Guest Post: The Endgame Of State/Local Government Pensions

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

There is no way the pensions and benefits promised in an era of financialized abundance can be paid once the wheels of financialization fall off.

Yesterday I described the destructive effect of abundance on decision-making: An Abundance of Bad Decisions. One aspect of this dynamic is the tendency to extrapolate prosperity into the future as a permanent state of affairs.
One example of this is state/local government pensions: during the past 30 years of financialized abundance, the benefits and pensions promised to public employees were increased substantially. Public unions are a powerful political force in many states, and in eras of rising tax revenues, it's an easy political decision to increase public employee benefits and pension payouts.
The rising stock and bond markets generated huge profits for the public-employee pension funds, enabling them to grow without taxpayer contributions. The effortlessness and persistence of this growth encouraged the mindset that pensions would be paid for via the magic of ever-rising markets; if tax revenues weren't even needed to fund the pension plans, then no hard political choices would ever have to be made.
Alas, the 8+% annual growth rate of the boom era is now structurally unrealistic.The New Normal is bond yields of 2% or 3% at best, and equities markets that are increasingly at risk of significant sell-offs.
The illusion that the pension funds can pay the promised benefits is maintained by plugging wildly unrealistic 7% or 8% returns into projections of future pension fund earnings. Now those unrealistic projections are being questioned: California, Illinois on Brink of Pension Crisis (Mish).
This means tax revenues will have to be diverted from other government expenses to fund the pension plans.
A key dynamic in the pension crisis is called the the ratchet effect: it was effortless to increase the benefits and pensions of public employees, but it is effectively politically impossible to trim those promises.
The Ratchet Effect is one reason why the nation's political machinery has become sclerotic and ineffective: Dislocations Ahead: The Ratchet Effect, Stick-Slip and QE3(February 14, 2011).
As correspondent Mark G. explains, the public pension crisis has been 20 years in the making, and cannot be resolved without massive, sustained political and fiscal pain:

1. Long term interest rates began a secular decline in 1981. This continued until at least early this year. 

2. In the early 1990s state and local politicians and their nominees began awarding management contracts to RIAs (Registered Investment Advisor) who promised higher rates of return. These promises were eagerly accepted at face value since it allowed them to reduce their annual contribution for defined benefit pension plans and spend the money elsewhere.
#1 plus the Reagan bull market made it possible to present this as fiscally responsible, or at least as progressive. Over the same period of time private corporations tended to shift to defined contribution plans for new hires. iow they ceased underwriting market risk for their pension funds. State and local governments will eventually be forced to follow this example. 

Where Mish writes: "Pension plans typically assume 7.5% returns. That's not going to happen on a sustained basis with 10-year treasuries yielding close to 2%. Yet, any significant rise in bond yields will crush existing bondholders as well as wreak havoc in equities," he's underestimating the return assumption for a great many pension plans. CALPERS & CALSTRS (California public employee pension plans) are functionally at 8% or higher. 

3. As a consequence of 1 & 2 defined benefit pension plans (along with charitable endowments) began a long-term movement out of bonds. The portfolio percentage allocations to stocks, followed by other forms of equity, began shooting up. Why would they not? The last time 30-year Treasuries saw 8% was in late 1994. It was already crystal clear by 1996 that investing in bonds was just a way to slowly sink into insolvency.
We're not on any "brink." It took two decades to get into this systemically insolvent condition. And I don't think this situation will produce further market instability. It's already been the main catalyst of market volatility since the mid 1990s in my second hand educated opinion. The and subprime housing bubbles could never have gotten so big without the participation of public and non-profit funds heaving hundreds of billions around in a chase for investment grade high yield.
In other words, the real casino action started at the precise moment that planning IRRs exceeded the 30-year US Treasury Bond rate. 

What happens next? Probably a lot of things will happen. This particular crisis will revolve around defined benefit state and local government employee pension funds. It was created in the political arena and that's where it will be resolved.
I think the Democratic Party will be the most affected. The public employee unions are a core constituency and produce most of the ground troops for the Democrats. Broadly speaking there are two approaches. These are; 1) obtain more money and 2) reduce benefit payouts. 

