Earlier this week, we reported of an daunting predicament facing the dramatically underfunded Illinois Teachers Retirement System (TRS), the state's largest pension fund which is only 41.5% funded: cut its existing future returns assumption from 7.5% to 7.0% (which was previously lowered from 8.0% in 2014) and suffer the wrath of the state's governor Bruce Rauner, who would be forced to implement even more unpopular tax hikes, or keep its existing projected returns, and potentially suffer an even greater shortfall - and greater taxpayer funding needs - over the long-run if it was unable to hit its bogey.
Despite tremendous political pressure, on Friday afternoon, the Board of Trustees for the Illinois Teachers’ Retirement System, which serves almost 400,000 teachers, voted to cut the assumed rate of return to 7% from 7.5%. "We have to do what we believe is the right thing,” Richard Ingram, the pension’s executive director, said during the board meeting in Springfield.
As a reminder, Illinois' fiscal 2017 pension payment to its five retirement systems was estimated at $7.9 billion, up from $7.6 billion in fiscal 2016 and $6.9 billion in fiscal 2015, according to a March report by a bipartisan legislative commission. The country's fifth-largest state's unfunded pension liability stood at $111 billion at the end of fiscal 2015, with TRS accounting for more than 55 percent of that gap.
This is how the Chicago Tribune summarized the Pension Fund's dilemma:
"if the board voted for the 7 percent figure, state government would be on the hook to make up the difference, estimated to cost an extra $400 million to $500 million a year, an expense that would come due starting in July. The governor and lawmakers would have to find that extra money, worsening a state budget that's already in free fall amid a budget impasse that's lasted more than a year. Alternatively, if the board voted for the 7.5 percent figure, the state would not have had to pay all of that extra money right away. But if investments failed to hit the benchmark, the shortfall would have been tacked on to the pension fund's $65 billion debt. Taxpayers would be hit either way; the question was whether it would be in the short term or long term."
Needless to say, fearing a popular revulsion, Gov. Bruce Rauner wanted TRS to delay the decision, which was "odd position for him to be in" considering Rauner has long criticized state and city government for kicking the can down the road on financial issues, and yet that's precisely what he was advocating as he tried to delay the teacher pension decision.
To be sure, the chronic under-funding of the pension system is not Rauner's doing and predates him: TRS was created in 1939, and in no year since then has the system received enough money from the state to keep it fully funded. However, when push came to shove, and when the governor's office learned that the change was afoot, his team mounted an effort to block it, firing off memos that warned of a secretive attempt by the TRS board to saddle taxpayers with a new, unaffordable expense.
As a result, Michael Mahoney, Rauner's senior advisor for revenue and pensions, unleashed the "fire and brimstone" scenario, writing to the governor’s chief of staff, Richard Goldberg. "If the (TRS) board were to approve a lower assumed rate of return taxpayers will be automatically and immediately on the hook for potentially hundreds of millions of dollars in higher taxes or reduced services," Mahoney also cautioned that "unforeseen and unknown automatic cost increases will have a devastating impact on the state’s ability to provide adequate resources to social service programs and education,” and would lead to "crippling" tax hikes.
This is how we simplied the verbal pressure the fund was facing from politicians:
"please keep your heads stuck in the sand, and dare not admit the reality of near-zero returns in the new normal, but instead keep the projected return rate at 7.5%, or else you will not only admit just how much bigger the underfunding hole truly is, but the resultant surge in public anger following the broad rise in taxes coupled with cuts to pensioner benefits could lead to millions of furious voters sweeping all of Illinois' current career politicians right into the unemployment office."
When the verbal threats failed, as trustees prepared to consider the question Friday morning, Rauner attempted to stack the board with allies by appointing new trustees to fill three vacancies the Tribune adds. Had that move been successful, Rauner may have had a majority of the votes on the board. It's made up of 13 members — six trustees appointed by the governor and six chosen by pension system members, and it is chaired by the state superintendent of schools, also an appointee of the governor.
Bruce Rauner and his wife Diana
However, Rauner erred by attempting to fill one of those seats with a person who hailed from Chicago. State law requires that appointees reside in an area that is covered by the retirement system. Chicago teachers have their own pension system and aren't covered by TRS. Rauner's staff said the erroneous appointment was the result of a "miscommunication" and withdrew it. As a result, just 12 trustees were seated for the Friday vote. Ten voted in favor of lowering the expectations on returns, while Rauner's two new appointees abstained.
As a result, the TRS voted to lower its long-term return estimate to 7%, "given widespread belief that retirement funds won't continue to perform as well as they have in recent years."
Naturally, Rauner was furious. His spokesman Lance Trover blasted the decision as a blow to taxpayers, and questioned whether legal requirements to provide advance notice of such a meeting had been met.
"With less than two hours' notice, Illinois taxpayers including our social service providers and small business owners were just handed a bill for nearly a half-billion dollars," Trover said in a statement. "While questions remain about the legality of today's action, it further underscores the need for real pension reform in Illinois."
The irony deepens because, as the Tribune notes, Rauner - a wealthy PE executive - sold himself to voters as a businessman with the financial discipline to right Illinois' ship. That the first-term governor found himself on the other side of that message by resisting calls to better fund a historically shortchanged pension fund was an indication of Rauner's continued struggle to grapple with the pressures of governing when they run up against his political promises.
He won't be the last.
Meanwhile, even Rauner's allies on the TRS board were convinced that the financially responsible move was to lower expectations and start sending more dollars to the pension fund. The vote came after an actuary chided the trustees for the state's poor funding of its pension systems. "When you're paying a bill off, you want to at least make some progress toward paying the bill off," said Kim Nicholl, an actuary with Segal Consulting, who lamented that in Illinois "your bill keeps getting bigger and bigger each year."
In what was one of the more somber analogies, Nicholl said that "at some point, it starts to come down. But it would be like taking out a 30-year mortgage on your home and then not paying your mortgage payment so that at the end of the year you have to take out a bigger loan and then start paying it again."
Sadly, in a world of low returns, there is no simple explanation; in fact, as we put it several weeks ago, it is an "unsolvable math problem" in a world of ZIRP and NIRP, and as the Tribune said "Taxpayers would be hit either way; the question was whether it would be in the short term or long term."
Perhaps the biggest surprise is that Illinois politicans decided on a short-term hit, despite knowing that by deciding to make pensioners whole on legacy funding promises, they put their own careers in jeopardy as the taxpayer blowback would be swift and merciless to the existing administration.
Finally, as we concluded earlier this week, "this is precisely the fight that countless ponzi schemes, pardon pension funds, across the US will be forced to go through in the coming months, unless somehow the Fed funds a way to guarantee 8% returns every year, or else sending inflation soaring, and wiping out the fund's liabilities."
For now, however, the "hit" will end up as a new line item to local tax bills, first in Illinois then everywhere else, as the gradual bailout of pension funds by taxpayers across the nation (and then, the world) begins.