done. And that the lower past taxes and unjustly increased benefits might be forgotten, and the sacrifices could be handed out “due to circumstances beyond our control.”

    Reply

  6. Posted by PS Drone on April 22, 2016 at 7:14 pm

    I guess California was looking to head off major employee turnover by pumping up the drone pensions by 50%. We all know how valuable (and almost irreplaceable) the average public sector drone is so the possible loss of so many incredibly productive public servants had to be deterred by (in hindsight) the very much deserved retroactive pension increase. None dare call it “Grand Larceny”.

    Reply

  7. Posted by S Moderation Douglas on April 22, 2016 at 9:56 pm

    California didn’t increase pensions by 50%, despite how many times that has been repeated. Except for safety workers who actually retired at age 50, which is very few. 2%@50 is a progressive formula that goes to 2.7%@55 (2.7%@57 under the new formula). A safety worker who retires at 57 gets exactly the same pension under either formula.

    Most miscellaneous workers who retired at 63 or older got about a 3% increase. According to Calpensions, “Retirees received pension increases of 1 to 6 percent, depending on the amount of time they had been retired.”

    Reply

    • Posted by George on April 22, 2016 at 11:55 pm

      “Most miscellaneous workers” How many miscellaneous workers are there, and what are their healthcare arrangements? I suspect there are a huge number of such workers, so for every $100k or more retiree there are 10 $10k retirees, and they all get pretty much the same medical benefits, so the smaller salary beneficiaries actually cost more when you add a health care policy.

      Reply

      • Posted by Smooth Moderation Difficult on April 23, 2016 at 1:56 am

        Scads. As I recall there are about 500,000 retirees and beneficiaries drawing a pension right now. And most of them have retiree healthcare. With some exceptions, the janitor gets the same healthcare as the doctor.

        Reply

  8. Posted by George on April 22, 2016 at 11:39 pm

    There will be a lot more old people in the world in the future. Is that reflected in the actuarial tables? I wonder if private annuities will all fail.

    Will YOU live to be 100? Figures reveal massive rise in centenarians – and predicts there will by 3.7 million by 2050

    Read more: http://www.dailymail.co.uk/sciencetech/article-3554122/Will-live-100-Figures-reveal-massive-rise-centenarians-predicts-3-7-million-2050.html#ixzz46c5eWFeS

    Reply

    • Posted by PS Drone on April 23, 2016 at 1:37 am

      90, 95 or 105 if almost does not matter. If you think you are going to be able to rely on SS (and Medicare) or worse, these outrageous public sector pension plans, to provide for your years after age 100, you better have a Plan B because they are all going belly up.

      Reply

    • Posted by Smooth Moderation Difficult on April 23, 2016 at 2:03 am

      That’s still less than half a percent.

      “Most of us won’t live to be 100, as the average age in the world is 71”

      Reply

  9. Posted by Anonymous on April 23, 2016 at 11:42 am

    Will private retirement accounts be nationalized to meet shortfall in public sector pensions?

    Martin Armstrong Economics Blog

    QUESTION: Martin,

    I’m still fairly young, so I don’t have a lot saved in my retirement accounts yet, but I’ve been maxing out my IRA for the last few years to get the tax deduction. I worry because I’ve heard you and others talk about congress wanting to steal our 401k and IRA accounts to “save” social security and/or state pension funds. Do you think that is likely to happen, and will we have time to liquidate our retirement accounts before they steal them?

    What should we watch out for that would indicate congress is getting ready to move on our accounts?

    I am not a lawyer, but I imagine this would take an act of congress to accomplish. Do you think something like this would be a swift action where they just seize them outright, or a gradual change through a combination of penalties and incentives that get people to move their money from private retirement accounts to a government one? If you were going to nationalize everyone’s retirement accounts, how would you do it?

    Thanks for all you do,
    Dave

    ANSWER: I am very cautious about what I say. I never speak in speculation or hype. The markets have taught me that humility is the best course of action. So I will state bluntly when I know something to be a FACT. I try to be responsible and this is why I never comment on anyone else’s forecasts or even care to know what they say. I will respond to emails but will omit names. I am not here to be some politician who says the other guy is a piece of shit. I am not endorsing what anyone else has said about 401Ks.