1. Obtain More Money.
a. Raising taxes (primarily targeting Republicans) will be the attempted default of Democrat single party states. But the crisis is most acute in precisely those single party Democratic states with the highest taxes already. It is therefore not clear this approach will really raise more money. It could equally create a large refugee movement of targeted taxpayers fleeing these jurisdictions, thus producing lower net revenues overall. The available demographic data says this process is well underway in California.
b. Shift appropriations between budget lines. This means reducing money for schools, police, highway maintenance, welfare et al and transferring it to pension funds. This will create conflict inside the Democratic party between key constituency groups.
c. Get the Federal government (or Federal Reserve) to undertake direct bailouts. This is going to create conflict between Democratic and Republican states over issues of federalism and "transfer payments". 

2. Reduce Benefit Payouts.
Recent events in Wisconsin show the potential for this action to create extreme political unrest.
I have long been watching this situation as a potential vector for political collapse.

Thank you, Mark, for this primer on the unsustainability of public pension promises.Raising taxes is the default solution to state/local government shortfalls, but there's a structural problem with raising taxes:
1. Fulltime jobs--the kind that pay the bulk of state/local taxes--are stagnant.
2. Real income is down for the vast majority of workers.
If state and local governments think low-income part-time workers can pay more taxes and survive, they are engaged in magical thinking:
The percentage of the population with a job is back to the levels of the 1970s:
Real (adjusted for inflation) household income has declined by almost 8%; exactly how are households supposed to pay higher state and local taxes as their income steadily declines?
State and local governments planning on a Federal bailout should ponder this chart, which clearly shows a structural gap of monumental proportions between Federal tax revenues and Federal spending.
The endgame of promises made in an era of illusory, financialized abundance will be hurried along by a collapse in the equities and bond markets. I addressed the likelihood that all three primary investment markets would decline together in What If Stocks, Bonds and Housing All Go Down Together? (May 24, 2013): in a nutshell, if yields rise, mortgage rates rise and that sinks the housing market. Rising yields also sink stocks, as higher yields pull money out of risky equities. And rising yields also collapse the value of existing bonds, wiping out much of the wealth that is currently considered safe.

In sum: there is no way the pensions and benefits promised in an era of financialized abundance can be paid once the wheels of financialization fall off.

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Whatta's picture

State and Local government pensions nothing...WHAT ABOUT US PLAIN FOLK TRYING TO LIVE OFF SAVINGS?

Asshat Bernank and Company chase us out of "safe" investments and then fleece us in risk assets.

Fuck each and every one of them and may they get their justice served cold.

Momauguin Joe's picture

Pensions are I.O.U's. I.O.U's are for S.U.C.K.E.R.S.

max2205's picture

there is always a way...print MOAR

King_of_simpletons's picture

Pensions will get paid at the expense of future taxpayers, no matter how small a base that is. A combination of ultra high taxes and monopoly money printing from Yellen and other lose screws at the Fed will make sure that happens. State and Local Government / Federal Government Unions vote Democrat. There is no way in heckloon pensions are not going to get paid - What i am saying is Republicans can't win anymore. There will not be a republican president for some time to come. Welfare State will prevail until everyone is broke and lost their will to survive. There is no way out.

jbvtme's picture

my only fear is that when the time comes to watch bureaucrats standing in line at the soup kitchen, the tickets will be sold out.

MisterMousePotato's picture

Question ... does that first chart (Full-Tme emplyment as a % of U.S. Population) include teachers, firemen, cops, city administrators and their minions (in other words, the 20-30 million parasites that are responsible for having this discussion at all? If so, the problem is far, far, far worse than indicated by the article.

MagicHandPuppet's picture

Without responding to the previous poster's "simpleton" view of the democrat vs. repulican false dichotomy...

I will seriously celebrate when these gubment assfuck jokers' pensions dry up.  I know at the federal level they can always print to keep the payments going.  But, the local leeches may very well hit a point before hyperinflation where the well of blood that they draw from dries up.  For those of us remaining, this day will be bitter sweet.

gorillaonyourback's picture

The well is dry allright. Its only when the blood suckers realize the host is dead is when all hell breaks looae. Think about this average gov employee makes about 100k/yr and average household (2 people) make 50k/yr. Almost 48% of all gdp is funded by gov spending. Makes u go hmmmm right

Meat Hammer's picture

I will seriously celebrate when these gubment assfuck jokers' pensions dry up.  

