States Take Aim at Pension Costs ...

By: Mike Shedlock | Sun, Jun 20, 2010
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Public Employee Unions on the Defensive; Chris Christie's Freight Train; No One Wants to be Christie's Next Piñata

States are beginning to do something about insanely unaffordable public union benefits. Unfortunately, states are only at the recognition phase and current efforts are a tiny drop in the bucket of pension changes that need to be made.

The New York Times discusses the situation in States Take Aim at Pension Costs.

Many states are acknowledging this year that they have promised pensions they cannot afford and are cutting once-sacrosanct benefits, to appease taxpayers and attack budget deficits.

Illinois raised its retirement age to 67, the highest of any state, and capped public pensions at $106,800 a year. Arizona, New York, Missouri and Mississippi will make people work more years to earn pensions. Virginia is requiring employees to pay into the state pension fund for the first time. New Jersey will not give anyone pension credit unless they work at least 32 hours a week.

But there is a catch: Nearly all of the cuts so far apply only to workers not yet hired. Despite its pension reform, Illinois is still in deep trouble. That vaunted $300 million in immediate savings? The state produced it by giving itself credit now for the much smaller checks it will send retirees many years in the future -- people who must first be hired and then, for full benefits, work until age 67.

Joshua D. Rauh, an associate professor of finance at Northwestern University who studies public pension funds, predicts that at the current rate, Illinois's pension system could run out of money by 2018.

If a state pension fund ran out of money, the state would be legally bound to make good on retirees' benefits. But paying public pensions straight out of general revenue would be ruinous. In Illinois's case, it would consume about half the state's cash every year, bringing other vital state services to a standstill.

Lawyers, though, are raising the possibility that those laws are being misinterpreted.

"An employer is free to move from one legal plan to another legal plan, provided that it does not diminish vested interests," or the benefits workers have already earned, wrote Chief Judge Frank H. Easterbrook of the Seventh Circuit Court of Appeals in Chicago. He did not distinguish between corporate employers and states.

In New Jersey, the administration of Gov. Christopher J. Christie recently imposed pension cuts on future hires, but has been quietly looking into whether it could also reduce the benefits that current employees expect to accumulate in the coming years.

"Can they change the benefit formula going forward? Sure. It's not etched in stone," said Edward Thomson III, an actuary and trustee of the New Jersey pension system who was asked to offer an opinion on whether New Jersey could adopt the federal pension law -- the one that covers companies -- as its governing statute.


Joshua Rauh is an Optimist

Joshua D. Rauh at Northwestern University is an optimist. Illinois will be out of money in some of its pension plans before 2018 because he is assuming 8% rates of return on investments. Flat to negative returns for the next 5 years are certainly possible, and in my opinion, likely.

Rauh has a plan to save the public pension system involving freezing benefits in conjunction with pension bonds. Freezing benefits for new hires certainly needs to be done, but that only helps down the road.

Something needs to be done now, and that means we have to scale back current promises for existing plan members. The union will not like it but so what? Public unions have had it too good, for too long.


Seven State Pension Plans Out of Money by 2020

I repeat what I said in Seven State Pension Plans Out of Money by 2020

Main Points of Agreement

I am certainly in agreement with Professor Rauh that [public] pensions are THE number one thing bankrupting states.

I also agree with Rauh that we need to kill defined benefit plans going forward. Moreover, we really need to go the next step and get rid of public unions altogether. They wrecked Europe and they are wrecking the US.

At a bare minimum, the defined contribution plans and wage scales for public unions should be no better than in the private sector.

However, I cannot support pension bonds even though I understand Rauh's point that "politicians will inevitably cave in and waste loads of money on the bailout... they do it every time."

As I see it, pension bonds are nothing more than a taxpayer sponsored bailout (caving in) in advance. If returns come in at 0% for 5 years, exactly what will the bailout cost?

I would like to see some real numbers here and I do not want taxes to go up one dime to pay for this mess.

Instead I would rather pursue legal option to overturn pension benefits or taxing pensions in excess of $40,000 at some very steep rate. If that fails, I fully support bankruptcy except unfortunately there is no provision for states to declare bankruptcy. However, Congress could pass a law allowing it and perhaps that would scare some sense into the unions.

Privatizing everything in sight might also scare some sense into the unions. If all else fails there is always default. I am a proponent of default over higher taxes.

Something must be done and raising taxes to pay for pension bonds is not that something in my opinion.

Fantasyland Projections

Given that 8% returns are likely Fantasyland material, I believe states will be out of money long before the dates proposed.

The economic headwinds right now are enormous. Those headwinds include massive debt overhang, boomer demographics, global wage arbitrage, massive housing inventory, massive shadow inventory, rising taxes, rampant overcapacity, and structurally high unemployment.

I will ask Rauh to project the numbers at 4%, 0% and -2% rates of return for the next 5 years (numbers I find far more likely than +8%).

In case you missed it, please consider Interactive Map of Public Pension Plans; How Badly Underfunded are the Plans in Your State? based on a report by the American Enterprise Institute showing public pensions are underfunded by more than $3 trillion.


