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Pension Bomb Ticks Louder?
The WSJ
reports, Pension
Bomb Ticks Louder:
The time-bomb that is
public-pension obligations keeps ticking louder and louder. Eventually
someone will have to notice.
This month, Stanford's Institute
for Economic Policy Research released a study suggesting a more than
$500 billion unfunded liability for California's three biggest pension
funds—Calpers, Calstrs and the University of California Retirement
System. The shortfall is about six times the size of this year's
California state budget and seven times more than the outstanding
voter-approved general obligations bonds.
The pension funds responsible for the time bombs denounced the
report. Calstrs CEO Jack Ehnes declared at a board meeting that "most
people would give [this study] a letter grade of 'F' for quality" but
"since it bears the brand of Stanford, it clearly ripples out there
quite a bit." He called its assumptions "faulty," its research "shoddy"
and its conclusions "political." Calpers chief Joseph Dear wrote in
the San Francisco Chronicle that the study is "fundamentally flawed"
because it "uses a controversial method that is out of step with
governmental accounting standards."
Those standards bear some
scrutiny.
The Stanford study uses what's called a "risk-free"
4.14% discount rate, which is tied to 10-year Treasury bonds. The
Government Accounting Standards Board requires corporate
pensions to use a risk-free rate, but it allows public pension
funds to discount pension liabilities at their expected rate of
return, which the pension funds determine. Calstrs assumes a rate of
return of 8%, Calpers 7.75% and the UC fund 7.5%. But the CEO of the
global investment management firm BlackRock Inc., Laurence Fink, says
Calpers would be lucky to earn 6% on its portfolio. A 5% return is more
realistic.
Last year the accounting
board proposed that the public pensions play by the same rules as
corporate pensions. But unions for the public employees balked because
the changed standard would likely require employees and employers to
contribute more to the pensions, especially in times when interest
rates are low. For now, it appears the public employee unions will
prevail with the status quo accounting method.
Using these higher return rates for their
pension portfolios, the pension giants calculate a much smaller, but
still significant, $55 billion shortfall. Discounting liabilities at
these higher rates, however, ignores the probability that actual
returns will fall below expected levels and allows pension funds to
paper over the magnitude of their problem.
Instead, the
Stanford researchers choose to use a risk-free rate to calculate the
unfunded liability because financial economics says that the risk of
the investment portfolio should match the risk of pension liabilities.
But public pensions carry no liability. They're riskless. That's
because public employees will receive their defined benefit pensions
regardless of the market's performance or the funds' investment
returns. Under California law, public pensions are a vested,
contractual right. What this means is that taxpayers are on the hook if
the economy falters or the pension portfolios don't perform as well as
expected.
As David Crane, California Governor Arnold
Schwarzenegger's adviser notes, this year's unfunded pension liability
is next year's budget cut—or tax hike. This year $5.5 billion was
diverted from other programs such as higher education and parks to
cover the shortfall in California's retiree pension and health-care
benefits. The Governor's office projects that, absent reform, this
figure will balloon to over $15 billion in the next 10 years.
What to do? The Stanford study suggests that
at the least the state needs to contribute to pensions at a steadier
rate and not shortchange the funds when markets are booming. It also
recommends shifting investments to more fixed-income assets to reduce
risks.
But what the public-pension giants find "political" and
"controversial" is the study's recommendation to move away from a
defined benefits system to a 401(k)-style system for new hires. Public
employee unions oppose this because defined benefits plans are usually
more lavish, and someone else is on the hook to make up shortfalls.
Calpers and Calstrs are decrying the Stanford study because it has
revealed exactly who is on the hook for all of this unfunded
obligation—California's taxpayers.
Shifting
investments into more fixed-income assets when bond yields are at
historic lows? While it sounds counterintuitive, it may be the wisest
decision (read my
last comment).
Jonathan Jacob of Forethought Risk set me these
comments, which I share with you:
A couple comments on recent blog posts:
First off, apparently bonds
are by far the most hated asset which makes them a reasonable
candidate for outperformance.