Watching the free-shit brigade battle for the crumbs will be must-see tv.

StychoKiller's picture

Grab some popcorn and lessee what happens in Detroit, Mich...

americanreality's picture

Minnesota is trying to institute a 5 dollar tax on all home and auto insurance policies for the purpose of restoring public pensions.  So every non-public employee who lost money in their 401k is now responsible for making the retirement accounts for public workers whole while eating the loss on their own accounts. What's not to like? 

kchrisc's picture

One has to admire the shit: steal another dollar to replace the stolen dollar that you stole in the first place.

And I would bet you $5 that the pols and crats will find a way to steal this "fix" as well. Mark my words.

Panafrican Funktron Robot's picture

I would expand the available options:

1.  Move to 401K plans 2.  Cap or decrease pension payouts 3.  Increase employee contributions 4.  Increase taxes #1 is what I think is going to be likely, particularly if there were to be a Fedgov sponsored plan.  States would for the most part gladly offload this liability, and converting those pension funds to 401K would help resolve the D vs. R, as they would not technically become a Fedgov liability (it would in the off-balance sheet sense, via "guarantees).   I could also envision a scenario in which this Fedgov plan were to be the only 401K still tax deductible.  Further, this plan be run by a sponsor, say, the corporation that currently run food stamps.   I know, such nonsense, crazy theories going on in my brain.  This could never happen, right?
NoDebt's picture

The recipients of those promised pensions are, at this point, largely Democratic/Union.  They will NEVER give one inch they don't have to.  They KNOW they got a sweetheart deal and they're going to fight against ANY attempt to decrease benefits or increase their contribution to it.  If they have to bankrupt the entire nation to pay for it, then so be it.  Multiply Wisconsin by a million and that's the fight you have on your hands, although states are starting to nip around the edges here and there.

MisterMousePotato's picture

Remember that scene from the Terminator? When Kyle was trying to explain the implacable nature of the beast? ("It can't be bargained with. It can't be reasoned with. It doesn't feel pity, or remorse, or fear. And it absolutely will not stop, ever, until you are dead.") The good news is that at least we're living in a pretty good B movie.

Example: Detroit. Did they change? Did they do anything differently, at all, before the money simply ran out? No. And they won't anywhere else either. They absolutely will not stop, ever, until you are dead.

Totentänzerlied's picture

Once more, but this time, don't sugarcoat it.


BidnessMan's picture

Actually they are dead.  The parasites have finally killed the host. It is remarkable the host lived as long as it did.  Would have died decades ago without financialization.

The leading edge of many, many promises that will not be kept.

Blankenstein's picture

This is Illinois right now.  The state can't pay its bills, yet the unions block ANY attempt to contain the penions, which are spiralling exponentially out of control.

g'kar's picture

The pension money doesn't even include the unsustainable health care costs for retirees.


The tipping point will be the 50 to 100 million immigrants that will result from the amnesty bill through chain migration, with the bulk of them going on to government services.

MisterMousePotato's picture

The best estimate of the number of illegal immigrants in the country was done by Bear Stearns several years ago. (Maybe five or six or more at this point.) Anyway, they calculated that there were, in fact, 30 million, far different than the gub's estimate of 8 million then and 10 million now. Might even be more now.

Now that, by itself, is a big difference and a much, much bigger problem than we're being told.

Even more to the point, though, is the chain migration thing. Historically, every single such immigrant brings in nine more. Always. No exceptions. (So, whatever number you hear or wanna use, multiply it by ten to get a true understanding of the medium- and long-term consequences.)

Anyway. let's do the math, shall we?:  9 x 30,000,000 + 30,000,000= 300,000,000.

That's right. 300 million illiterate (in their own language, mind you), unskilled, uneducated, third world democrats.

Twenty years hence, the architects of all this will be saying, "Who coulda foreseen that?"

