No, I’m not referring to the recent precipitious decline in global stock markets (though there may be a connection). Instead, I’m talking about the tidal wave of state pension obligations that threaten to put the country’s entire economic infrastructure in peril. From a story in today’s Financial Times:
Joshua Rauh, associate professor of finance at the Kellogg School of Management at Northwestern University said that, without reform, some state pensions might run out within the decade. By 2030, as many as 31 states may not have the money to pay pensions. And, if these funds exhaust their assets, the size of payments for the benefits they have promised will be too large to cover through taxes, putting pressure on the federal government for a bail-out that could potentially cost more than $1,000bn, he says.
For those of you not accustomed to the British rendering, that last number would normally be referred to stateside as a jaw-dropping “trillion” .
But how could this scenario have ever gotten this far? The FT piece explains:
Estimates put the unfunded liabilities at between $1,000bn and $3,000bn after years of states promising benefits but not contributing enough in both good times and bad to cover them.
Many states base their calculations on an 8 per cent annual return and use an accounting method called smoothing, which staggers gains and losses over several years, two factors that some observers warn could mask the size of the shortfalls. The problem has come to the fore with the financial crisis and recession. Pension funds, like most money managers, suffered losses. The tax revenues that fund annual contributions to pensions, along with essential services such as healthcare and education, have plummeted, leaving little room to reimburse the losses.
Assuming that governments can get themselves out of this morass before it’s too late, the only way to prevent a reoccurence is to switch public-sector pensions from “defined benefit” plans to “defined contribution” plans. Mort Zuckerman did a good job of showing why over at U.S. News and World Report earlier this week:
[New York City] pensions are “defined benefit” plans, which are more expensive since they guarantee specific benefits on retirement.
On the other hand, private sector workers in the survey were mostly in “defined contribution” plans, which means that, unlike their cushioned brethren in the public sector, they do not have a pre-determined benefit at retirement. If New York City were to require its current workers to pay contributions toward health insurance equal to the amounts paid by the employees of local private sector firms, the taxpayer savings would approximate $628 million a year. In New Jersey, [Governor Chris] Christie says government employee health benefits are 41 percent more expensive than those of the average Fortune 500 company.
We know when the next bubble is coming. But with the coming attractions provided by belligerent bureaucrats in Greece, which American politician will be the first to throw himself in front of the union gravy train?