Rauh Testimony (3) Roadmap for Public Plans?

Joshua Rauh’s written testimony to the Joint Select Committee on the Solvency of Multiemployer Pension Plans (Bailout Committee) included this warning:

How Congress decides to address the multiemployer pension crisis may well set a precedent for how future legislators will deal with the possibility that they will face similar calls for bailouts of state and local pension systems. On their own accounts, using discount rates of around 7.1% under GASB 67, state and local pension systems were $1.7 trillion underfunded in the 2016 year. On the Treasury yield curve standard they were $4.0 trillion underfunded. The stronger their belief that the federal government will bail them out, the less discipline they will choose to impose upon themselves to address these problems.

I don’t see it.


Rauh goes into detail on where the $4 trillion number came from (full text below*) but as for his conclusion….

  1. Can there be less discipline in the public plan funding world? Though the line about choosing to impose that discipline “upon themselves” makes the valid point that there is no effective oversight.
  2. Public plans have never had a government backstop unlike multiemployer plans with the PBGC.
  3. Nebraskans are not bailing out New Jerseyans even if they had the money (or the slightest inclination) to do so.

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* V. Public Plans

How Congress decides to address the multiemployer pension crisis may well set a precedent for how legislators will deal with the possibility that they will face similar calls for bailouts of state and local pension systems. In this section I present an update of analysis in my paper “Hidden Debt, Hidden Deficits: 2017 Edition” (Rauh (2017)), which calculates stated and solvency-based measures of unfunded pension liabilities for state and local governments for plan year 2015. The methodology is based on Novy-Marx and Rauh (2011). The update in this section presents statistics using the same methodology for plan year 2016.

The study is conducted in a sample of 269 state pension plans and 387 local pension plans, for a total of 656 plans. The state plans consist of all primary plans sponsored by U.S. states. The local plans consisted of all municipal plans in the top 170 cities by population according to the U.S. Census, and the top 100 counties by population. I estimate that this covers over 95% of the public plan universe by assets.

I calculate that as of 2016, unfunded liabilities had reached $1.74 trillion under recently-implemented governmental accounting standards (GASB 67). However, they amount to $4.01 trillion under solvency valuation techniques that use the Treasury yield curve as of December 2016 to value the liability. This represents an increase of $160 billion over 2015.

The GASB 67 standards first implemented for plan year 2014 still preserved the basic flaw in governmental pension accounting: the fallacy that liabilities can be measured by choosing an expected return on plan assets. As with the multiemployer actuarial liability, this procedure uses as inputs the forecasts of investment returns on fundamentally risky assets and ignores the risk necessary to target hoped-for returns. The GASB 67 accounting standards tempered the effects of this assumption slightly by requiring some systems (58 plans or 8% of the sample) to use somewhat lower rates in their liability measurement for GASB 67 purposes.

The liability-weighted average discount rate that plans in this study chose as of 2016 for the purposes of their GASB 67 disclosures was 7.1%, in contrast to a weighted-average expected return of 7.5%. Funding decisions are still generally made with respect to the expected-return benchmark, not the GASB 67 rate. The solvency standard I calculate using the Treasury yield curve selects the point on the Treasury yield curve closest to the duration of the liabilities, which is implied by the GASB 67 disclosure on rate sensitivity. The average rate used for the solvency yield based on the December 2016 yield curve is 2.7%.

Table 2 summarizes further results. Panels A and B show assets, liabilities, and discount rates. Panel C shows cash flows into and out of state and local plans. Total state and local employer contributions were $114.2 billion in 2016, plus supplemental state government contributions of $14.2 billion, for a total of $128.4 billion in governmental contributions. These plus the $46.9 billion in member contributions total $175.9 billion in total contributions against $278.6 billion in payouts. For plan funding to remain stable, the difference must be made up for with investment returns.

