Monday, October 17, 2016

"Public Pensions: Promises Promises"

Sydney M. Williams

Thought of the Day
“Public Pensions: Promises Promises”
October 17, 2016

“You made me promises promises
Knowing I’d believe
Promises promises
You knew you’d never keep.”
                                                                                             From the Neil Simon musical “Promises Promises” – 1968
                                                                                             Lyrics by Hal David
                                                                                             Score by Burt Bacharach

The end of liberalism is not an original thought, but it is a possibility. In 1969 (revised in 1979), Theodore J. Lowi, professor of government at Cornell, published The End of Liberalism: The Second Republic of the United States. He argued that government had become too big and that interest groups had caused Congress to cede responsibilities to unelected (and, in some cases, unaccountable) agencies. These agencies, including the Environmental Protection Agency (EPA) and the Consumer Financial Protection Bureau (CFPB), control more than a trillion dollars in annual expenditures – almost 25% of all federal spending. Ironically for Democrats, special interest groups have created another problem – they compete with unionized government, and the demands public-sector retirees exact from American taxpayers.

Today, global progressives see the end of liberalism in the rise of nativism, xenophobia and populism – manifested in decisions such as Brexit, the Republican nomination of Trump and the Colombia-FARC Accord. It is seen in the failure of the Arab Spring and the resurgence of Putin’s Russia and Xi’s China. Conservatives bemoan the unraveling of liberal values, which date to the age of enlightenment – the acceptance of anti-Western ideologies, cultural and moral relativism, and political correctness. The latter denies language from being used as it was intended – to accurately describe people, their actions and events.

I do not pretend to know if “liberalism” is at an end. What I believe is that big, activist government is being hoisted with its own petard. Promises have been made that will prove impossible to keep. Activist government was conceived in the belief that equality of outcomes supersedes that of opportunity. In the United States, “big” government was born during the New Deal, reached maturity in LBJ’s Great Society, and has come into senescence with ObamaCare and the CFPB; it is seen in the Administration’s videos: “Life of Julia” and “Pajama Boy.” The factors progressives cite allow them to ignore what seems an inevitability – that promises politicians made to those who elected them will not be possible to keep.

This is a world-wide problem, moving in slow-motion toward crisis. Citigroup recently identified nine countries where public sector pension liabilities (not included in debt figures) exceed more than 300% of their respective GDP – Austria, Britain, Denmark, France, Germany, Italy, Poland, Portugal and Spain. 

Progressives talk of “fairness,” when the conversation should be about saving a foundering ship. They talk of the one-percent not paying their “fair share,” when, in fact, they pay half of all federal income taxes. They say government is the answer, when what is needed is faster economic growth – requiring less regulation and flatter, lower tax rates, less government. They want to protect young people from “harmful words,” to grow up without the challenges and hardships that are part of everyday life. They find “victimization” everywhere, and then wonder why civility has receded.

The consequence of Goldilocks-like promises are most prominent in the public pension arena. Last Monday, the New York Times ran the story of tiny (700 people) Loyalton, California, a small town with four retired public employees. In 2012, the town opted out of CalPERS (California Public Employees Retirement System), because the annual cost of $30,000 was crimping their budget. CalPERS then sent the town a bill for $1,600,000 to fully fund the pensions of the four retirees, else annual pension payments would be reduced by about 60 percent. CalPERS only fully funds pension plans when a participant chooses to leave. They assume (probably correctly) that if an exception is made to Loyalton, the rest of the 3,007 participating governments will want similar treatment. Four people and the forgiveness of $1,600,000 doesn’t seem like much for a fund with total assets of $290 billion. But, could CalPERS afford to treat the other 560,000 retired public pensioners as liberally? Should contract law be abrogated so dismissively?

In August, Pensions & Investments wrote of a Pension Finance Task Force (PFTF), a joint effort created by the American Academy of Actuaries (AAA) and the Society of Actuaries (SoA).  The task force was not allowed to publish their findings. They had concluded that, since public pension plans are purported to be default-free obligations, they should use default-free interest rates when determining the discount rate to estimate returns and calculate future obligations. For example, the risk-free yield on the 30-Year Treasury is 2.5 percent. Yet the current actuarial practice is to use 7.5 percent. The more conservative number would add significantly to liabilities.  The Economist recently suggested that using a discount rate of 4% would mean that the average public pension fund would have a funding ratio of 45%, not the 72% used by the Center for Retirement Research. Using the higher rate makes funding look less of a problem than it is. It is delusional, at a time when $12 trillion in global debt has been issued at negative interest rates.

This is a big problem. Five states – Connecticut, Massachusetts, New Jersey, Illinois and Kentucky – have the largest unfunded liabilities. New Jersey has the highest pension debt per resident: $15,000. The underfunded portion of Illinois pensions has increased 500% since 1995, and 75% in the past five years! Scranton (PA) city auditors calculated that police and fire pension funds will be depleted in three to five years. If the discount rate used was actually the Thirty-year Treasury, estimates suggest the shortfall would exceed $3 trillion, instead of the $968 billion reported for fiscal 2013. Stephen Moore, writing in Investors’ Business Daily two years ago, put the unfunded number between one and five trillion dollars.

There are no easy solutions for a country with generous public retirement benefits and an aging population, apart from simply expunging the elderly, an unappealing suggestion to me. The best option – grow the economy. Other measures include: an increase in tax rates, which would hamper economic growth; raise retirement ages, which would further worsen youth employment; reduce contractually agreed-to pension payments, which may be illegal; convert existing and future plans from defined benefit to defined contribution plans, which will have to be done. It will probably take some combination. It is not unionization per se that is the problem. It is the willingness of politicians to make promises they cannot keep. Unions, though, are not innocent. In 2014, four public sector unions (NEA, AFT, SEIU and the AFSC&ME) contributed $85.6 million to political campaigns, with all but $210,000 going to profligate Democrats.

ObamaCare has made entitlements costlier. Debt, will increase should Hillary Clinton’s plan to provide free public college education be adopted. Debt and pension obligations have hampered infrastructure rebuild and military preparedness. They are a reason the Fed has kept interest rates so low. God help us, should we again face a crisis as we did in 1941, 2001 and 2008. Politicians should address these concerns. Thus far they have chosen a broom and a carpet.

Promises promises you knew you’d never keep.” But at some point the piper must be paid.

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