Andrew Biggs published a very good essay in the Wall Street Journal Monday on the problems facing public pensions. PERS discussions go over your head? Mr. Biggs argues public employee retirement systems such as PERS will face more problems as they are forced to make riskier bets in the stock market and gobble up more taxpayer dollars:
The threat that public-employee pensions pose to state and local government finances is well known—witness the federal ruling earlier this month that Detroit's pension obligations are not sacrosanct in a municipal bankruptcy. Less well known is that pensions are larger and their investments riskier than at any point since public employees began unionizing in earnest nearly half a century ago.....
How much riskier are public pensions now? According to my research, public pensions pose roughly 10 times more risk to taxpayers and government budgets than in 1975. And while elected officials—a few Democratic mayors included—are now pushing for reforms, even they may not realize the danger.
In 1975, state and local pension assets were equal to 49% of annual government expenditures, according to my analysis of Federal Reserve data. Pension assets have nearly tripled to 143% of government outlays today. That's not because plans are better funded—today's plans are no better funded than in 1980—but mostly because pension plans have grown as public workforces have aged.
Enlarge Image
The ratio of active public employees to retirees has fallen drastically, according to the State Budget Crisis Task Force. Today it is 1.75 to 1; in 1950, it was 7 to 1. This means that a loss in pension investments has three times the impact on state and local budgets than 40 years ago.
Enlarge Image (KF note: PERS mirrored this trend: 1.79 in 2013.)
And pensions can expect to take losses more often because of increased investment risk. Public plans have historically assumed roughly an 8% rate of return. But thanks to falling yields on safe assets, pensions must invest in riskier assets to have any hope of getting 8% returns. A one-year Treasury bond in 1975 yielded a 5.9% return. In 1980, it offered 14.8%, and in 1985 an investor could expect 6.5%. Today, the Treasury yield hovers at 0.1%. (Thank you Bernanke and now Yellen for your Quantitative Easing BS.)
Meager yields leave America's enterprising public-pension plan managers with a choice: Accept a lower return—forcing higher taxpayer contributions—or take on more risk to keep 8% returns flowing. My estimate, based on Treasury yields and analysis from economists at the Office of the Comptroller of the Currency, is that a pension today must build a portfolio with a standard deviation—how much returns vary from year-to-year—of 14%. Such high volatility means that a fund would suffer losses roughly one out of every four years.
By contrast, in 1975 a plan could achieve 8% expected returns with a standard deviation of just 3.7%. Those portfolios would lose money once every 65 years. This level of risk varied little through the 1980s and 1990s: An 8% return portfolio in 1985 would require a standard deviation of 2.7%, and 4.3% in 1995. Risk began inching upward after 2000 and has increased rapidly since the recession as low-risk assets continue to fall.
These figures aren't theoretical. They represent public pensions' decades-long shift from safe bonds to risky stocks, along with the recent growth of "alternative investments" such as hedge funds and private equity. These alternatives are, according to Wilshire Consulting, 60% riskier than U.S. stocks and more than five times riskier than bonds.
Larger pensions and riskier investments combine to increase risk to state and local budgets. The standard deviation of public pension investments equaled 1.8% of state and local budgets in 1975. That figure crept upward to 2.2% in 1985, and reached 5.8% in 1995. Today it stands at 19.8%. Pension investment risk to budgets has risen roughly tenfold over the past four decades.
As pension plan managers in Detroit, California and elsewhere can attest, there aren't easy solutions. Mature pensions should move their investments away from risky assets, but many plan managers are doing the opposite in a double-or-nothing attempt to dig out of multitrillion-dollar funding shortfalls. In most instances, significant benefit cuts for current retirees who made the contributions asked of them is difficult to justify and legally problematic.
The only real option, then, is to make structural changes, including more modest benefits and increased risk-sharing between plan sponsors and public employees. But that will only happen if elected officials accept that they can't continue with business as usual without accumulating tremendous risk.
Mr. Biggs is a resident scholar at the American Enterprise Institute. Rest of essay
18 comments:
Does Mr Biggs report that money for pensions was
siphoned off to pay for pet projects and funneled to
The selected few in the private sector ? Irresponsible
governance and snake oil salesmen are a bad combination. Guess the pensioners will get screwed
and vilified by the Right.