More focused on
pensions, however, is my disagreement with the massive public plans – I
think by creating these megafunds we would be inventing a new financial
entity which would be “too big to fail” as large segments of the
population would rely on them for future income.
Jonathan is right on both counts, which is why I
keep harping on setting the tightest governance standards on large
public funds. I also think we should cap them after they reach a certain
size.
The problem is that public pensions are already “too big
to fail”and if they're understating their true liabilities by using a
discount rate based on rosy investment expectations, then some time in
the near future those pension bombs will stop ticking, and just explode
in our faces.
»
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Tell me how you can tax Californication Nation anymore?.
They are going to give the state back to Mexico just for debt relief.
This state is SO screwed, it's beyond comprehension.
They cannot cut taxes, more than 15%........total, without state Constitution Amendments...........
Stick a fork in this bitch.She's a goner.
What I see may happen is that the states may try for a two teir system in order to have the current union public workers fighting with the retired workers. By taking from the ones retiring and giving more on the workers working.
Gunther,
I'm curious as to how well functioning you're going to view your government during the upcoming commodities crash.
Canada (like any other government) is a pawn, get over yourself.
Hey Leo... are you buying this dip today?
No, waiting from the bigger dip (down to 200 m.a.) before I pull the trigger again. Having said this, some stocks continue to do well. Be selective here. Europe is a basket case - risk of contagion rising as they show their political ineptitude.
Leo, Political Ineptitude isn't just a European problem.
Gently, moving Greece out of the Euro or allowing a default sounds like (at last) there's somebody doing the math.
Do Canadian pensions mark-to-market or mark-to-model" ? PLEASE keep this pension info flowing - it's much more important than the GS "stupid questions" show.
Leo,
I want to answer your question how to improve the Canadian Pension System; even if it takes a bit time.
A pension is in a way a transformation of money in time; I save today to take out money several years from now. The big problem is that the future payment has to be covered by future economic activity. On a big scale it has to be a pay-as-you-go system because the supporting economic activity can not really be stored.
Even a fully funded system has to have economic activity to pay the benefits.
A model of that is to finance a corporation and use the profits to pay the benefits.
Second and current way is to invest the savings, hope for good returns and distribute the returns when needed.
Third way would be some taxes that are used to pay the pension.
All rise and fall with the economy.
Thus it becomes important to have an efficient system that uses as little expenses for administration as possible; that would be paying according to income tax and funding with income and possibly sales tax.
That is somewhat similar to the German system that so far survived two lost wars, two currencies and one bankrupcy of the state.
Any private system might yield higher benefits but sometimes the pension fund looses money big time and the pension is gone.
To go from the more abstract view to a general suggestion, my solution would be as follows:
For everybody above the pension age a tax-financed pension on welfare level; additionally a tax-funded pension proportional to former income tax, years worked and current taxes. The third part would be a basket of pension funde funded by contributions.
Canada values equality very high, so this system should be open for everyone.
Dear American readers,
this solution is clearly not for you but in other countries exists a functionimg government.
Systematic insolvency at all levels...who knew?
The monetary system itself is a manifestation of insolvency. The future CANNOT pay back today's claims.
Good thing we didn't take Leo's advice and buy Greek bonds! The public pension system is going the same route and for the same reasons, more or less. As the poem says, "take the cash and let the credit go".
Illinois recently hiked the eligibility age for pension funds to 67. NJ took away pensions from temp employees. Start of a trend?
The only way to begin with the CA pension crisis is the threat of massive public employee terminations. And there is a lot of wailing about that already at the municipal levels. But it is the only stick available to tame this beast.
The gutless and corrupt politicians in CA are the real problem. They've gone underground on this issue because a) they rely on the general ignorance of the voters on the seriousness of this issue, and b) they are terrified to defy their union handlers.
I have said many times that public employees should never have been allowed to organize under the banner of a union. It's a no-win arrangement for the private sector taxpayer. B-I-G F-A-I-L is written all over the arrangement.
