I just read a little blurb regarding the Pennsylvania GO bonds being affirmed by Fitch at AA+ but with a negative outlook. One of the primary reasons cited for the outlook was pension obligations — one of the big bugaboos in the debate regarding fiscal responsibility these days.
--PENSION FUNDING DEMANDS: The funding levels of the commonwealth's pension
systems, historically adequate, have materially weakened, with annual
contribution levels remaining well below actuarially required levels. Despite
changes made in 2010 to soften sizable increases in contributions due to the
systems, significant increases were required in the current-year budget and are
forecast in the coming years.
It reminded me of a rare dinner out with my wife last week. We were watching a spectacular California sunset when a group of inebriated vacationers was seated behind us. We got to talking, and the conversation turned to the California economy. One woman (who visits our town several times a year from Texas because she just loves it here!) asked how we could stand living in a place like California. She whispered conspiratorially: “Why, all the public employees are trying to bankrupt ya’ll’s state!”
I get asked about pension obligations a lot. I spent most of my Wall Street years helping pension plans with their investments, so I have more than a passing familiarity with the subject. And, my uncle was one of the drafters of the original ERISA legislation back in 1974 (I’m sure you’ve all read The Effect of Actuarial Methods and Assumptions on ERISA Minimum Funding Standards and Actuarial Statements.) In my family, you’re nobody until you’ve passed at least two actuarial exams (they tolerate me because I have degrees in math and economics and am an MBA/CFA.)
I think ERISA is one of our country’s finest pieces of legislation. Personally, I think defined benefit pensions are essential to the economic security and well-being of retired persons in our country. We all know how hard it is to invest well — and we devote a great deal of time and study. So, how in the world can we expect the average construction worker, teacher or middle-manager to effectively manage a portfolio of securities in such a way that their retirement needs will be met?
In the old days, you saved your money and hopefully your kids took pity on you if you went broke. Then, social security came along — providing a security blanket of sorts. But, it wasn’t adequate for most folks retirement needs. ERISA provided that employers set aside a portion of employees’ paycheck and invest it prudently for their future retirement needs. The traditional defined benefit plan promised a specific amount of money based on your income.
It was correctly assumed that with millions or billions of dollars in a common fund, plan sponsors could hire excellent investment advisors and consultants to professionally manage the assets. Actuaries could tell companies how much of a future benefit could be paid based on the amount of money contributed, the expected retirement dates of employees and the investment return assumptions.
As long as nothing goes wrong with any of those inputs, a plan sponsor wouldn’t have to worry about not having enough money to pay out the promised benefits. If they invested poorly, didn’t contribute enough money or had a bunch of people retire all at once, they’d have a liability on their books that would require better returns or more contributions.
On the flip side, they could have surplus funds. Many takeover artists made a killing by acquiring companies with overfunded plans that could be cashed out post-acquisition. And, many corporations discovered that employees could easily be fooled into exchanging their future retirement benefits for a pile of cash that could be rolled over to an IRA (and cashed out) at the whim of the employee.
It was billed as “giving employees more control,” but was really all about “liberating” the surplus pension funds and eliminating the future liability implicit in sponsoring a plan. True defined benefit plans have been under assault for years — from 112,000 in 1985 to only 25,000 in 2011.
Many union employee groups have been successful in maintaining their plans — as have many public employees. They’re extremely popular. When I first ventured into the working world, it was understood that the lower compensation and sex appeal of a government job was largely offset by greater job security and retirement benefits.
Most of those who work for the government, whether it be state, local or federal, performed the same calculation when they took their jobs. Their leaders did their jobs and bargained for increases over the years. And, the politicians who control the purse strings were generally amenable to reasonable increases. Access to ever-increasing tax revenue meant they could afford it; and, moreover, they could curry the favor of thousands of registered voters at a time. What could go wrong?
Everything. For starters, investment returns haven’t exactly been stellar. Big investment management firms have mostly underperformed the markets — which themselves have delivered sub-par returns. Those funds whose solvency is based on a 8-9% return are sucking air right now.
Remember, if you’re short on funds to cover future liabilities, you have to earn more or contribute more. Many plan sponsors sought higher returns in such areas as real estate, venture capital, private equity, hedge funds, etc. And, of course, some of those asset classes blew up spectacularly over the past few years.
Contributing more hasn’t worked out so well, either. Recessions reduce tax revenue from all sources, meaning governments have less money to work with. At the same time, they are reducing the rolls of active employees who are paying into the system (if that sounds familiar, it’s because it’s the same basic problem social security has had for decades.)
Government employees have been laid off at a disproportionately high rate during the Great Recession. And, now the military is downsizing, too. Put simply, increasing numbers of retirees means greater pension expense outflow at a time when less funds are coming into the system (less from tax revenues and less from employee contributions.)
It’s a leaky boat that’s rapidly taking on water. Those in the front of the boat, who have jobs, health insurance, well-funded pensions and/or money in the bank are pointing to the have-nots in the back, shouting “look! Their half of the boat is sinking!”
If you’re a Greek civil servant, this is old news. You’ve already had your retirement benefit slashed by 20%. And, another 22.7% is on the way. But, hey, this is America — not Greece. Nothing to worry about here…
…unless you’re an employee of Stockton, San Bernardino, Scranton, Harrisburg, Jefferson County, Central Falls, Boise County, multiple cities and school districts in Michigan, etc. The list goes on — cities, counties and school districts across the country that are filing bankruptcy or operating under receivership in order to “restructure” their pension obligations. It’s a two-fer: lose your job and the retirement benefits you’ve worked for.
…or, unless you’re an employer who’s trying to do the right thing by offering employees solid retirement plans, but has to compete with companies who threw their plans overboard in order to goose last quarter’s earnings.
…or, how about the 1.5 million retirees who’ve lost their home to foreclosure in the past five years? It’s tricky getting a reverse mortgage to supplement your retirement income when the bank takes your house (and, somehow that $2,000 you got from the settlement doesn’t go very far.)
There is no shortage of potential culprits or victims in this debacle. Obviously, we can reduce expenses by cutting benefits to retirees, just like we can cut back by firing teachers, downsizing police and fire departments, riffing soldiers, eliminating school days, buses and kindergarten. We can increase revenue by raising taxes, charging for public education, giving oil companies more access to offshore drilling and settling huge lawsuits (tobacco, foreclosures and now LIBOR) “on behalf” of the afflicted without passing along any benefits.
But each of those “solutions” has negative repercussions and can potentially cost more in the long run. And, they each chip away at the foundation of what makes America great — a commitment to fairness, equality, sovereignty, opportunity and our environment.
In a country where we spend $3 for every $2 we take in, something has to give. But, don’t blame the public employees who took the deal offered to them and now expect their employer to honor a promise. Blame the politicians who made the crummy deals, took kickbacks from the lame investment advisors and consultants they hired, and refused to deal with the whole mess back when it was solvable.
And, while you’re at it, blame the media which has devoted 1,000 X more air time to Octomom and the Kardashians than to the financial future of our nation — and brain-dead American citizens who question nothing as long as there’s something funny on the boob tube and TV dinners in the fridge.
Who’ll stop the reign?
The picture is a little clearer on the daily chart.
If I’m not mistaken, that’s a very nice tag of TL 1 at our objective of 1367 (well, 1366.64) and probably marks the low for the day…less a few more easily rattled options buyers whom the market makers wanted to shake free of their winning positions. Gotta love OPEX.
