Last weekend, in our latest report on the unsustainable US public pension system, we quoted Steve Westly, the former California controller and Calpers board member who made a stunning admission about the largest public pension fund in the US, i.e. California Public Employees Retirement System (oddly, his tweet has since been deleted):
"The pension crisis is inching closer by the day. @CalPERS just voted to increase the amount cities must pay to the agency. Cities point to possible insolvency if payments keep rising but CalPERS is near insolvency itself. It may be reform or bailout soon."
The "admission" will not come as a surprise to readers who have followed our series on US public pensions (more recently here, here, here, here, and here) and who are aware that one of the key reasons behind the systematic underfunding of US public pension funds has been the chronic optimism that they can continue to generate outsized investment returns.
Recall that it was only in December 2016 that Calpers voted to lower its earnings projection to 7.0% – it had been 7.5% – hoping to avoid another disaster were the economy to turn sour. Prior to 2016, the last time Calpers lowered its investment expectation was in 2012 when the rate dropped from 7.75% to 7.5%
So while the Sacramento-based CalPERS may be on the verge of insolvency, it is at least taking baby steps to admit it has a problem and to address the "new normal" reality of far lower projected returns (as a reminder, just last month the San Fran Fed concluded that "that the current price-to-earnings ratio predicts approximately zero growth in real equity prices over the next 10 years").
Meanwhile, to the shock and dismay of muni and pension analysts everywhere, Calpers' peer over in Trenton stunned many last week when it decided to go the other direction: on Thursday New Jersey’s acting state treasurer Elizabeth Maher Muolo said that she will increase the expected rate of return for the state’s struggling public pension system which manages over $76 billion in assets, from 7% to 7.5%, "then lower it again over time" in hopes that the recent market surge persists indefinitely into the future and quietly wipes away some of the state's massive underfunding.
The announcement prompted Bloomberg's Muni expert Joe Mysak to simply exclaim that "this is madness."
The accounting switch to a higher assumed rate means that the state, and participating local governments in New Jersey, will for now escape the higher costs that arise when investment return assumptions are lowered.
This accounting sleight of hand comes at a "fortuitous time" for new New Jersey Governor Phil Murphy, who took office in January and is facing a major funding shortfall ahead of his first budget proposal in mid-March.
The higher rate - based on nothing but the Treasurer's sheer optimism - will save about $238 million for the state and more than $400 million for local governments in the near term, according to Reuters. Of course, in reality it won't "save anything", and will merely defer the moment when the state's pension fund finally has to admit that its participants are either looking at a massive haircut, or state taxpayers will have to bail it out.
State Sen. Anthony R. Bucco, R-Boonton Township, blasted Muoio's pension change, noting that the Christie administration’s moves to lower the assumed rate of return to 7% in steps from a high of 8.25% was praised by actuaries and ratings agencies. He said “rosier assumptions” would result in lower required payments into the pension funds.
“Our pension funds got into bad shape by making overly optimistic projections on the rate of return that we could expect,” said Bucco in a statement. “We need to stay the course and keep making the biggest pension payments that we can.”
New Jersey's heavy pension burden has weighed heavily on the state, playing a major role in 11 rating downgrades from 2010 to 2017. The Garden State has general obligation bond ratings of A3 from Moody’s Investors Service, A-minus from S&P Global Ratings and A from Fitch Ratings and Kroll Bond Rating Agency.
According to Bond Buyer, Moody's analyst Tom Aaron said that the revised assumptions are a "a relative credit negative" for New Jersey because they are higher than other large public pension funds. Aaron said Moody's generally views the lowering of pension fund investment return assumptions as a credit positive for the sponsoring government.
"Lower return assumptions tend to force more contributions by governments, and sooner," said Aaron. "While initially more expensive, front-loaded contributions mean less long-term risk that unaffordable unfunded liabilities will accumulate."
Meanwhile, as New Jersey is bucking the trend adopted by virtually all other states who like Calpers are gradually reducing their expected returns, in the process raising the amount of capital that has to be raised by "other means" to satisfy pension promises, the Pew Charitable Trusts’ public sector retirement systems project found that investment returns that fell short of assumptions were the biggest contributor to worsening financial positions of the pension plans studied.
Furthermore, Pew found that New Jersey has the worst pension funding level of the 50 U.S. states at only 37% for the 2015 fiscal year.
Ultimately, Jersey is simply hoping that the recent market euphoria will persist: while Muoio is moving New Jersey’s rate up beginning in fiscal 2019, her plan will then step down the rate over the following five years, falling back to 7% in fiscal 2023.
The change took place just month after former Treasurer Ford Scudder cut the pension funds’ rate of return to 7% from 7.65% in November, but Muoio - who was appointed by Chris Christie's replacement Phil Murphy - said that move was too drastic and would saddle local governments with heavy additional costs.
Instead, the logic supposedly goes, it's best to pretend there is no problem and just hope the central banks can keep pushing stocks higher indefinitely: “A gradual path to a lower rate will help mitigate the undue stress that would otherwise have been placed on local governments,” Muoio said.
And who knows: maybe they can pull it off. New Jersey’s five main pension funds, which as noted above were responsible for nearly $76 billion in pensions, performed well in fiscal 2017, returning 13.07% according to a February report from the state investment council. Unfortunately, that strong performance followed 2016, when the funds lost nearly 1 percent net of fees. The funds’ 20-year annualized return was 6.79 percent.
But here's the bad news: even if the fund manages to return 7.5% for the next 4 years, Jersey pensioners are still out of luck: according to the state Treasury's annual report, the pension system's total funded ratio is a shocking 49%. Indicatively, a ratio of at least 80% is often considered healthy.
Meanwhile, New Jersey state workers are realistically looking at a "half-off" haircut on the post-retirement income that was promised to them.
One wonders if when this latest act of desperation fails, whether the final Hail (or rather fail) Mary for the various members of America's insolvent pension system will be to put all their cash in cryptocurrencies and pray...