The Next Major Bailout Is The State Pension Crisis

by: Michael Chandler

Just recently, I was reading an interesting article by William Baldwin from Forbes, entitled "Do You Live In A Death Spiral State?" Baldwin compares the states according to the number of "takers and makers" that live there. A taker is classified as a person who draws money from the government as an employee, government pensioner or welfare recipient. A maker is simply someone working in the private sector. He went on to talk about how in 11 states, there are more takers than makers. For example, California has 139 takers for every 100 makers. In Illinois, there are 103 takers for every 100 makers. In states like these, you find the highest state tax rates in the nation.

Texas, on the other hand, has only 82 takers for every 100 makers. After deciding to drill down into these "taker-dominant" states to take a look at their unfunded pension liabilities, I was stunned. I always suspected those liabilities would be a problem, but I had no idea of the magnitude. For example, Illinois has 66 billion in its pension coffers to cover pension obligations of $233 billion. In fact, state pensions in Illinois are 71% underfunded. From this perspective, the best state in the nation is North Carolina, which is underfunded by "only" 37.1 %. Did you get that? The best is 37.1% underfunded.

But we have 50 states, so you may be wondering what these unfunded liabilities add up to. According to the Joint Economic Committee for the Republicans, in a report published September 26, 2012, the total unfunded pension obligation among the states is $2.8 trillion. But according to their calculations, that's not the total liability. They add $627 billion in unfunded healthcare benefits, $55 billion in debt, and $25 billion in Unemployment Insurance Trust Fund Loans, bringing the grand total to $4.2 trillion.

What really grabs my attention is this: many states and localities have regularly skipped or underfunded contributions to their pension plans, even those which have a constitutional mandate to balance their budgets. In the private sector, this would be considered by many as criminal. Illinois is the worst culprit. It has underfunded its pensions by $28 billion over the last 15 years. That money has been spent to shore up other government spending.

A deficit of this size cannot be met by simply raising taxes and cutting spending. A number of these pensions will be completely out of money by 2018... five short years away. How do you suppose this problem will be fixed? You got it! I expect a new federal bailout.

Some might contend the U.S. Government has already set a precedent by bailing out General Motors and Chrysler. But the United Auto Workers union was saved even more dramatically. It was protected by being excluded from taking a "haircut" of the type that all other share holders and bond holders were forced to take in the restructure. And that special treatment for the UAW made it inevitable that the U.S. taxpayer would lose $20 billion on their investment, according to the Heritage Foundation.

Before a bailout comes, there will be some bloodletting. Remember the Gubernatorial race in Wisconsin? It was ugly, to say the least. The collective bargaining agreements are going to be renegotiated as they were there. The unions are pushing for collective bargaining in all of the right-to-work states at the local and state levels. At the same time, just yesterday, I read the great state of Michigan could become our 24th state to become a right-to-work state. In Detroit, the mayor just recently asked President Obama to bail out the city, which for all practical purposes, is already broke. I expect to see some serious clashes between the governments and the unions in the non-right to work states. Stay tuned for some serious arbitration, and some very disappointed people coming down the pipeline.

If in fact these pensions are bailed out, the sums involved would be larger than the bank and the auto bailout combined... which is roughly $4 trillion and growing. Here again, we are faced with an issue that will ultimately need to be resolved, and there is no easy way out. The economic impact of this is the same as it always has been when you rob Peter to pay Paul. This predictable bailout is the coming wave, a wave that will sweep money out of the pockets of consumers and dry up spending and slow an already fragile economy.

As for my friend Mr. Baldwin at Forbes, you're dead on in your article. I suspect at some time, the makers will have to overcome the takers in all those 11 "taker-dominant" states you mention. The ride there, however, will be very bumpy. You have already heard about a software company that has moved from San Francisco to Houston. I suspect many others may follow. To invest in municipal bonds in those 11 states would be speculative at best. I think caution should be taken before any municipal bond investments are made.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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