Commentary: Study calls for “drastic reform” of public pension regulation
Published: June 1st, 2012
Politicians are forcing public pensions to take more risks with taxpayer money and public workers’ retirements. Recent accounting reforms actually will make the crisis worse, according to a study just released by three economists. They call for “drastic reform.” Congress actually has the power to impose something drastic now.
According to “Pension Fund Asset Allocation and Liability Discount Rates: Camouflage and Reckless Risk Taking by U.S. Public Plans?” posted Tuesday (May 29) on the Social Science Research Network, “current laws and regulations effectively exempt states and cities from behaving prudently in how they manage and disclose the financing of pension systems of their employees.”
The result is “… camouflaging and risky behavior of U.S. public pension plans seems driven by the conflict of interest between current and future stakeholders, and could result in significant costs to future workers and taxpayers.”
This report comes as a comprehensive study by the Center for Retirement Research calculates the 126 largest plans have only half the money they need to pay promised pension benefits.
“The Funding of State and Local Pensions: 2011-2015” says that while official funding is 75 percent, and “… the funded ratio is projected to remain steady next year and then gradually improve as the market meltdown is phased out of the calculations …,” real numbers reveal how bad the pension crisis really is.
Calculating “… liabilities using the riskless rate, as advocated by most economists for reporting purposes … shows an aggregate funded ratio in 2011 of 50 percent.”
The difference between the 8 percent investment return pushed by politicians — so they don’t have to invest more taxpayer money in pensions now — and the “riskless” 4 percent return economists say is based on reality, is what pushes pension boards to bet on long shots.
Taxpayers are on the hook when those bets go bad because, unlike private pensions and 401(k) plans, full public pension benefits are guaranteed. Now public pensions are betting they will average about 10 percent return a year every year for the next 30 years, and there never will be another market downturn.
If investments fall short, generations of citizens who face destitution in old age will get hit with higher taxes to pay twice for public pensions.
According to the SSRN study, “Our findings indicate that in a highly politicized setting and a tough economic environment … U.S. public pension funds willingly made strategic decisions … (that) … may have a large negative impact for future stakeholders and taxpayers. In sum, we argue that U.S. policy pertaining to public pension funds needs drastic reform and to be brought in line with regulations pertaining to U.S. corporate pension funds … .”
They point out that lack of oversight and regulation allows politicians to short pension contributions by rigging the numbers.
Recent efforts by the Government Accounting Standards Board (GASB) to recommend more honesty in pension bookkeeping may backfire: “ … the new GASB proposals would create even stronger incentives to camouflage liabilities and engage in reckless risk-taking for funds that are close to being underfunded. …”
The study compares municipal and state policy with public funds in Europe and private companies in the U.S.
“We find that U.S. public pension funds behave different from all other pension funds and not in line with economic theory. … Hence, a major worry is that their increased risk-taking is reckless and could lead to substantial future costs to taxpayers or public entities if their more volatile risky investments fail to meet the expected rates of return.
“U.S. public funds are unique in not choosing more conservative asset allocations and not choosing lower discount rates as their client base matures. These decisions by the boards of U.S. public DB (defined benefit) pension funds have large economic effects and could have potentially severe future consequences.”
Bad policy “… amplifies the risk that DB plans will run out of assets before they run out of liabilities …”
Nobody knows what will happen when the money runs out and citizens refuse to pay higher taxes for reduced government services.
Recent studies by the Harvard Kenney School Mossavar-Rahmani Center and the Federal Reserve Bank of Cleveland prove all municipal and state pension funds will run out of money without immediate radical reforms and “huge” future tax increases.
Taxpayers owe state and municipal employees more than $4 trillion based on the most recent realistic calculations.
Politicians push the lower official funding shortfall number — still about $900 billion, according to the CRR study — so they can stiff public workers on pension contributions.
And then they don’t even contribute that entire artificially lowered amount. According to CRR, states only kicked in about 79 percent of what they said they owed in 2011.
What we end up with is public policy that hides trillions of dollars in debt, puts 27 million public workers and retirees at risk of poverty and actually encourages the risky, reckless behavior that caused this municipal and state pension crisis in the first place.
Now is the time for drastic reform from the top. Even though the federal government cannot run — or bail out — municipal and state pension systems, they must operate under laws, rules and regulations of the Internal Revenue Service.
Even our dysfunctional Congress should adopt standards already routinely in use by pension funds around the world, then let the IRS enforce them.
For more information on public pension funds and risk, take a look at these earlier analyses:
Note: Frank Keegan is editor of Statebudgetsolutions.org, a project of sunshinereview.org. The State Budget Solutions Project is nonpartisan, positive, pro-reform, proactive and anchored in fundamental-systemic solutions. The goal is to successfully engage political journalists/bloggers, state officials and opinion leaders in a new way of thinking about state government and budgets, fundamental reforms, transparency and accountability. This article is adapted from Watchdog.org