When it comes to state and local government crises, Illinois and Chicago, respectively, have become the poster children for what not to do if you want to be considered fiscally responsible.
Illinois’ budget crisis was thrust into the national spotlight earlier this year when a State Supreme Court struck down a pension reform bid, setting off a series of events which culminated in Moody’s downgrading the city of Chicago to junk.
From there, the nation media picked up on the story, leading to all sorts of amusing coverage including several pieces documenting the plight of Illinois lottery “winners” who the state began paying in IOUs thanks to the fact that Springfield couldn’t pass a budget even with the help of $30,000/month “guru” and Laffer disciple Donna Arduin.
The fiasco culminated in the October announcement by Comptroller Leslie Geissler Munger that the state would miss a $560 million pension payment in November. As a reminder, here’s a look at Illinois pension problem:
Now, as WSJ reports, cracks are starting to show in Houston, where public sector pension plans have been underfunded for years. Here’s more:
Houston is weathering a prolonged plunge in oil prices, but the city may have an even bigger problem: its pensions.
Though economic growth has only slowed, not stalled, in Texas’ largest city, its finances are showing what several investors and analysts describe as warning signs.
Those include a rapidly growing gap in funding its retirement plans for public workers and a limit on its revenue-raising capabilities imposed by a voter-approved cap on property taxes.
The $3.2 billion pension-funding gap is threatening Houston’s Aa2 credit rating from Moody’s Investors Service, hurting demand for its debt and emerging as an issue in the city’s mayoral race.
Moody’s this summer warned it may downgrade the city’s debt if Houston fails to address its pensions, noting the cap limits the city’s financial flexibility.
A downgrade could lower prices for outstanding bonds and increase Houston’s borrowing costs at a time when it needs improved infrastructure.
And as we’ve documented extensively, this is a growing problem in America:
Houston is the latest U.S. city to face threats from credit-rating firms and investors over bulging pension obligations. Investors have grown concerned about state and local governments’ ability to address unfunded retirement costs. Examples include Chicago and the states of Illinois and Connecticut, whose unfunded retirement costs have ballooned after investing losses from the 2008 financial crisis and chronic underpayments by policy makers.
“Correcting” the problem means either, i) increasing revenue, i.e. raising taxes, or ii) cutting back on public services.
Houston residents are reluctant to support any tax increases [but] unsustainable pension costs have contributed to reductions in hiring of police officers and spending on pothole repairs.
Of course the situation isn’t helped by the ubiquitous (among public sector plans) practice of using outrageously optimistic return assumptions:
Among other concerns, the city’s plans assume relatively high investment returns of 8% or above, meaning the funding gap may be understated, said Marc Watts, chairman of the Greater Houston Partnership’s Municipal Finance Task Force.
Yes, “relatively high investment returns,” as in, “returns that in today’s world can’t possibly be generated by anything that even approximates a conservative mix of assets.” Of course Moody's is not a fan of these type of assumptions. As we documented back in June, after 2008, Moody’s stopped relying on the investment return assumptions of cities and states opting instead to use its own models. Unsurprisingly, this led the ratings agency to adopt a much less favorable view of state and local government finances.
And while some city officials claim concerns are overblown, a more realistic assessment seems to be that sooner or later, perpetually borrowing from the future will catch up to the city and as we saw with Chicago, Moody's isn't exactly shy about pulling the trigger lately. Don't forget, one energy job generally creates the purchasing power of three non-energy jobs, which, in the face of a prolonged slump in crude, doesn't bode well for Houston's economy. We'll leave you with the following from John Bonnell, senior portfolio manager of tax-exempt investments with San Antonio-based USAA Investments who spoke to WSJ:
“If they end up doing nothing to address this budget issue, 10 years from now Houston could be facing the same problem Chicago is now."