New Jersey's Pension Crisis: A Canary in the Coal Mine? 30 comments
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In the same way that drivers are compelled to slow down to observe the aftermath of pileups, I find myself fascinated by the slow motion destruction of state and local government finances due to chronic underfunding of pension systems. A toxic combination of gold plated benefits, skipped pension fund contributions, and fanciful investment return projections has resulted in a looming fiscal catastrophe which was evident even before the current recession. The combination of the recession and decades of irresponsible pension policy could easily result in Federal Government bailouts of states and municipalities, bankruptcies, and municipal bond defaults.
Fortune Magazine recently published an article outlining New Jersey’s pension dilemma. Based on the information in this article, it appears that New Jersey could very well be the canary in the coalmine when it comes to the widespread pension crises that threaten to impact states and municipalities throughout the country. For additional background information on the pension crisis, I recommend reading Roger Lowenstein’s recent book While America Aged which I reviewed in February.
New Jersey had a $34 billion shortfall based on a study released in June 2008 which was before the bulk of the decline in the financial markets. Fortune estimates that the plan’s invested assets declined a further $26 billion due to market declines. Of course, pension benefits promised to retirees have not declined due to the fact that benefits are fixed by law. Let’s take a look at New Jersey’s situation and the broader implications for taxpayers, bondholders, and retirees.
Accounting Games
Public sector accounting often allows for assumptions that would not be permitted for a private sector business. The Fortune article on New Jersey outlines a few areas where the state government took actions that severely impair the solvency of the pension funds. Politicians invariably wish to reduce current year contributions to pension funds to avoid the need to cut services or raise taxes. Since benefit levels are set in stone, the only way for politicians to evade fund contributions is to play with the assumptions regarding investment returns.
Investment Practices
Fortune reports that New Jersey’s Pension Revaluation Act of 1992 lifted the projected rate of return on plan assets from 7% to 8.75% which allowed contributions to be cut by $1.5 billion in 1992 and 1993. A year later, another pension reform permitted state and local governments to reduce contributions by an additional $1.5 billion.
Even more outrageous is the fact that the state issued $2.75 billion in bonds in 1997 paying 7.6% interest and then turned around and invested these funds hoping to earn returns that beat the cost of funds. Fortune reports that the actual return on these funds worked out to less than 6%.
Demonstrating uncanny timing, the state decided to invest funds in “alternative investments” in 2006 shortly before the current bear market began. Contrary to the projections of the Wall Street professionals selling these alternative products, the diversification benefits were nowhere to be found during the bear market since the expected negative correlation between alternative investments and the stock and bond market failed to materialize.
Gold Plated Benefits
Over the past two decades, politicians have continued to provide rich benefits to the public sector workers covered by the plans. Fortune reports that New Jersey’s pension liabilities have increased by $6.8 billion over the past decade due to new benefits that have been added since 1999. Essentially, while politicians were trying to figure out ways to reduce contributions to pension plans, they were handing out ever increasing benefits to satisfy powerful public sector unions with significant political influence.
Some of the new benefits include increasing benefit levels by 9% for large groups of government workers and, more outrageously, approving a “20 and out” measure that permits firefighters and local police officers to retire after twenty years of service at 50% of final pay. This implies that workers in their early to mid 40s could be eligible for four of five decades of pension payments.
Regardless of whether one agrees with the idea of gold plated benefits for public sector employees, it should be obvious that if such promises are made, the government should set aside the funds to pay for the obligations. The corrupt aspect of the New Jersey situation is that politicians promised higher benefit levels to satisfy a political constituency while evading the responsibility to fund the promises which hid the true long term cost of the benefits from taxpayers.
Implications for Municipal Bonds
The implications for investors in municipal bonds as well as companies insuring these bonds should be readily apparent. The Federal Government could also be on the hook for municipal bond defaults if an ill advised plan for the Federal Government to insure municipal bonds is enacted into law.
In Warren Buffett’s letter to Berkshire Hathaway (BRK.A) shareholders that accompanied the 2008 annual report, he warned about potential risks for municipal bond insurers that could arise if governments default. More details on Buffett’s comments can be found in an article I wrote at the time the letter was released. The central point of his concern is that municipalities may be more willing to default on obligations if the bonds are insured since a large insurance company would be on the hook for the losses rather than municipal bond investors who tend to be wealthy and influential residents of the state.
As a Berkshire Hathaway shareholder, the more I read about the pension crisis in this country, the more nervous I get about the implications for municipal bond insurers. The political will does not seem to exist that would be required to make the hard choices necessary to fully fund the promises made to public sector workers. New Jersey may be the most extreme current example, but it will not be the last state to face these issues.
