Stephanie A. Miner, the Mayor of Syracuse NY, has an important op-ed essay in The NY Times Thursday. Syracuse is one of hundreds of cities around the state and tens of thousands around the country that are struggling with the potentially disastrous effects of out-of-control pension costs. Where this crisis is heading can be seen in California, where San Bernadino has become the third California city to declare bankruptcy. These cities are dying. They are caught in a bind. Either they decide not to pay their promised debts to pensioners; or, in honoring those debts, they so fully raise taxes and cut services as to ruin the lives of their citizens.
In Syracuse, Mayor Miner understands well the depth of the problem. First, public employee labor costs are too high not because salaries are high, but because pension costs and medical benefits are rising without limit. Second, revenues are being slashed, both from the recession and from cutbacks from the state and federal governments. Finally, the middle and upper class flight from cities to suburbs have left the tax base in cities low at the moment when poorer city dwellers are disproportionately in need of public services.
The result is that cities are faced with a stark choice: Do they pay older citizens what has been promised to them? Or do they cut those promised pensions in order to provide services for the young? This is a generational conflict that is playing out across the country.
Miner is worried that the response by NY State is making the problem worse. In short, Governor Cuomo and the legislature have decided to let cities that cannot afford to fund their burgeoning pension obligations borrow money to pay those pensions. The kicker is, that the cities are being told to borrow money from the very same pension plan to which they owe money.
If this sounds suspicious, it is. As Danny Hakim—one of the best financial reporters around—wrote almost exactly one year ago in the NY Times, this is a desperate and dangerous move:
When New York State officials agreed to allow local governments to use an unusual borrowing plan to put off a portion of their pension obligations, fiscal watchdogs scoffed at the arrangement, calling it irresponsible and unwise.
And now, their fears are being realized: cities throughout the state, wealthy towns such as Southampton and East Hampton, counties like Nassau and Suffolk, and other public employers like the Westchester Medical Center and the New York Public Library are all managing their rising pension bills by borrowing from the very same $140 billion pension fund to which they owe money.
The state’s borrowing plan allows public employers to reduce their pension contributions in the short term in exchange for higher payments over the long term. Public pension funds around the country assume a certain rate of return every year and, despite the market gains over the last few years, are still straining to make up for steep investment losses incurred in the 2008 financial crisis, requiring governments to contribute more to keep pension systems afloat.
Supporters argue that the borrowing plan makes it possible for governments in New York to “smooth” their annual pension contributions to get through this prolonged period of market volatility.
Critics say it is a budgetary sleight-of-hand that simply kicks pension costs down the road.
Borrowing from the state pension plan to pay municipal pension costs is simply failing to pay the pensions this year and thus having to pay more next year.
Hakim, as good as he is, allows Thomas P. DiNapoli—the state’s comptroller—to get away with calling the scheme “amortization.”
The state’s comptroller, Thomas P. DiNapoli, said in a statement, “While the state’s pension fund is one of the strongest performers in the country, costs have increased due to the Wall Street meltdown.” He added that “amortizing pension costs is an option for some local governments to manage cash flow and to budget for long-term pension costs in good and bad times.”
But how is this amortization? The assumption or hope is that the market will rise, the pension fund will go up, and then the municipalities will owe less. That is hardly amortization. No, it is desperate speculation with public monies.
The crisis in our cities afflicts the whole country, according to a study by the Pew Center on the States.
Cities employing nearly half of U.S. municipal workers saw their pension and retiree health-care funding levels fall from 79% in fiscal year 2007 to 74% in fiscal year 2009, using the latest available data, according to the Pew Center on the States. Pension systems are considered healthy if they are 80% funded.
The reason to pay attention to the problems in cities is that cities have even less ability to solve their pension shortfalls than states. The smaller the population, the more a city would have to tax each citizen in order to help pay for the pensions of its retired public workers. The result is that either cities get bailed out by states and lose their independence (as is happening in Michigan) or the cities file for bankruptcy (as is happening in California).
Mayor Miner, a Democrat, takes a huge risk in standing up to the Governor and the legislature. She is rightly insisting that they stop hiding from our national addiction to the crack-cocaine of unaffordable guaranteed lifetime pensions. Piling unpayable debts upon our cities will, in the end, bankrupt these cities. And it will continue the flight to the suburbs and the hollowing out of the urban core of America. Above all, it will sacrifice our future in order to allow the baby boomers to retire in luxury. Let’s hope Miner’s call doesn’t go unheeded.
Here's the headline of the day from our friends over at Via Meadia.
Illinois’s Blue Robin Hoods Stealing from the Young to Give to the Old
The topic is the pension crisis, specifically in Illinois, where the legislature has decided to cut spending on education by $400 million — for the third year in a row. All to pay back money owed to the states horribly underfunded pension plan.
Sticking it to either group, the young or the old, isn’t appealing, but the boomers are politically organized and better positioned to fight for their interests, particularly because powerful unions are on their side. The young, by contrast, are among the least politically active groups in the country, making them much easier for politicians to ignore. Illinois has obviously chosen the path of least resistance.
Two articles in the Wall Street Journal and the New York Times this weekend show the grave threats to two great institutions, both of which I care deeply about.
The Times has a story on the threatened cuts looming over the University of California and the State University of California system.
Class sizes have increased, courses have been cut and tuition has been raised - repeatedly. Fewer colleges are offering summer classes. Administrators rely increasingly on higher tuition from out-of-staters. And there are signs it could get worse: If a tax increase proposed by Gov. Jerry Brown is not approved this year, officials say they will be forced to consider draconian cuts like eliminating entire schools or programs.
