The pension funds of state and local governments and corporations are facing a total shortfall of up to $6 trillion.
Some 200 multi-employer pension plan companies face bankruptcy. And unless this fiscal shortfall is remedied, as many as 1.5 million retirees could lose their pensions.
Almost every state could default on their pension obligations. California has the biggest unfunded liability at approximately $464 billion. Already, Illinois spends as much on pensions as it does on welfare and public protection.
Unfortunately, fixing the problem in state and local governments will be more difficult than addressing the shortfall in private corporations. This is because it’s not clear whether public pension benefits, once vested, can be altered and because most public companies have reduced significantly the percentage of their workers covered by traditional pensions, shifting them instead to defined contribution plans such as 401(k)s.
The problem stems from the 2008 financial crisis, when yields on 10-Year Treasury bonds dropped below 2 percent but many pension plans continued to promise employees 8 percent returns. Since bonds represent about 50 percent of pension investments, equities would have to return approximately 16 percent to make the 8 percent difference.
Instead of politicians acknowledging that they could not continue to promise retirees 8 percent returns, they allowed the illusion to persist. Sadly, postponing action meant that the problem worsened each year until we have today’s crisis.
To overcome low fixed-income yields, pension plans by the end of 2017 had increased their stock holdings to 53.6 percent. This is too high because stocks are risky. Just look at the stock market’s temporarily plunge of more than 10 percent this month.
Unfortunately, the Public Benefit Guaranty Corp., the government agency that insures pension plans, does not have sufficient assets to meet the crisis. According to its latest annual report, the agency is likely to run out of money by the end of fiscal year 2025.
A bi-partisan committee has been formed to recommend solutions to Congress by this November.
Sen. Sherrod Brown, D-Ohio, has proposed shoring up our pension plans with 30-year loans from the Treasury Department, as long as plan managers can demonstrate that the loan would put them on a path to solvency. His solution might help some pension plans but most of them lack the money to qualify for a loan.
James Hosek, senior economist at the Rand Corp., wrote in November in an article entitled “The Looming Pension Crisis” that “the severe underfunding of public pension plans will not be fixed easily. A failure to resolve this issue will lead to budgets being slashed, services curtailed and taxes raised.”
Hosek is right.
In a nutshell, because politicians failed to address our pension crisis promptly, we will all suffer. Pension holders will not get the financial benefits they were promised. Taxpayers can expect significant increases to fund the shortfalls.
Washington has limited financial resources to fix the pension problem. The federal government’s $20 trillion deficit and expected future deficits of additional amounts of $7 trillion to $10 trillion have eviscerated its ability to address this issue.
I strongly recommend that pension funds should obligate themselves to provide returns tied to the yield on the 10-year U.S. Treasury note. If pension plans earn more than their obligatory commitments, they could pass it on to the retirees.
I applaud the voters of San Jose, California, who approved pension reform ballot initiatives. San Jose created a two-tier structure. It limited benefits for new employees, required voter approval for new benefits and capped earnable compensation — the maximum amount that can be factored into contributions to employer-sponsored retirement plans.
Winston Churchill famously said: “Americans can always be counted on to do the right thing — after they have exhausted all other possibilities.”
I’m sad to say it, but the best we can hope for at this point is that he is right.
Originally published in the Sarasota Herald-Tribune