John Hussman estimates 10yr total nominal return of the S&P500 at 6% per year, based on valuation. The 10yr is at 4%. With a 50:50 portfolio, that gets you 5% per year. Minus 1% for the consultants, fees, funds of funds and all the rest, leaves you with 4%. So, a 4.14% discount rate is not too far off for a large, dumb pension fund.
I'm with the union dude. By all means, shoot the messenger. Problem solved.
Fractional reserve pension funds guaranteed by the taxpayer. What could possibly go wrong!?
"But public pensions carry no liability. They're riskless. That's because public employees will receive their defined benefit pensions regardless of the market's performance or the funds' investment returns. Under California law, public pensions are a vested, contractual right."
This is why it will go so terribly wrong. This is as bad as the french town that was worried about ufo's landing, so they made a law that it was illegal for them to land there. Problem solved!
Of course, yesterday in San Francisco the local paper revealed that 1/3 of all City employees make over $100K a year. That's gonna be real sustainable. In the end, perhaps hyperinflation will be preferable, since the politicos "kept their promise" not to lower the amounts of the pensions (but not their ultimate purchasing power). Or that 'health care' will be tweaked toward only un-pensioned citizens surviving into old age.
Look at it like this. If we pay for those old people who don't give a fuck about us, maybe our children and grandchildren will also be stupid enough to do so for us. Right?
I'm teaching my four children how to never ever pay retail, shop yard sales and flea markets and use retail stores only as last resort, save before buying, stay debt free, and S.T.A.R.V.E T.H.E. B.E.A.S.T.
I really don't need them to provide for my old age because what I teach, I also do. And I'm also teaching them to find that sweet spot between earning income and not having to pay taxes on it, so that they'll never be contributing much towards strangers' old age.
Thought you might like this:
http://vodpod.com/watch/1105098-yertpod19-diggin-dugout-dick-in-idaho
Just shows you how cheap one can live...
Hulk, thanks for the awesome video... just what the real estate brokers and stock market pumpers want us to see!
(This is the fourth time I tried to post a thank-you... I think TPTB were messing w ZH earlier today)
Old people, who needs them anyway...
Strip the pensions of the gauranteed bullshit protection.
One thing I can assure you - no citizen of another state will voluntarily pay for another's retirement plan. Hell, I doubt *anyone* in the private sector would accept higher taxes to pay for their own state's plan.
Any federal official who diverts funds to a private state pension plan will be voted out of office. If they raise taxes, there will be taxpayer flight.
California, Illinois, etc, are completely on their own.
The Germans certainly aren't eager to pay for the Greeks retirement, particularly at ages earlier than the Germans enjoy.
Those promised pensions (and unions) in the USA that don't voluntarily reduce their benefits per eligible, will soon meet clawbacks if not repudiation. The formulas currently in place cannot be borne out, will NOT be delivered, and it is past time for people to understand this for forward planning for their individual selves.
The private sector can't afford the public sector. In 15-years, the cost of interest, health care & pensions will eat 100% of government revenues. Even now, all my divorced buddies (in their late 50's / 60's) are shopping for a public sector retiree to hook up with as their "security for old age".
Hot DMV ass!
Selma & Patty, America's most eligible bachelorettes!
http://worldwide-web.com/JeffreyBabad/Simpsons/PattySelma/selmapatty.gif
That's some hot stuff!
I'm amazed RoboT hasn't found out about them gals.
It certainly can't afford them the way things stand right now. What are these guys ar CalPERS and CalSTRS smoking? Using some rosy investment return to discount future pension liabilities is just a pipe dream. The Stanford study uses what's called a "risk-free" 4.14% discount rate, which is tied to 10-year Treasury bonds.Even if it might overstate the liabilities, it is a better measure to use. Better be safe than sorry.
Either California and other states like it become subsumed by the federal government or private assets get confiscated outright to pay public sector employees or both.
Of government employees
For government employees
By government employees
Get a government job before it's too late. That will be the last chair left when the music finally stops for good.
Oh, not to worry...the "retirees" WILL get their swill, but it will be rather in devalued dollars. And when they do, gold will prove itself.
I believe a lot of public pensions have COLA provisions. So even though that number is fudged, it can only be fudged so much.