What's Up With These Trust Funds?
The topic of the day is the Military Retirement Service (MRS) and the Federal Employee Retirement Fund (FERS). Let me be very clear at the onset of this – I don’t understand what is happening with these two. But, that's the point. I’m not sure that anyone knows what's going on here. At least not the folks in the Press, or the public.
My interest in FERS/MRS was tweaked a week ago with the release of the Congressional Budget Office’s (CBO) annual report on the economy and the budget. The critical number from the CBO was its calculation of the future Debt to Public/GDP ratio. There is a footnote to the CBO’s calculations:
a. Off-budget surpluses or deficits comprise surpluses or deficits in the Social Security trust funds and the net cash flow of the Postal Service.
I read this (me being the suspicious type) and said to myself;
Why did CBO exclude the results for FERS and MRS?
Social Security IS adding to the Debt Owed to the Public (DOP). CBO calculates the SS cash shortfall and includes it in the total for DOP. My question was do FERS and MRS also contribute to DOP? If so, by how much?
I did do some research; there is information on-line related to these entities . I did not find the answers to my questions however. I determined that the Congressional Research Service (CRS) is the source of most of the information that is available. The more I read, the more questions I had. Over the weekend I wrote a long e-mail to the author of the report for FERS. Sure enough, Monday morning I got an answer. Not bad for the Government, huh? Unfortunately it was not quite the answer I was hoping for:
CRS provides research and analysis exclusively to the U.S. Congress. Because we work only for Congress, we are unable to respond to other inquiries.
I can understand that CRS is too busy helping out legislators to answer any of my silly questions. But there is no other way to get the information I wanted other than to ask the folks in D.C. Color me disappointed.
For what it’s worth, I think that FERS and MRS are adding to the DOP in a significant way. It will be measured in the hundreds of billions over the next ten-years. Anyway, I do have some questions about the published materials, including:
FERS has a trust fund called the Civil Service Retirement and Disability Fund (CSRDF). Some raw data on CSRDF from CRS:
- The Balance of the Fund is $800 Billion! Sounds good! But…
- Because CSRS retirement benefits have never been fully funded by employer and employee contributions, the Civil Service Retirement and Disability Fund has an unfunded liability.
How big is the hole at FERS? Pretty big…
- The unfunded liability was $622.3 billion in FY2010. According to actuarial estimates, the unfunded liability of the CSRDF will continue to rise until about 2023, when it will peak at $684.8 billion.
There is a requirement to measure the projected results of any government trust fund over a 75-year period. I think this a complete waste of time as no one has a clue what the world will look like in 50+ years. This is what CRS thinks is in the future for its TF:
Well look at those beautiful numbers. The TF grows to a cool 14 trillion! There is one assumption that drives these results - The US economy is going to soar every week, month year and decade – for ever! CRS has the economy growing from a measly 16T today to – hold on - $450T in 2085. This miracle is the result of uninterrupted compound GDP growth of 4.5%. A growth rate like this is possible, but for a mature economy, with a non-stop aging problem and monstrous deficits this appears to be a “blue skies” outlook. Based on this, a 1 dollar cup of coffee today would cost $1,750 in 2085. With a tip, $2 grand.
The way FERS is set up, it gets bigger and bigger. Today it has a TF equal to 10 times current year payables. The TF will grow to 20 times then current payable over the forecast period. I think this is a perfect example of why the entire TF logic is flawed. The TFs should have a balance of one-year's worth of payments. The CRS recognizes the flaws in TF accounting:
Observers have suggested that investing the CSRDF entirely in U.S. Treasury bonds does not represent true “pre-funding” of CSRS and FERS annuities because these bonds are merely a claim held by the government against its own future revenues.
Bingo!! CRS says there is no “money” in the TF. For those of us who have been pounding the table on this, it's nice to see in print. CRS explains further:
From a cash perspective, when trust fund holdings are redeemed to authorize the payment of benefits, the Department of the Treasury finances the expenditure in the same way as any other Federal expenditure—by using current receipts or by borrowing from the public.
FERS will collect $4.2B in CASH and $90B in PAPER in 2013. It will pay out $78B in CASH. To me, this implies that FERS will be forced to redeem $74B of its paper for the year. Every penny of that would force an equal increase in DOP. This number would not be reflected in any deficit calculation. If this interpretation of the cash flows is correct, then it would be a very big deal.