To get a sense of the problem, just consider this:
While there are more students than ever, the number of academic advisers has dropped to 300, from 500 a few years ago, for more than 18,000 undergraduates. Courses that used to require four writing assignments now demand half that because professors have fewer assistants to help them with grading papers, something other campuses have implemented as well.
Meanwhile, the WSJ reports that policemen and firefighters in San Jose, California are being insulted, flipped off, and outright despised. One officer was recently criticized at a supermarket checkout line for buying steaks. A firefighter reports being given the finger while in his truck. This is sad. These are people who are prepared to risk their lives to protect us. They do so for salaries that allow them to live well, but not well enough to actually afford a home in San Jose, where the median house price is over $400k. Are these officers and heroes really the blood-sucking vampires that they are being made out to be?
Clearly the answer is no, and yet the officers do make very rich pensions. As the WSJ reports:
In the current fiscal year ending June 30, San Jose's retirement obligations soared to $245 million, up from $73 million a decade ago, according to the city. For police officers and firefighters who have retired since 2007, the average pension is $95,336, making them among the most generously compensated in the state.
The threat to the California public universities and the animosity to public-safety officers who make up an important part of the middle class are two sides of the same problem. As pension costs soar, governments are taking away middle-class services like education, park playgrounds, and libraries. As middle-class taxpayers see their services cut, they blame those whose middle-class lives they are supporting. We are in for lots of this over the next decade.
The Arendt Center continues to follow the pension crisis because it is another example of the way that facts staring us in the face can simply be denied and ignored by those who don't want to see them. We also are following the pension mess because we care about politics and government. The attack on government today too often takes the form of a rejection of all public activity and the claim that all services and all valuable activities are private, not public.
I have been trying to understand our pension mess for years now, and I will tell you that the numbers and acronyms are at times baffling. But help is here.
Two of the nation's Federal Reserve Banks (the Cleveland and the Atlanta Federal Reserve Banks) have joined together to form a "Financial Monitoring Team to study pension funds and municipal finance with an eye toward implications for the wider economy and financial system." In other words, these two banks are seeking to shine a light on the dark and difficult to understand corners of municipal finance. Chiefly, the banks are interested in learning about Municipal Pensions.
The Cleveland Fed publishes a newsletter, "Forefront", and the latest issue contains a number of incredibly helpful articles about the state of municipal pensions. The main article is: Public Finances: Shining Light on a Dark Corner. This is a clear and helpful article, with a glossary and helpful sidebars. It also comes with a video primer on the pension crisis that is sober, clear, and helpful.
One question the article addresses is just how big the pension shortfall actually is. According to government numbers, the shortfall is $800 billion. The government estimates are based on assumptions of an 8% rate of return, which inflates the assumptions about the present value of pensions. In all likelihood, the return will be somewhere between the 8% historic average and the painfully low return offered by persistently low interest rates. Thus, many private economists estimate the shortfall at around $4 Trillion. Here is what the Cleveland and Atlanta Feds say:
Some economists, however, have come up with a $4 trillion shortfall. They have pointed out that for most state and local plans, promised pension benefits are protected by constitutional, statutory, or common law guarantees. (See related article, “Navigating the Legal Landscape for Public Pension Reform.”) By definition, this ought to make them riskless obligations to the pensioners. Thus, the appropriate valuation methodology should discount promised benefits using the risk-free interest rate, usually calculated as the yield on long-term U.S. Treasuries. This method, argued cogently by Jeffrey Brown and David Wilcox in “Discounting State and Local Pension Liabilities” (2009), has the virtue of being supported by both economic and legal principles. It also produces substantially higher estimates of the present value of pension liabilities. Given the currently low yields on Treasury bonds, this approach implies a present value of accrued obligations as high as $6.7 trillion, leaving an unfunded liability of $4 trillion.
In other words, the actual size of the pension shortfall is probably somewhere between $800 Billion (the size of the 2009 stimulus package) and $4 Trillion. The likely shortfall, as the Fed says in its video on the site, is in the $3-$4 Trillion range.
So what does this mean? The Cleveland and Atlanta Feds offer a few conclusions:
1. At this point, it seems unlikely that any major pension fund will run out of cash in the next few years, barring a general worsening of economic and financial condition.
2. But we are not out of the woods yet. Many funds will require significant reforms to reduce underfunding levels, with painful new contributions from employers and employees.
3. Another concern is that some states’ legal protections may be too strong to give reforms enough time and flexibility to put plans on sustainable paths. In that case, states would ultimately be on the hook for covering pension benefits out of general revenues. This scenario, by creating crisis conditions in those states, could stress economic conditions more generally.
The real problem is the combination of #2 and #3. For if state laws make it too difficult to cut or reduce pensions, the only option is "painful new contributions from employers or employees." It may be that we cut the guaranteed pensions of pensioners, making them less well off in retirement. That would hurt the workers. Or, if legal protections prevent that option, we the taxpayers will have to dig deep to pay their pensions, probably as we at the same time cut other essential services. And that will not be pretty. Either way, the state and local government crisis is shaping up to be one of the most important challenges of our generation.
For more on the pension crisis, you can revisit our other posts on the subject here.
My colleague Walter Russell Mead has also been covering the entitlements problem that pensions pose. He has an excellent post on the current dispute over pensions at the NY Times. The Times staff is considering a strike to defend its defined benefit contribution plan—a plan that guarantees a certain yearly payment until death. These pension plans are the best of the best for workers, but as workers still retire at 65 and live longer, they are bankrupting the companies that offer them.
Thus, the Times, like many other companies, is seeking to switch over to a defined contribution plan, one that pays out a pension that is somehow related to what one actually puts into it. These plans risk reducing a worker's standard of living in retirement, as do 401k's. Mead's essay is clear in addressing the entitlement of the Times' staff, which insists on protecting its benefits even if it destroys the paper for which they work. You can read Mead's post here.