Kiss America good-bye, my friends.

g'kar's picture

Unfortnately, very few people out there understand this.

americanreality's picture

I agree with what you are saying however illegal immigration is generally a Mexican/Latin issue.  Mexico's entire population is 112 million. I suppose we could empty mexico and find another 200 million in Latin america.  But I doubt it.  Its bad enough without the hyperbolic numbers.

aerojet's picture

A much more pliant group of slaves than the current ones.

dontgoforit's picture

Notice how 9-11 shook the line?  How much trouble has been spawned by that horrendous event?  bin laden and his ilk have really screwed things up.  Set the stage for the really bad one to emerge.

Terminus C's picture

yea, Bin Laden...

You sir, are deluded, moronic, or both.

Ask, cui bono? 

km4's picture

"In sum: there is no way the pensions and benefits promised in an era of financialized abundance can be paid once the wheels of financialization fall off."

Yup !

foodstampbarry's picture

That which cannot be sustained, won't be.

El Viejo's picture

Not all states are in the same boat.  Some actually have laws that prevent the raising of taxes to balance the pension books.

reTARD's picture

Laws can be changed easily.

El Viejo's picture

When private sector workers out number government workers that would be difficult. If they succeed anyway that would be tyranny.

reTARD's picture

Are there any private sector workers remaining in this economy? ;-) Those who work at Starbucks, temp working and needing more than one job don't count. They simply don't have the time to see the big picture.

El Viejo's picture

I repeat my statement, hopefully with clarity.  There are no guarantees in life. We certainly in the private sector had no guarantees with our pension plans. If governments lied to government workers and said they had a guaranteed good life then maybe the government workers don't see the big picture. Here is the big picture:  Government workers used to be paid less than private sector workers. They had more holidays and rarely worked more than 8 hours a day. They also had better job security. Then shortly after Reagan in congress they cried that they needed to attract the best and the brightest and government salaries started climbing until they had the best salaries along with job security and in some cases like Wisconsin "Guaranteed" pensions. We in the private sector found ourselves making less than government workers. This is nothing less than an oligarchy or Mob Rule. Thankfully, in most states the private sector still out numbers government workers and can "if they see the big picture" will out vote them on any referendum to fund government pensions with higher taxes (probably fraudulently labelled for education) If government employees want moar money then maybe they should take the same risk the rest of us take. If by some subtrifuge they manage to get their pensions funded by raising our taxes after we have lost our good jobs and are making less now then that is nothing short of tyranny. For decades the Democrats were criticized for raising taxes during the great depression and blamed for sending the slowly recovering economy into another tailspin. If the idiots do it again well I think it speaks for itself. And most people however blind of the big picture know when their taxes have been raised expecially if they are making less than they used to.

reTARD's picture

I agree there are no guarantees in life. Guarantees are illusions sold by snake oil salesmen. The government also sells the promise of taking care of what should be your own responsibilities. As a result, people of today generally shun self-ownership of their own responsibilities and consequences of their own actions.

However, government (together with the banks) really does not need to raise taxes in order to "generate moar revenue." They simply can steal another, more obscure way. Just have the Fed "expand their balance sheet" or counterfeit moar currency. Theft by inflation is much more devastating.

Oliver Face's picture

All government workers, huh? What about the ones that guarantee your safety and security, more than "8 hours per day"? Without security and safety, there is no economy or private sector. Your points are taken, but a bit naive and narrow-sighted.

BidnessMan's picture

And the problem with Socialism is eventually you run out of other people's money. We are just about there.

bluskyes's picture

Here's a new campaign slogan: "Let Them Strike!"

RSloane's picture

This article is false. Every single patriotic American is willing to pay more and more tax dollars to ensure that old public pensioners are free to make pirate hats out of their Depends and frolic without a care on beaches in Florida.

insanelysane's picture

We wouldn't want the public "worker" to put off retirement any later than age 59.  The private sector workers won't mind working till age 79 to pay for it.

BidnessMan's picture

They are sitting in front of a slot machine - not at the beach.

10mm's picture

Here we go againn,painting the 2 party fraud that is one.

Jumbotron's picture

However....don't forget...even though these pensions should indeed be cut if not eliminated in order for at least a part of the government behemoth to be downsized.....that will be less money going back into the economy when these guys finally retire...if they ever do.  And if they don't that means less jobs for the younger generation coming up.