I put my nest egg in fixed income but if I had made the 60% asset allocation into equities like PERS I'd have almost 50% more.
The public has the same exposure with not quite as pro money management as a pension fund garners. If I had stuck with my own winners like energy and defense stocks I'd have done almost as good...
The political gridlock in Washington frightened me more than the general market risk.
Agree with 7:55. If I hire you to do a days work for agreed upon pay, what would you do at the end of the day if I said oops, I spent the money I can't afford to pay you as promised? That's our legislature.
If you did that in the private sector, you would go to jail. If you do it as a state legislator, you are called a conservative.
The pension funds being greater by 149% of government outlays is a product of the financial orientation of the economy. Banks are facing a federal re-write that limits them in financial speculation but adds more regulation on the smaller, more localized banks. The money center banks would be limited to traditional banking which is NOT how they see themselves really. They want to be like hedge and equity players instead of banks.
Financial assets would be more stable in the future if banks and pension funds invested more in real estate instead of paper. PERS has only $2B out of $22B in real estate.
The public has the same exposure with not quite as pro money management as a pension fund garners.
Shudder the thought that the enemic PERS ROI is the result of professionals.
Last year the ROI was 13% and the year before it was zero. Then the next two years ROI was 25% and 15%. 2009 ROI was minus 20, I think. It would be interesting to know why it was nil in 2011.
The alternatives: have the PERS board set up a committee of their own to pick stocks, use an index, let lawmakers pick stocks, let PERS participants pick stocks, let rich doctors or their wealth managers pick them, or hire other money managers.
The "math" is not partisan. Whining about promises made or unfounded statements about funds being siphoned off does nothing to address the problem. It's like arguing over gravity.
The combination of low returns (function of interest rates) rates and increasing longevity of pensioners means the plans cannot be adequately funded.
Rightsizing the funds comes only through algebraic manipulation......increasing the returns (increasing volatility and mathematically impossible absence leverage); increasing the amount of contributors (not logistically feasible or needed); killing off pensioners to reduce benefits (only works in Obamacare through rationing--generally frowned upon by both unions and general public); or reducing benefit payments (either voluntarily or through Chapter 9 Bankruptcy).
The plans are not recoverable financially, and like socialism, the prospect only works until you run out of other people's money. It's neither right or left.....it's simply the math and it affects us all.
The recent returns show the volatility 10:49 mentions. The only way to get those returns is with greater risk. Even with those above average returns, the funding gap grew. Why......people on pensions are living longer.
Even investing 100% in stocks (when you need an income stream to pay benefits) would not get it to solvency. You would have to issue pension bonds (borrow) for the express purpose of buying more stocks and options to try and get higher returns. We just had a bubble burtst from leverage, and the recent stock returns are just another asset bubble. This won't end well.
Let Tim Medley and Cecil Brown manage the PERS assets. Their private clients are satisfied with their returns.
Hire Malachi!
Ponzi schemes never end well.
PERS = PONZI
the operator of the ponzi is the legislature, not the working stiffs.
Ponzi schemes never end well because ponzi schemes never end. That's the definition of ponzi. At least this discussion has (so far) been about the problems with investments, not Kingfish bashing employees or Kangaroo giving his expert opinion on the stock market.
Hopefully, the number one rule will continue to be that the legislature can NOT touch the damned money.
If the math shows the pensions can't be paid, why
are other state obligations not treated in the same fashion? Why aren't bond holders taking a hit ?
9:14--do you not see the ratings for states with the largest unfunded positions.....like CA, IL, NJ, etc. These states must pay higher rates of interest to compensate for their credit risk. Bond holders are at risk.....a higher risk of default and loss of principal.
Our state leaders have it under control. 'One time money' will not be used as it was to get us through the downturn. We have little left in the rainy day fund to spend anyway.
No Republican is ever going to raise taxes unless its a 'user fee' or maybe a sin tax. The tax on wine is low comparatively, but you are hitting the yuppie Republicans so that is off the table.
PERS will be fine if it remains in a lock box and capitalism is not run in the ground again by Wall Street misconduct and fraud.
Some here have made valid points. Others, well, gang, you're shooting from the hip.
Those shooting from the hip, PERS has a website, read it! Read the handbooks and the regulations. After you've done that then a responsible conservation can be held.
Is the system in trouble, oh yeah.
Post a Comment