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The Pension Bubble

By The Washington Times

June 29, 2012


 Picture Credit: Obama bubble by Greg Groesch for The Washington Times.

As if the housing market collapse and European debt crisis weren’t bad enough, another fiscal disaster looms on the horizon. New rules adopted last week by the Governmental Accounting Standards Board (GASB) clarify the depth of mismanagement of state and local government pension programs. When the bills come due, it’s going to be very, very expensive.

The Pew Center reports a $1.38 trillion gap between the assets states have set aside to fund retirement and health care programs compared to the amount of their obligations to retirees. The revised accounting standards will show the true gap is even wider - something that could trigger a round of downgrades by rating agencies.

The problem is, state and local politicians always find it easier to make lavish promises than to back up their commitments with proper funding. Without immediate and significant reform, many other governments are going to find themselves filing for Chapter 9 bankruptcy, just as the city of Stockton, Calif., did on Tuesday.

The Pew Center says states may be able to meet immediate obligations, but as of 2010, Wisconsin had the only fully-funded program. A decade ago, more than half of state government pensions were properly funded. The worst offenders were Connecticut, Illinois, Kentucky and Rhode Island, with less than 55 percent of obligations covered. Maryland funded only 64 percent of its liability. Virginia did slightly better at 72 percent, but even that is well below 80 percent funding necessary for a pension system to be considered healthy.

The situation looks more dire using the updated accounting standards. Governments with larger shortfalls in their pension funds will be required to factor in the probability that they will have to borrow to meet their obligations to retirees. Plans currently are using an 8 percent discount rate when calculating the value of future obligations. Already underfunded programs will have to cut that to 3 or 4 percent under the new rules, which means their books will reflect even more red ink.

The new rule is going to hit the plans with large shortfalls particularly hard. The Center for Retirement Research at Boston College estimated the rule change will increase the shortfall in funding from 76 cents on the dollar under the current rules to 57 cents, or a total increase in shortfall of about $900 billion.

These funding gaps can’t be met without cuts in benefits, increases in contributions or tax increases. And even the new rules might be understating the true extent of the liability. The correct discount rate for pensions, arguably, is the risk-free rate for annuity, not the average return on high-risk stocks, which many plans will still be able to continue using.

Raising taxes on already overburdened residents isn’t the answer to the pension problem. Politicians at every level need to realize government must cut back before the entire system collapses.

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