The first line of Panel D shows that under the expected return actuarial standard, state and local governments in total fell $8.4 billion short of meeting the “treading water” standard of normal cost plus interest on the unfunded liability. Under the solvency standard, $130.7 billion of additional contributions would be required to tread water and prevent negative amortization. As with the measures of unfunded liabilities for multiemployer systems, the total unfunded liabilities of public systems have not improved substantially in the past five years. In response to my estimate in 2012 that public pension liabilities were approaching $4 trillion, Robert Merton, an economics professor at MIT and Nobel Laureate was quoted in the Financial Times: “ ‘This $4tn figure is a lower bound,’ argues Robert Merton, economics professor at MIT.”

This is relevant for the multiemployer private plan discussion for several reasons. First, many of the issues are parallel. Second, the stronger the belief by state and local governments that the federal government will bail them out, the less discipline they will choose to impose upon themselves to address the funding problems on their own.

15 responses to this post.

  1. Posted by Analyst on August 3, 2018 at 9:47 am

    It is unfortunate that so many smart people are able to promote illogical ideas and get so much traction . Thanks for a thorough assessment .

    lawyers would call it a non sequitur..one doesn’t have to follow the other . Rauh was the least informed speaker on the committee , he didn’t understand the elements of the Butch Lewis act which was the impetus for the committee and so was able to provide his perspective which is mostly concerning public funds . While he has some insightful thoughts, he did himself and the industry a disservice with his version of ” fake news”.

    Reply

    • Posted by Tough Love on August 3, 2018 at 11:52 am

      What MORE “unfortunate” is that Elected Officials who seek-out and gladly accept Public Sector Union BRIBES (disguised as campaign contributions) in exchange for their favorable votes on Public Sector pay, pensions, and benefits are not prosecuted along with the Public Sector Union Officials making those bribes.

      Reply

    • Posted by Tough Love on August 3, 2018 at 12:25 pm

      I seriously doubt that Mr. Rauh …………….”didn’t understand the elements of the Butch Lewis act which was the impetus for the committee”……….. and I believe he is MUCH more informed about all matters pertaining to pensions.

      Unlike the others …….. POLITICIANS (who care ONLY about being re-elected) or STAKEHOLDERS (impacted workers, retirees, Unions, Employers who will benefit from a bailout) who find using OTHER people’s money in ways that get them additional votes or money is fine and dandy ……. Mr. Ruah believes (as do I) that this is wrong-headed.

      Taxpayers had ZERO to do with the pension arrangement between the Unions and the participating employers, and should contribute ZERO toward a bailout (or a bailout mislabeled as a “loan”).

      Reply

  2. Posted by skip3house on August 3, 2018 at 10:44 am

    Sure using lots of explaining to say ‘rules of arithmetic were not followed’. Why do we complicate stuff beyond understanding of average person relying on it?

    Reply

  3. Posted by MJ on August 6, 2018 at 6:13 am

    Seriously, is there really any money at all to bail out these plans….short of firing up the printing press? Seems like simple math to me and as unfortunate as the situation presents, why is everyone else responsible for everyone else’s reitirement?

    Reply

    • Posted by Tough Love on August 6, 2018 at 7:39 am

      They’re not, it’s just that our self-interested Politicians see an opportunity to garner re-election support by supporting the use of national tax dollars (via a BAILOUT) from ALL of America’s residents to fund a clearly unjustifiable* local problem.

      * unjustifiable in the sense that Taxpayers had absolutely ZERO to do with the pension agreements between the Unions and the workers. It would be MUCH more appropriate to FORCE the MEP Plan companies to materially up their contributions to support these Plans ….. even if all future profits go solely into the MEP Plans.

