America’s public pension plans were already on shaky ground well before the nation got swept with COVID-19 fever. But like Social Security and Medicare, the system’s fragility has been exacerbated and exposed due to the pandemic, from California to New Jersey. Will Congress or the Federal Reserve come to state and municipal governments’ rescue with bailouts to cover their deficits and insolvency prospects? As the old Cole Porter tune says, “Anything Goes.” That could be the nation’s new anthem.
Ghosts of Our Pasts
State and local government pensions just endured their worst quarter since the Great Recession more than a decade ago, further amplifying the system’s hemorrhaging and fiscal hardship. According to a new study by the Wilshire Trust Universe Comparison Service, the median government employee pension lost a median 13.2% in the January-March period, which is a little bit more than the fourth-quarter plunge in 2008. Since July 1, these retirement plans have lost an overall 8%.
This is devastating news for state and local governments facing budget shortfalls the size of the San Andreas Fault. Some estimates suggest they could face funding gaps of as much as $650 billion over the next three years, and many public pensions will fall short of their assumed annual return targets of 7%.
States and cities will only have a handful of options that would need to be implemented permanently: boost funding, raise employee contributions, suspend cost-of-living adjustments, or reduce payments. Whatever happens, politicians will inevitably choose to add to their unfunded liabilities, leaving the bloodshed to the next generation of leaders and taxpayers.
S&P Global Ratings noted in a recent report that these retirement schemes typically phase in extra contributions when returns fail to meet their projections. The average funded ratio – a pension fund’s current financial position between assets and liabilities – is about 73%. This figure could slump to as low as 60% should these schemes fail to record a 30% Q2 return. It is anybody’s guess if it is attainable.
But do not be fooled into thinking that this dire situation is only because of the Coronavirus. For years, governments have been kicking the can down the road and refused to address their unfunded pensions that are failing to keep pace with the benefits owed to civil servants. How bad is it? Moody’s Investors Service estimated that they are unfunded by $4.4 trillion. This could easily eclipse $5 trillion by next year as the outbreak decimates budgets everywhere, says Pew Charitable Trusts.
California Makes the First Move
Politicians have overpromised in their quest to rise to power, promising firefighters and sanitation workers the moon. What makes matters worse is that they have failed to tackle the problem, explained Olivia Mitchell, a professor of business economics and public policy at Wharton, in 2018.
“Every year that goes by leads to more red ink and more concern because the state and local plans across the country have clearly not done what they should have done to contribute the right amounts, to invest their assets in their pension plans carefully and thoughtfully. Older folks are living longer and needing more medical care, needing longer retirement benefits. It’s a series of challenges that, frankly, nobody is paying much attention to.”
After years of neglecting the problem in front of them, they will be forced to tackle the issue.
In California, Governor Gavin Newsom (D) proposed to alter the $203 billion budget to combat the $54 billion deficit. He has announced several measures to combat his fiscal calamity, including the removal of $2.4 billion in supplemental payments to CalPERS and CalSTRS, the state’s largest public pension plans. This could be devastating for the California Public Employees’ Retirement System since it lost $69 billion from the market chaos in March. The Golden State already possessed one of the nation’s largest public pension shortfalls.
Is it any surprise why former Governor Jerry Brown (D) warned of “darkness, uncertainty, decline, and recession” in his final state budget remarks?
But Gov. Newsom’s latest actions could be the new normal for a long time for a lot of states and localities, particularly those that are already in trouble. Illinois, for instance, spends one in five tax dollars to cover its pensions, but people are fleeing the Land of Lincoln. New Jersey’s public worker pension system is still considered the worst in the country due to its more than $100 billion in unfunded liabilities. The most likely scenario among governors and mayors is to defer costs to ensure budgetary flexibility to mitigate the crisis. By doing this, officials add to their long-term pension obligations, which are already massively bloated.
In the end, it will be the taxpayers in the private sector who will need to foot the bill and pay for the mistakes of yesterday’s leaders. They will also be mandated to cover the exorbitant amount of spending at all levels of government, plus the interest on the accrued debt. Suffice it to say, Americans will eventually be tapped out – if they are not already. How is that fair?
Toss A Bone
All states and cities will be cash-strapped for many years to come, but the ones that have immense budget shortfalls, missed revenue projections, and incompetent leadership will suffer the most. They can only hope that Congress or the Federal Reserve will throw them a multi-billion-dollar bone to survive until tomorrow. If the central bank is willing to scoop up state and municipal bonds, then why would it sit on the sidelines as this potential tsunami engulfs the nation? If not, politicians will need to make some tough choices that could perturb the ever-powerful public sector unions. As most leaders know, you never irk these folks – they have the time, resources, and media support to protest and march all day long on your tax dollars.
Read more from Andrew Moran.
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