Harbinger of Doom
- Oct 23, 2001
the emperor truly has no clothes.[O]ne of the next shoes to drop is going to be a pension disaster. This too will be more easily measured in trillions than billions.
I am expecting a public pension wreck based on management so flawed as to cross over into gross negligence or worse.
So far so good, eh? I mean especially if you dont think about it too hard. After all, the only way a scheme to borrow money to plug a fiscal hole can work is if you are earning more from investing that cash that you are paying out in interest. Makes sense right?March 3 (Bloomberg) -- The Chicago Transit Authority retirement plan had a $1.5 billion hole in its stash of assets in 2007. At the height of a four-year bull market, it didnt have enough cash on hand to pay its retirees through 2013, meaning it was underfunded to the tune of 62 percent.
The CTA, which manages the second-largest public transit system in the U.S., had to hope for a huge contribution from the Illinois state legislature. That wasnt going to happen.
Then the authority found an answer.
Weve identified the problem and a solution, said CTA Chairman Carole Brown on April 16, 2007. The agency decided to raise money from a bond sale.
Your investment gains have to exceed your interest costs or the scheme becomes a sure-fire money loser.
Well, heres the punch line:
Wow. I am speechless. That was the "plan"?In the CTA deal, the fund borrowed $1.9 billion by promising to pay bondholders a 6.8 percent return. The proceeds of the bond sale, held in a money market fund, earned 2 percent -- 70 percent less than what the fund was paying for the loan.
Borrow at 6.5% and earn 2%?
This is an unfortunately accurate illustration of the type of talent with which many state pensions have been saddled.
As long as the perpetual growth machine is chugging along, all of the collective assumptions about pensions more or less work out according to plan. But what happens when a model predicated on exponential expansion not only expands, but retreats?
Well, this is pretty much of an actuarial and financial disaster of biblical proportions. Heres an example:
At its height in October 2007, CalPERS had $260 billion in assets and at the end of 2008 it had $186 billion. Based on the stock market performance this year, we might estimate that CalPERs is now worth somewhere in the vicinity of $140 to $150 billion.The nations largest public pension fund, California Public Employees Retirement System, has been reporting an expected rate of return of 7.75 percent for the past eight years, and 8 percent before that, according to Calpers spokesman Clark McKinley.
Its annual return during the decade from Dec. 31, 1998, to Dec. 31, 2008, has been 3.32 percent, and last year, when markets tanked, it lost 27 percent.
How long would it take CalPERS to get even? Well, ignoring inflation, even if we use their extremely generous and woefully unmet assumed rate of return of 7.75% it would take between 8 and 9 years, and thats assuming that cash in meets cash out the entire time.
If we use their actual 10 year performance as a rate of return, then its a 20 year haul to climb back to even, again ignoring inflation.
What does this mean?
Among the many wrenching adjustments that we are just now beginning to face, state legislators must now include a trillion dollar pension shortfall to the list of things that must be negotiated. A government retirement plan cant go bankrupt, even if its insolvent; state treasuries must put up the money if a fund runs dry.
So we are now facing the first actual set of hard choices in several generations. Choices that increasing look like they can no longer be passed to the future. The future is here, it has arrived. Will states decide to pay their retirement obligations, pave roads, educate children, or feed the hungry? These are the choices that now sit before us and I remain skeptical that we will successfully borrow our way out of the predicament this time.
It would seem that decades of intellectually weak and fiscally negligent political leadership has finally caught up with us.
The pain of this adjustment is going to send up a mighty hue and cry from the populace and politicians alike and the response, I fear, will be the same as it always is; print more money.
That is the weak and easy road to take, and so, with history as our guide, we can be nearly 100% sure that our leadership will follow that route as certainly as water will seek a drain.