      Reply

    • Seriously, is there really any money at all to bail out these plans….short of firing up the printing press?
      Rhetorical Question, yes? Of course NOT!@ There is no money $$$ for a bail out. There was no $$$ for the TARP bail out. And sooner or later NO ONE is going to be buying Treasuries. And when the chumps STOP buying Treasuries the rubber is going to meet the road and we are going to be in BIG BIG trouble…We have been running red ink budget deficits since Ronnie Raygun took office in 1980. 38 years of red ink. Clinton claimed to have a balanced budget for ONE single year, except he left off Social Security. Hardly! We went from the LARGEST CREDITOR nation in the world, prior to 1980, to the largest DEBTOR nation in the world, thanks to Ronnie. Ronnie set the mold and every single President since has followed it. NOT ONE has attempted to actually run a balanced budget. IT CAN BE DONE! Trump is one person I expected to at least try. Boy was I wrong with Trump. Massive tax cuts and huge military build up, aka Ronnie Raygun 2.0. Thank you Artie Laffer for your “supply-side” economic bullshit. The sad part is Laffer is right to a certain degree, low taxes, along with LOW government spending providing essential services, are the best way to promote economic growth ( the funny part is as a Grad student I worked for a business that did business with Laffer and I used to go to his La Jolla office every single day). But you cannot have low taxes, high government service costs and run huge budget deficits with no way to pay for it. It is simple math. I give Trump BIG CREDIT for at least trying to narrow the trade deficit, especially with China. Ronnie had the TWIN deficits that killed America, HUGE budget and trade deficits. If Trump can get better trade deals/agreements, America will improve exponentially. And the fact is every president prior to Trump gave away the farm on these trade deals. All of them. NAFTA is a perfect example, and Henry Ross Perot nailed it when he said that if NAFTA passed you would hear a GIANT sucking sound; the sound of American jobs getting sucked away across the borders. And he was 100% on the money.

      Reply

      • Posted by PS Drone on August 6, 2018 at 1:03 pm

        You are correct; our economy, particularly with regards to employment, is wholly dependent on borrowed $. If we attempted to “live within our means”, that is spend only what is raised through taxation, our unemployment rate would be 20% or more. Think about the employment funded by Medicare/Medicaid, the military, government and education. And worse, most of this employment is overhead, not productive (value adding). Financially, we are doomed to eventual chaos because there is nothing we can do to remedy this dire situation.

        Reply

        • Posted by skip3house on August 6, 2018 at 1:10 pm

          Any way to resurrect Ike’s logic for a balanced budget, with high taxes in upper bracket incomes? https://www.forbes.com/sites/davidmarotta/2013/02/28/dwight-d-eisenhower-on-tax-cuts-and-a-balanced-budget/#3943e2005047

          Reply

          • Posted by Stephen Douglas on August 6, 2018 at 2:36 pm

            “Let’s be clear. Eisenhower deplored high taxes.”

            David John Marotta

            “But I merely want to point out that unless we go at it in the proper sequence, I do not believe that taxes will be lowered.”

            Eisenhower

            Looks like he wanted lower taxes, and a balanced budget, but the spending reductions should come before lowering taxes; the proper sequence.

            Not the Art Laffer way.

          • Posted by skip3house on August 6, 2018 at 3:15 pm

            We understand. For equal tax cuts for all, just eliminate the low income brackets. For upper half to match the lower half of us, lower the mean brackets, maybe into average incomes too. For only just upper incomes (that 5 or 10% of us), lower only high bracket rates.
            When will we catch on to those ‘income tax cuts’ since ~1980, that equal % is not the same as equal dollars.
            Your ‘..Looks like he wanted lower taxes, and a balanced budget, but the spending reductions should come before lowering taxes; the proper sequence.

            Not the Art Laffer way…’ should have been followed.

          • Posted by PS Drone on August 6, 2018 at 4:59 pm

            I do not know why the top bracket (joint – 2018) stops at $600k. I would increase it 1% for every $500k additional until we hit 50%. Someone making $6MM can pay a lot more tax than someone making $600K.

  4. Posted by Harry Chernoff on August 6, 2018 at 10:37 am

    John:

    If you don’t see it, look more broadly at the possibilities.

    If New Jersey pleads for a Congressional bailout all by itself, then you are probably correct. There is no way States like Nebraska are going to support it.

    If New Jersey is part of a cascade of pension-insolvent states you are probably wrong.
    Substitute CT, KY, IL, and so on for Lehman, Bear, AIG, etc. and you can see where this goes. If there are enough failed or failing States, the risk of a systemic crisis may outweigh the moral hazard.

    It’s the same with multiemployer pensions, national flood insurance, and student loans.

    Reply

  5. Posted by Bill Hamm on August 6, 2018 at 2:42 pm

    Where do I find the Table 2 with the panels you mention above?

    Reply

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