Potential Deal for State Pension Reform

With states eager for federal bailout money for, among other things, making their severely underfunded public pension plans whole Andrew Biggs and Sheila A. Weinberg put out an article with some useful historical information (excerpted below) proposing “that if a state requests and receives federal aid for pension funding, then the state must agree to bring that public pension under federal regulation that was qualitatively similar to what private pensions work under.”

Three reasons why I don’t see it happening:

1. The IRS and PBGC are already overburdened overseeing the impending demise of multiemployer plans and won’t have the ability or inclination to handle extra work.
2. The holes are too big and vary among states. In New Jersey’s case the number is $200 billion and politicians here would gladly accept funding rules for that money.
3. Funding rules can be undermined. It is not PPA that accounts for the relatively robust funded ratios of private sector plans (as HATFA diluted those rules a few years later) but rather the draconian premiums PBGC charges (sometimes exceeding company contributions) that forced plan sponsors to overfund, freeze, or terminate.

Instead, what the federal government should demand in exchange for any bailout money is to have state and local governments clean house. Based on what I have seen in Union  County at least 20% of my tax money is wasted on political paybacks and change will not originate from insiders who benefit.

Now on to the excerpts:

Worse, state and local government have not turned out to be the model employers one might have supposed at the time of ERISA. Governments have used overoptimistic investment return assumptions, taken excessive investment risk, and often failed to make their full annual contributions. Pension trustees often have not acted as true fiduciaries on behalf of pension participants, collaborating with government officials – often the very people who appointed them – to reduce current contribution costs, even if doing so left fewer resources available to pay future pension benefits.

……….

Moreover, the constitutional arguments against federal regulation of state and local government pensions today seem quaint. The federal government regulates state and local government labor practices in myriad way: federal rules dictate minimum wages, working conditions, the provision of health care insurance and other actions that state and local governments undertake as employers. It is no stretch to believe that federal regulation of state and local government pensions would be constitutional.

……….

What then? If Illinois formally requested federal assistance for its pensions – a request that surely would be followed by New Jersey, Kentucky, Connecticut and other fiscally-stretched states – how should the federal government respond?

The most tempting answer, and one that would hardly be unjustifiable, is “Forget about it.” COVID may have been unforeseen, but state and local government pension funding problems have been brewing for ages, the result of decades of bad stewardship and denial of financial and fiscal realities. Just as a poorly-managed private firm must face bankruptcy, there is nothing inherently wrong with a poorly-managed state or city also doing so. And just as private investors lose money, municipal bond holders in an insolvent state would take a substantial financial hit. And that market discipline might cause municipal bond markets to pay closer attention to public pension funding and general fiscal health, using interest rates as a way to reward well-run governments and punish malefactors. Congress would need to pass legislation to set up a bankruptcy process for states, but that’s possible: in 2016 Congress passed legislation establishing a bankruptcy-like process for Puerto Rico, a U.S. commonwealth of three million residents that defaulted on its debt in that year. More recently, Senate Majority Leader Mitch McConnell has spoken approvingly of establishing bankruptcy procedures for states.

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Put in simple terms, in exchange for near-term financial assistance, states would accept the same deal that federal law requires of private sector employers: Run your pensions right or don’t run them at all. If a state chooses to continue running a defined benefit pension plan, it must do so using more prudent funding rules and more rapid repayment of unfunded liabilities. If the state can’t run a traditional pension on those terms, federal law would give the state the leeway to shift its employees to defined contribution retirement plans. That may be a better option than waiting for states to declare bankruptcy.