Pension Bonds are Money Losers

As noted in Toxic Pension and Municipal Bonds; State and Local Borrowing Hits All-Time High pension bonds do not work.

As Bloomberg reports, pension bonds have been money losers since 1992.

Worse yet are the current unsustainable pension plan assumptions of 8% coupled with a horrific fundamental backdrop of debt deflation, boomer retirement dynamics, and short-term treasury yields at close to 0%.

It is extremely difficult right now to make money on borrowed money with the above conditions and with short-term treasury yields close to 0%.

Moreover, pension management clowns are nearly always 100% invested, 100% of the time, and typically 100% long. Good luck with that.

If the stock market rises 2-4% annualized for the next five years, that will be a good achievement.

However, borrowing money at 3% and getting a 3% return before interest (netting zero%), while needing 8% is a veritable disaster. Yet 3% annualized is my best case scenario, and I doubt we hit it.

Pension bonds are not the answer.

Please click on the above link for more on pension bonds.


Public Unions on the Defensive

At long last, Public employee unions on the defensive.

Despite record high membership and dues, and years of unparalleled clout in state capitols, public-sector unions find themselves on the defensive, desperately trying to hold onto past gains in the face of a skeptical press and angry voters. So far has the zeitgeist shifted against them that on one recent weekend, government employees were the butt of a "Saturday Night Live" skit, and the next day, a New York Times Magazine cover article proclaimed "The Teachers' Unions' Last Stand."

Public unions' traditional strength - the ability to finance their members' rising pay and benefits through tax increases - has become a liability. Although private-sector unions always have had to worry that consumers will resist rising prices for their goods, public sector unions have benefited from the fact that taxpayers can't choose - they are, in effect, "captive consumers."

At some point, however, voters turn resentful as they sense that:

-- They are underwriting, through their taxes, a level of salary and benefits for government employment that is better than what they and their families have.

-- Government services, from schools to the Department of Motor Vehicles, are not good enough - not for the citizen individually nor the public generally - to justify the high and escalating cost.

We are at that point.


Unions Resort to Fear Mongering

Indeed we are at the point of recognition for the the public. Taxpayers are fed up with giving enormous and unjustified benefits to public sector employees while listening to the unions whine for still more.

Moreover, Union Thugs Resort to Despicable Ads to Garner Support. We are at the stage where the public is so angry that those ads will backfire.

Taxpayers realize this is not "about the kids" but rather about raping taxpayers for the benefit of union thugs.


New Jersey's Freight Train

Fortunately, one governor and one governor along has the courage to confront the unions head on, and in a big way. Please consider Democrats will yield to Christie's freight train

Democrats ruling the Legislature don't want any budget fight with Governor Christie that shuts down state government. The reason is very simple – they'll lose.

There is no way they can beat Republican Governor Christie in a prime-time siege. They know it.

Christie will be center stage on the dais of the Assembly, presiding over a "special" session of the Legislature demanding an end to the crisis.

He would be a star of the cable news cycle, ranting against Democrats as the enemies of reform and deriding them as over-greased cogs of political machines. Democrats lucky enough to be caught on camera will sit defiant and purse-lipped like those aging generals of the 1970s-era Politburo, anemic and indifferent to the empire crumbling around them.

And in the end, they will have to swallow most of his demands, sweetened a little with a few fig-leaf concessions heralded as a "compromise." Christie will win.

Christie news conferences also have brought a new level of suspense to the State House.

No one, including his staff, is really sure what he's going to say, or whom he is going to back-hand in public. The New Jersey Education Association is drubbed as "thugs" one day, and accused of turning students into "drug mules" the next. It also creates the impression that he is at war with the special interests, when in reality, he has simply taken aim at an unsuspected legislator or a patronage hack or union leader.

Nobody wants to be the next Christie piñata. And a government shutdown could turn the whole Democratic Legislature into a herd of piñatas. It's not beyond the Christie pale to call each one of them out by name and Legislative District if a shutdown dragged for a few days. He might even make the case at the entrance of Island Beach State Park, handing out leaflets blaming Democrats for the closed beaches. ....

No One Wants To Be Christie's Next Piñata have written about Chris Christie many times.

March 02, 2010: Governor Christie: "Time to Hold Hands and Jump Off the Cliff" - Chris Christie For President?

March 18, 2010: Governor Christie Calls Unions "Crass Bullies of State Street"; Says Unions Have a Choice "Givebacks or Layoffs"

May 29, 2010: Can Chris Christie Fix New Jersey?

June 06, 2010: Chris Christie on Teachers' Unions, Vouchers, Union Dues, Change: "We are going to lead the way!"; Ron Paul-Chris Christie for President, VP

Chris Christie is a national hero. He is willing to say or do anything to fix New Jersey's budget problems. Christie is exactly what we need at the national level. Instead we are stuck with Obama, an economic illiterate, beholden to public unions.

 


 

Mike Shedlock

Author: Mike Shedlock

Mike Shedlock / Mish
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Mike Shedlock

Michael "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com/ to learn more about wealth management for investors seeking strong performance with low volatility.

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