Accounting for Public Pensions?

Leo Kolivakis's picture

Via Pension Pulse.

Floyd Norris of the NYT reports, Accounting for Public Pensions:

A
generation ago, when Ronald Reagan was president, the accounting rule
makers forced American companies to come clean on the cost of the
pension plans they were promising to employees. That decision, perhaps
more than any other, heralded the eventual demise of defined-benefit
pensions for employees of American companies.

 

Now something
very similar may be in store for public sector employees, thanks in
part to the Republican victories in last month’s Congressional
elections.

 

Forcing companies to account in a reasonable
manner for their pensions was a contentious issue at one time.
Companies feared it would slash reported profits, and they preferred a
system where the only expense they had to count was the money the
company actually put into the pension plan. Roger Smith, then the
chairman of General Motors, came to a hearing of the Financial Accounting Standards Board to denounce the idea. G.M. argued that such accounting would violate its agreement with the United Automobile Workers union, an argument that seemed to perplex the accountants.

 

The rule adopted was far from perfect, but it forced companies to
estimate the cost of pension benefits being accrued each year. Companies
were allowed to “smooth” the numbers by phasing in market changes in
the values of pension fund assets, so there was reason to complain that
the figures could be misleading. But the principle was established.

 

Today, not nearly as many companies offer defined-benefit
plans to new employees. It is far more common to see a company that has
stopped allowing workers to accumulate new benefits, even though
companies are still liable for benefits earned before plans were
changed or closed. The accountants forced companies to confront the
risks they were taking — in effect guaranteeing that pension fund
investments would grow — and the companies decided the risks were too
great.

 

As a result, a
part of the safety net that previous generations took for granted
became far less secure. Workers now tend to have defined-contribution
plans, like
401(k)’s,
to which they and their employers contribute. The worker chooses the
investments, and bears the consequences when they go up or down in
value.

 

That fact
almost certainly contributed to the severity of the 2007-9 recession
and the slowness of the recovery that has followed. Far more Americans
than ever before had a direct stake in the stock market, and the sharp
fall in stocks meant that their retirement plans had to change. The
number of people over 60 with jobs is up 10 percent over the last three
years while the number of jobs held by people under 60 has fallen by 7
percent.

 

The stock market has regained most of
the lost ground since then, but many 401(k) plans have not benefited.
Many people reduced their stock market investments at precisely the
wrong time. Mutual funds that
invest primarily in American stocks have suffered net withdrawals of
$90 billion since the stock market hit bottom.

 

As
companies moved away from defined-benefit plans, most cities and states
did not follow. One reason for that may have been that the Government
Accounting Standards Board — the public sector equivalent of FASB — has
done much less to force good disclosures, or comparable ones.

 

Having limited information available can obscure problems, but when
concerns arise, a lack of good data can have the opposite effect; people
assume the worst.

 

Estimates of unfunded pension liabilities can be breathtaking. Two economists, Robert Novy-Marx of the University of Rochester
and Joshua Rauh of Northwestern, put the figures at $3 trillion for
state governments and almost $600 billion for municipalities. Those
figures are far greater than official government figures, and are highly
dependent on interest rate levels, which can and do fluctuate. They
may be too high, but there is no way to be sure of that.

 

Some people say the 1974 passage of the Employee Retirement Income
Security Act, known as Erisa, led to the demise of private pension plans
because companies for the first time really had to honor pension
promises. But the trend did not pick up steam until the accountants
forced disclosure of real numbers. Most state constitutions have long
barred cutting public pension benefits that have been earned, but that
fact alone did not force change.

 

This week, three
Republican members of Congress, led by Representative Devin Nunes of
California, a senior member of the Ways and Means Committee, proposed legislation
to force states and cities to report pension fund liabilities on the
same basis, and to force them to disclose market values of assets. The
bill would not even allow smoothing, so the state of pension funding
will seem volatile as markets rise and fall. Such volatility could be
reduced by putting more pension money into bonds than stocks, but doing
so would force governments to admit they were likely to earn less on
investments, and thus need to put even more money into pension plans.

 

The congressmen would not like to have it said they are
forcing anything. The bill gives local governments a choice: they can
report the way the members want them to report, or they can give up the
ability to issue tax-exempt bonds. That is, of course, no choice at
all.

 

Introducing a bill is not the same as passing one,
but this may be an idea whose time has come. There is rising concern
over the state of local government finances, and governments may be
forced to make better disclosures if they simply want to issue new
bonds.

 

Disclosures are
likely to lead to growing pressure to rein in pension costs, even
though that will be resisted by public employee unions, which often
have considerable political clout.

 

Even assuming
legislatures want to act, doing so is not easy, in part because of
state constitutional provisions. Governments could follow corporate
precedents by treating new employees differently and by stopping
existing employees from accumulating new benefits. But that may not be
enough to stem the flood of red ink, particularly in cities and states
where pension fund contributions have been deferred to avoid cuts in
other spending.

 

Some abuses can be stopped, such as the
practice of allowing retiring employees to work hundreds of hours of
overtime in their final year, and then counting that pay in determining
the pension payment, which is often based on a percentage of annual
pay. It is not clear how many abuses there are, but the publicity given
to some of those that do exist has damaged the image of, and public
sympathy for, public employees.There is also a widespread suspicion
that mayors and governors have agreed to excessive pension benefits,
often as a substitute for pay increases, simply because the bill would
be paid by some future administration.

 

Companies have the option of going bankrupt and getting the Pension Benefit Guaranty Corporation,
a federal agency, to take over their obligations. The P.B.G.C. can
then reduce payments on larger pensions. But it is not clear what will
happen when cities go bankrupt, in part because there are not that many
precedents, and states apparently cannot file for bankruptcy at all. Of
course, the fact a state cannot file in bankruptcy court does not mean
it cannot go broke.

 

There has been talk of shared
sacrifice, in which employees accept lower benefits, taxpayers pay more
and bondholders also take hits. You can argue that is what happened in
New York City a quarter of a century ago, when some bondholders were
forced to extend maturities. But widespread expectations that such a
thing was possible could drive up borrowing costs for all localities,
making their fiscal problems that much worse.

 

In the
end, I suspect ways will be found to abrogate some pension promises.
But even if that does not happen, the trend away from defined-benefit
pensions is likely to affect most younger public employees, as it
already has their counterparts in the private sector. The retirement
safety net will thus become a little more frayed.

The retirement safety net is already full of holes, and it will
most certainly affect younger public employees. If things get real ugly,
it might even affect retired pensioners who are enjoying gold-plated
public sector pensions. Of course, how bad things get is anyone's guess
right now and there is no reason to sound the alarm prematurely. At
least I hope not.