    So on this subject, it is a VERY SERIOUS ISSUE. I have reported on “lobbying” efforts that have been taking place behind the curtain from my direct sources. There are states looking for Congress to create some sort of mandatory contribution that would take from people’s private savings to bail out state workers. Nothing has been decided as of yet. However, I would expect this to become more forceful next year when Social Security goes bust.

    We will be doing a special written report on this topic with suggestions that will not be provided on the blog. We are investigating alternatives right now. Far too many people read this blog and we do not require registration to enter the site. So this is economic freedom for all, but the price of that is opponents reading the blog as well. So it is best to make such recommendations off the blog so the whole world does not catch wind of this possible solution, which should be for clients only.

    https://www.armstrongeconomics.com/future-forecasts/401k-coming-crisis-robbing-your-future-for-govt-employees/

    Reply

  10. Posted by S Moderation Douglas on April 23, 2016 at 2:33 pm

    And this is how rumors begin. No, they are not going to take your 401(k) or IRA. It would take more than an act of Congress. This rumor probably began because most of the tax advantage of retirement accounts goes to the top earning quintile. Those who earn $30,000 a year or less are unlikely to even try to save, and if they do, there is little if any tax advantage for them.

    So there is talk about leveling the field, but by changing tax incentives, not by taking or “nationalizing” accounts. And it has nothing whatsoever to do with public sector pensions.

    Reply

  11. Posted by eric blair on April 23, 2016 at 5:33 pm

    A Comprehensive Plan to Confront

    the Retirement Savings Crisis

    By Teresa Ghilarducci and Hamilton “Tony” James

    Under the Retirement Savings Plan (the “RSP” or “Plan”), all those who don’t have access to a workplace pension plan would be enrolled into a Guaranteed Retirement Account (“GRA”)—and those with 401(k)-type and all other plans would roll their savings over to a more suitable GRA.

    This includes part-time and self-employed workers.

    Page 14

    Can a spouse inherit a deceased partner’s GRA?

    Pre-annuitization GRA accounts would be inheritable by the spouse.

    After annuitization, which occurs on the household level, the annuity would already reflect longevity assumptions and would not be inheritable.

    Page 21

    Who would be responsible for investing the funds? Is this plan way to get more money for Wall Street to manage?

    This plan will increase competition among retirement investment managers, which will be good for retirement savings. The individual saver will choose their own manager, and there will be many to choose from— including traditional money management firms, mutual fund companies, state agencies that now manage public pension plans, a self-funded, national entity that could potentially be set up by the Federal Government, and maybe even Berkshire Hathaway—all competing for your business.

    This new class of “pension managers” would work like endowment and pension plan administrators. They would focus on asset allocation, risk management, and the selection of individual investment managers and sub-advisors to handle the actual buying and selling of particular investments. These managers would have a fiduciary obligation to the GRA holders and would need to be federally licensed and regulated.

    Individual GRA holders would select their pension manager based on fees and investment performance. They would be able to choose their preferred manager or change from one to another at the beginning of each year. Accounts would be fully portable and the assets would transfer based on the account balance. A national exchange of managers would be the best way to facilitate this process.

    A cottage industry could even arise to advise GRA holders and rate different managers (similar to Morningstar and mutual funds).

    Page 22

    Does the combination of mandating GRAs and ending tax breaks for 401(k)s and IRAs take retirement savings decisions out of the hands of individuals?

    No. Each individual will control their own account. For too long, the American people have been left on their own when it comes to preparing for retirement. That’s why almost no one is prepared for retirement today. The word “mandate” may be politically charged these days, but research and experience make it clear that it’s the only thing that will work.

    Page 23

    http://www.economicpolicyresearch.org/images/Retirement_Project/Retirement_Security_Guaranteed_digital.pdf

    Reply

  12. Posted by Anonymous on April 24, 2016 at 2:09 pm

    “Some state and local governments have sought to cover unfunded pension obligations by issuing long-term bonds; about $64 billion of pension obligation bonds are currently outstanding. (page 75)” yes, and i predict we will have QE where the FED will start buying pension debt. Bailout, bailout, bailout. the public sector will have the last laugh. who said life is fair. go to work for the government if you don’t like it.

    Reply

  13. Posted by eric blair on April 24, 2016 at 2:52 pm

    And when everyone works for the government we will all be bailed out by the Fed for certain.

    Reply

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