Note: While I’m unsure of the prior calculation, I’m certain that interest is a non-cash item. This would mean that FERS would force an increase of $16B in DOP in 2013. That’s still over $200B over the next ten years.
One final point on FERS – It breaks out the Postal contributions - $3.9B due in 2013. The PO has no money and no borrowing authority left. Any “payments” that the PO made to FERS in the past were the result of direct PO borrowing from the Treasury. There is no “money” in this system. It’s just a bunch of IOUs. Those IOUs are all going to be DOP at some point. What we have here is a house of cards.
MRS has a fancy annual report. The audit is done by that powerhouse CPA firm – Acuity Consulting. Never heard of them? Neither have I. This is a boutique accounting firm (on the D.C. Beltway, of course) that specializes in government audits. The principals of Acuity are all ex Air Force. The boss went to the USAF Academy. I think this is one of those “close” relationships you hear about.
MRS is different in many ways from either SS or FERS. But it is similar in that it has a trust fund, receives payment from the government and makes benefit payments.
The Military TF also has assets, and those assets are expected to grow at a very rapid rate. In 2013 the TF totals $500B, it will grow to $2.676Trillion over the next 20 years. The compounded growth rate of the TF is a whopping 9%. A portion of this a function of increasing government payments, but the bulk of the growth comes from interest income. At least that is what MRS is saying. Here is the footnote that explains the critical assumptions on interest rates:
The preceding projections assume a long-term 5.75% interest rate each year.
Huh? The Congressional Budget office released its estimates for the MRS Trust Fund today. CBO thinks the MRS TF will grow to $966B in 2020, MRS has reported that the number will be $1.174 Trillion. A modest $210B variance. What's a 1/4 trillion amongst pals?
MRS is restricted to investments in government securities. How does one achieve a 5.75% return investing in Govvies? The answer is that it's not possible. The assumption used to value MRS is way out of line with interest rate assumption used by CBO, FERS and SS. Why?
Look at how MRS invests its money. This blows my mind:
Fully 86% is invested in inflation-protected securities? The balance is in short date Treasury paper that has next to zero cash-on–cash return? What the hell are the Generals preparing for with this portfolio?
The military is storing its “nut” in an inflation bomb shelter. To get a 5.75% return on this portfolio, inflation (CPI) would have to be well north of 6%. If the country experienced inflation of that magnitude on a sustained basis, it would blow up. I wonder if the Generals consulted with Bernanke when they put this investment strategy together. Ben would have told the Brass they would never see those results. (Who knows?)
Some TIPS facts – They have a negative yield across all maturities today. The yearly inflation adjustment is added to the principal. The cash flows from a 5 Year tip (assuming 2% CPI)
Year 1 -102 (you pay a premium up front)
Year 2 0 (sorry, no cash interest for you)
Year 3 0 Ditto
Year 4 0 Ditto
Year 5 +110 (Finally, you get a cash return)
On paper, MRS is in good shape. For 2013 it anticipates “revenue” of $122.8B, of which $28.5B is interest income. Cash expenses will be $54.5B. If you assume that most of the interest income is accrual, and not cash, then the remaining income of $84.3b is more than sufficient to cover benefits. On the surface, there is a $30B surplus.
It's here that I get confused. MRS has to come up with $54.5B of cash this year. Where are they going to get that cash? The description of the MRS "money" flows:
From this chart I conclude that MRS has next to zero cash income. It has accrual (non cash) income from investments. All of the other sources are marked Intergovernmental Transfers. These are not cash transfers. The transfers are more of that “Borrowing Authority”.
There is a possibility that MRS gets a bunch of paper which it immediately redeems with Treasury for the needed cash. If that were the case, then MRS would be forcing Treasury to issue more DOP (+50B?).
For America, the DOP to GDP ratio is crucial (more important than the Total Debt to GDP – that includes those meaningless TF IOUs). We know that DOP goes up when there is a budget deficit – but DOP also rises based on what is happening with the big Trust Funds. How much the TFs are driving DOP is something I would like to know, and I’m disappointed and frustrated that I can’t give you the “right” answer. If any readers can clear this up, it would be most appreciated. I’ll be sure to send a link of this to CBO, OMB, CRS, FERS, MRS and SS. If I do hear from someone, I'll let you know; don't hold your breath.
Note: For those who have a check coming from FERS/MRS please don't read this as a suggestion that your benefits are at risk. That is not the case. Those benefits are money good. The taxpayers, well, they are going to have a problem with this.
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