Should have never allowed them to grow like they did.....cutting it out will have all sorts of negative consequences.  An analogy would be the amputation of a grangenous limb and the loss of mobility and freedom that brings.....but the life is saved in doing it.

lasvegaspersona's picture

Issues like this cannot and will not be resolved. They will continue until something breaks. There is no such thing as political will. There is only the effects of reality coming to getcha.

mjcOH1's picture

"However....don't forget...even though these pensions should indeed be cut if not eliminated in order for at least a part of the government behemoth to be downsized.....that will be less money going back into the economy when these guys finally retire...if they ever do."

Luckily, the money to pay them isn't being removed from the private sector economy through taxes and inflation. Because that would make paying off the public sector pensioner a zero sum on the economy, and merely a redistribution scheme.

insanelysane's picture

Don't tell this to half the state of Rhode Island and the Providence Plantations.

lolmao500's picture

Time for some Syrian news??

  • Reports #Aleppo says big battles underway as #syria government tries to push back opposition forces. A push was expected post #Qusayr
  • President Assad's cousin Ribal al-Assad tells us US weapons for rebels will start an 'arms race' in #Syria. #FSA
  • BBC's Paul Wood tells us #Syrian #FSA rebels "want mortars, artillery + 'quality' weapons that can bring down an aircraft or helicopter".
  • BBC's Paul Wood says #FSA not as short of ammo as it used to be. Saudis and Qataris have been supplying small arms and ammo. #Syria
  • Desperate times for the rebels in #Syria: "We are in trouble, we are in a lot of trouble now", #FSA commander Gen. Idriss tells us.
  • #FSA commander Gen. Idriss says he fears what happened in Qusair will be repeated in #Aleppo if deliveries of weapons are delayed. #Syria
  • Fierce fighting has been going on for 4 hours around the palace of justice in Aleppo
  • Satellites track 20,000+ Assad & Hezbollah forces converging on Aleppo supported by 100s of tanks and bmp and silka fighting cars
  • Nasrallah says Hezbollah will maintain fight in Syria
  • A senior cleric in Islam's holy city #Mecca has exhorted followers to support Syrian rebels by "all means"
  • Ban Ki-moon, UN Secretary-General, has said there is no military solution to the conflict in #Syria
  • U.S. studying Syria no-fly zone near Jordan border, two senior Western diplomats (Reuters)
  • NATO: chemical arms use in Syria breaks international law (Reuters)
  • #German Chancellor Angela #Merkel has said the UN Security Council should meet urgently to reach a joint position on #Syria
  • NATO data: Assad winning the war for Syrians’ hearts and minds

  • German Intelligence: 95 % Of Free Syrian Army Non-Syrian Extremist Groups

The biggest danger lies in the Arab countries’ help releasing Islamic detainees and sending them to Syria with the aim of Jihad against the Syrian state violating the standards of anti-terrorism Conventions.

  • Naharnet: Saudi King Cuts Short Morocco Vacation amid Unusual Military Measures in Kingdom

The information come amid media reports that the Saudi military command has ordered measures that resemble a state of alert.
According to the reports, the army has suspended the vacations of soldiers amid unusual military moves in the bases that are close to the border with Jordan, especially the Tabuk military base.

  • Here's a map of the 23 places the US will bomb if there's a Syria no fly zone

  • Assad plans to open ‘resistance’ front in Golan, says report

Panafrican Funktron Robot's picture
  • Here's a map of the 23 places the US will bomb if there's a Syria no fly zone

That map was pretty interesting.  Note the Syrian bases located in the Damascus burbs.  Yeah, that won't cause any blowback at all.  

Totentänzerlied's picture

"Saudis and Qataris have been supplying small arms and ammo"

I'm sure the UN is looking into this absolutely incendiary claim.


Totentänzerlied's picture

"The good news is it probably won't be too hard to pull off, given the battered state of Assad's air defenses. The bad news is it could drag the U.S. into a wider war."

The second sentence is pure sarcasm, coming from the person who wrote the first. Zionist warmongers know exactly how this game is played.

wcvarones's picture

Please explain "CALPERS & CALSTRS are functionally at 8% or higher." Calpers is at 7.5%, I think Calstrs is too.