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there is a period of an appearance of extravegent wealth as a country is being looted and the taxpayers are raped. obamamama is fulfilling his appointed function. he promised equality and socialism, safety and security he is delivering.
focus you're anger on constitutional restoration. mob violence will play into the hands of statists and result in police state tactics under the excuse of restoring order.
Either way, people are going to be working longer than they had planned. In the first case because their benefits in inflation-adjusted dollars don't go nearly as far, in the second because their benefits are slashed. And considering that Social Security and pension indexing haven't come anywhere close to increases in longevity, that's a good thing. You shouldn't be able to retire at 55 on my nickel anyhow.
California has more welfare programs than the whole world combined.
Since April the fed added $10 tax to a carton of cigarettes, what happen after all the smokers quit or died ? Add more tax to diapers ?
Maybe that's good because people may make less babies.
When voters keep putting the same politicians back to their same old jobs, that's what happen !!
Business and property owners are taxed to death just to support more wasteful programs. The future is not good !!
Expect to see numerous actuaries offering commentary all over the news in the next few years as this "new threat" (which has been 30 years in the making) hits a broad spectrum of the baby boomers as they attempt to retire over the next few years.
Tax increases and pension reform have been the oil and water of state and municipal governments for years. Its tough polical territory to explain why taxes have to rise in the short term to fund a problem that used to be years away....
Now the pigeons are coming home to roost and the train wreck that we have seen in private (what is the PC term now, "legacy costs"?) corporations in the railroad/meat packing (1980's), and steel/airlines (1990's) is now at the door of local governments around the United States.
God help us all.
The political welfare class (from government "union" members to supposedly elected bureaucrats) have been robbing the electorate blind for decades. Dumb Americans just sit there and take it. Heck, we are so stupid we turn around and want to have even more parts of our lives controlled and decided by these criminals.
Obama is supposed to be smarter than Bush -- California is his first real test. If he thinks he can bail out California's welfare government, he will go down in history as the man who started the collapse of the United States.
It took Communist hater Nixon to start a dialog with China. Perhaps a socialist like Obama can reign in the out of control spending and fraud that is government. Based on GM and Chrysler -- he is not off to a good start
Its also impossible to dispute that, once those problems were "fixed", and the Leave It To Beaver generation started -- unions became an absolute nightmare for workers and for the country.
Textiles, steel, airlines, shipping, trucking, auto industries have all been destroyed by unions killing the goose that laid the golden eggs. Limits on changing work rules went from preventing worker injury to preventing any development or change at all. Pension benefits were received now, but somebody else was supposed to pay for them later -- they were always a ponzi scheme.
Union leaders meanwhile have vast office space in Washington DC for "lobbying". The AFL-CIO building is huge, and well staffed. What, besides perpetuating the union bureaucracy does it do?
Now the biggest union nightmare of all -- government employees -- are doing to the U.S. democracy what they already did to the steel, textile, airline and auto industries.
Has there ever been a more coddled, over-paid and under-worked group of individuals EVER? Government employees supposedly get paid 70% of what private sector workers are paid -- but they are only about 10% as productive. They have to work slow and be unproductive to justify such a bloated headcount. Further, the 70% figure doesn't include all sorts of "overtime" scams, double dipping on pensions, shorter working hours, bigger holiday schedule, etc.
These governments and their bureaucratic beneficiaries are acting contrary to the interests of the electorate they purportedly 'serve'. There is a doctrine in international law, used by the US to repudiate Cuba's debt to Spain, called 'odious debt'. When the debt taken on by some governing regime was not used for the benefit of the country or state or city, but was rather used for the benefit of the regime itself, that debt is 'odious' and it is not the responsibility of the taxpaying private sector citizens to pay for it.
So taxpayers rise up! Repudiate the gold-plated labor contracts and pensions of the bureaucrats and their political masters. What have they ever done for you, besides try to micromanage you to death?
On May 22 01:33 PM mwfall wrote:
> government workers should be getting the lowest pay with the lowest
> benefits. wake up taxpayers- you're getting raped.
used to be (and should be now) that high school kids did it for $8.00/ hour. the union garbage is tearing down society- better get rid of it.
Both states have solid infrastucture, and decent tax bases. It is the political misbehavior and pandering that have brought them to this point. NJ's situation is probably more dire, because their problems were acute before the economic turn down.
California, with discipline, will eventually work its way out of its troubles. They have the advantage of a tremendous and dynamic economy. All that is currently lacking is political will.
I fear, however, that Pelosi will influence the BHO administration to bail out CA, continuing a long tradition of California taking more than its share. If that happens, it will continue a long, painful, self-dealing slide down to a USA of political elitism and oppressive socialism...