Pension Shortfalls: Yet Another Time Bomb

The stock market's steep decline is a ticking time bomb for state and local governments and universities that have their employees enrolled in defined benefit plans. Think the Federal Government is the only entity with bailout problems? Think again.

The National Bureau of Economics Research published an article in September 2008 by University of Chicago professors Robert Novy-Marx and Joshua Rauch entitled “The Intergenerational Transfer of Public Pension Promises." In the article, the authors pointed out that the value of Public Promises is $7.9 trillion in the next 15 years. Their belief is that there is a 50% chance of underfunding these pensions by $750 billion and a 25% chance of underfunding these pensions by $1.75 trillion during this time period. One writer recently commented that this underfunding has grown to over $2.5 trillion. Where is this money supposed to come from to pay these obligations?

So, let’s look at the State of California as one example of the looming problems. The State Legislature just came through a bruising battle to solve a $40 billion hole in the State budget. Taxes were raised on sales taxes (up 1%), car license fees (100% increases) and gasoline ($.12 per gallon). The cost to taxpayers is estimated to be over $1,200 per family per year. What we didn’t see in this debate was any discussion of projected shortfalls in pension obligations. The State of California has some of the most powerful employee unions in the United States and pension shortfalls will be huge given the recent drop in the market. How many billions will be required to “top off” these pension funds? It remains a mystery but bears are watching to see how it will impact the state’s deficit.

Now there is a second potential impact to each state. Taking a quick look at public universities and potential pension shortfalls in this sector, we expect to see pension shortfalls of several billion dollars for some of the largest university systems which, in turn, are creating funding stresses for Regents and State Legislators. For instance, the University of California system saw its investments drop by about $6 billion as of June 30, 2008. Facing a funding problem, the California Regents agreed to fund an additional $877 million against an estimated $2 billion short fall. Since the stock market has only gotten worse since June 2008, we can only expect that the University of California pension shortfall will grow larger and will contribute to California’s budget deficit problems. It is safe to say that most other states have the same growing pension funding problem for public employee retirement systems and universities.

Are there any reasonable solutions for this ticking time bomb? It seems as if public pensions will have to be restructured and quickly or face looming bankruptcies in the near future. There are only so many tax dollars that can keep being transferred to unions at the expense of taxpayers that are struggling in a bad economy. Will any of the politicians recognize the problem and begin to make the hard choices needed? I doubt it but we must face it before the citizenry comes unglued.

Comments

[bklyn225:]

The problem is immense but it's day of reckoning is around the corner, maybe 2-3 years. Take Puerto Rico, their pension is greater than 80% underfunded. Over $13 billion in liabilities and maybe $2 billion in assets. Seven percent of the Commmonwealth's population receives benefits. Or consider New Jersey. They have a gaping hole int their pension and have decided to forgo contributions to the plan for the upcoming fiscal year and use the funds to help plug the growing budget deficit!

Mar 25 06:26 AM

[socrateazz:]

Many problems have just been moved down the line to other folk. There will be a clash between peoples beliefs and reality! And reality will win in the end. Note: I am not talking about religious beliefs here but beliefs about expectations and the costs of supplying those expectations as promised. Here are some of the bigger problems I see: Government too big , cumbersome, expensive, and inefective! Medicine: too beaurocratic and direct too much wealth toward too little help. Education: Going from teaching students to little states of propaganda deployment. Are their students coming out educated or propagandized? Taxes; The higher the taxes the less actual wealth there is to create more wealth. Now, Taxes encourage socking monies away in so called investments. Too much wealth is in the hands of the nonproductive and foriegn hands. This countries leaders are mostly inheritors of wealth who have never experienced real capitalism in their life. what can you expect from their decisions? Just what they are doing: Producing and acting on propaganda!

Mar 25 07:37 AM

[China Expert:]

Lets face it..... the unions "want" and the politicians will "give" until the very last day when the problem because a national catastrophe !

Neither the unions, politicians or public think about future problems since their only focus is "ME" and "NOW" !

Mar 25 09:27 AM

[kelm:]

The same issue applies to many major corporations who have legacy pension plans. What I think will happen is we will see these liabilities in some form transfer themselves onto the Federal books further swelling the debt. That will be the first step. At some point the plans will need to be restructured just as Social Security will need to be.

Mar 25 09:31 AM

[markb:]

Like Kelm, I see these liabilities being transferred to Federal books. But neither federal, state or local politicians have what it takes to make difficult decisions on taxes or benefits. So they will print money and everybody shares the pain of inflation. Pensions will be paid as promised and a loaf of bread will cost $12.00.

Mar 25 09:51 AM

[David Roskoph:]

The most productive change produced from this modern depression is the adjustment to retirement expectations. Retiring at 65 is not the 11th Commandment. Indeed 65 hasn't been meaningfully adjusted since it was incepted. In 1935 American mortality was only 58! This "adjustment" has exposed the lie of a financially and medically subsidized, 15 year of retirement. It just ain't so. The challenge will be to re-introduce all those formerly retired folks back into productive roles.

Mar 25 11:16 AM

[baird:]

China,

It's not just the unions, it's all of us who refuse to face some very simple problems in arithmetic, apparently we prefer to scream at each other across the political/philosophical chasms like school children in the locker room. Look at the projections for just social security, medicare and medicaid at about 2040, it's not difficult to understand we either have to reduce the rate of growth of these and any future health care programs and/or raise contribution limits or go bankrupt. It's not complicated, it's a matter of having a bipartisan intelligent adult conversation, but that's very unlikely to happen unless we the people require it of our "leaders"


On Mar 25 09:27 AM China Expert wrote:

> Lets face it..... the unions "want" and the politicians will "give"
> until the very last day when the problem because a national catastrophe
> !
>
> Neither the unions, politicians or public think about future problems
> since their only focus is "ME" and "NOW" !

Mar 25 01:10 PM

[AndrewBaker:]

Defined benefit pensions will be the undoing of many companies and institutions. With markets down over 40% in the past year or so, it will need massive extra funding to bring underfunded schemes up to par, and maybe there just isn't the money available. Europe and the UK are also suffering similarly: UK public employees have inflation proofed pensions which the taxpayer just cannot fund for much longer. When will government realise that the future cost is just too great?

Mar 25 02:52 PM

[henarl:]

Politicians want the votes in the next election and believe that telling the population hard facts that they don't want to hear and making tough decisions that cause pain today will lose them those votes.
They are right about that so they will keep their jobs by continuing to kick the can down the road to the detriment of future generations

Mar 25 03:49 PM