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Sanitation workers, firefighters, teachers and other state and local government employees have performed their duties in the public sector for decades with the understanding that their often lackluster salaries were propped up by excellent benefits, including an ironclad pension. But Moody’s Investors Service recently estimated that public pensions are underfunded by $4.4 trillion. That amount, which is equivalent to the economy of Germany, accounts for one-fifth of national debt. It’s a significant concern for public employees who were banking on a fully funded retirement to get them through their golden years.
But the issue has wider implications for all taxpayers, who likely will be tapped to make up the shortfall. The Knowledge@Wharton radio show, which airs on Wharton Business Radio on SiriusXM, asked two experts to explain how governments dug themselves into such a deep hole — and whether they can ever get out. Olivia Mitchell is a professor of business economics and public policy at Wharton. She’s also director of both the Pension Research Council and the Boettner Center on Pensions and Retirement Research at the school. Leora Friedberg is a professor of economics and public policy at the University of Virginia’s Frank Batten School of Leadership and Public Policy. The following are key points from their conversation.
Not Enough time, Not Enough Money
There are plenty of reasons why state and municipal pensions are sorely underfunded, and those reasons sound unnervingly familiar. Mitchell and Friedberg ticked off a list of ingredients reminiscent of other financial stews, including the collapse of the housing market. Like that event, the pension problem has been simmering for decades. Government administrators believed their investment returns would be bigger, and they believed retired employees would die sooner. They used overly optimistic actuarial assumptions, and they thought the long-term nature of the investments could handle higher risk.
They were wrong.
“It seems like there’s enough blame to point to everyone,” Mitchell said. “All of those different approaches proved wrong, especially after the financial crisis where state and local pensions lost 35% to 40% of their money. It’s true that things have been doing a little bit better in terms of their investments, but still the fundamental flaw is that over the years employees were offered a future benefit that was not properly collateralized.”
Mitchell said the problem is worsening because state and local governments have neglected to take corrective action.
“Every year that goes by leads to more red ink and more concern because the state and local plans across the country have clearly not done what they should have done to contribute the right amounts, to invest their assets in their pension plans carefully and thoughtfully,” she said. “Older folks are living longer and needing more medical care, needing longer retirement benefits. It’s a series of challenges that, frankly, nobody is paying much attention to.”
“Every year that goes by leads to more red ink and more concern because the state and local plans across the country have clearly not done what they should have done to contribute the right amounts….”–Olivia Mitchell
Friedberg said the problems with pensions are often inherent in the system, and they only compound.
“There aren’t strong incentives for the governments to actually take care of this … before it becomes a problem…,” she said. “After years of underfunding, some combination of taxpayers and state and local government workers bear the cost of that. We’ve already seen that going on for the last 10 years.”
In addition to the pension overhang, Friedberg noted, many states also face health insurance obligations that they aren’t adequately funding. Elected leaders are forced to increase taxes or cut spending to balance budgets thrown out of whack by pension debt, and the public workers are often vilified in the process.
“Politically, that ends up easier than dealing with the funding,” Friedberg said.
Money Problems Run Deep
Mitchell and Friedberg warned that the pension hole will swallow public- and private-sector employees alike, because all income earners will pay for it. Mitchell ran a simple calculation to illustrate her point: If the shortfall were $5 trillion, divide that amount by the 158 million workers in the American labor force for an obligation of about $32,000 per worker.
“That gives you a concrete sense of the shortfall that we’re facing,” she said. “A lot of people don’t have $32,000 for their own retirement, much less to pay for state and local workers.”
Mitchell also said that governments are probably underestimating pension debt because they are allowed to use whatever actuarial assumptions “that they feel like without any oversight from the federal government.” While states and municipalities are reporting that they are 72% funded, the real rate is closer to 45%, she said.
Broaden that to the federal level, where the impending shortfall in Social Security is well-documented, and the scope of the problem grows. Instead of $32,000 per worker, it’s about $171,000, according to Mitchell.
“I think the problem is one of political non-transparency and also of population aging,” she said. “You keep running unfunded or underfunded plans as long as you have a growing workforce. Our workforce is not growing as quickly as it should be or could be. Our productivity is not what it could be, and what it means is we are going to be supporting more and more retirees on fewer and fewer workers. That gets very expensive quickly.”
Save Your Pennies
The professors have some advice for public-sector workers who are counting on a pension — don’t.
“I think they need to be aware that the benefits they’ve been expecting may not be there.”–Leora Friedberg
They said workers should take control of their own retirements by saving often and early.
“I think they need to be aware that the benefits they’ve been expecting may not be there,” Friedberg said. “It depends on those states and how tight those legal obligations are. In some states, it’s written into the constitution. In other states, it’s not. And it’s not legally protected by the federal government in any way as private-sector pensions are.”
Governments sometimes manage pension debt by cutting benefits, postponing cost-of-living adjustments or extending the vesting period. Many states are also starting to require employee contributions, similar to a 401k.
“There’s some advantage to that because it makes workers aware of their own savings and it familiarizes them with investment in the stock market,” she said. “But we know from the history of the private sector and moving away from defined benefit plans toward 401ks that voluntary contributions often fall well below what workers need to replace their recumbent retirement.”
Governments have turned to other coping mechanisms, including shedding employees before they are vested or not filling vacant positions.
“I think it is undercutting the competitiveness of the public sector as a place of employment,” Friedberg said. “It was already the case that pay was often lower for comparable jobs, especially for high-skilled workers. The promise of the pension benefit was supposed to make up for that. If that promise is no longer being fulfilled, talented people will certainly go elsewhere.”
Indeed, some cities and states have turned to outsourcing items once thought of as strictly in the public domain. Mitchell pointed to the privatization of prisons and emergency services as examples. Governments that outsource don’t have to deal with a pension payout at the end of a worker’s career.
But those measures still aren’t enough, Mitchell said.
“The bigger issue is the so-called hidden borrowing problem that, when folks that hired teachers and firefighters and so forth 30 years ago, they didn’t pay them the full amount that would make their salaries as well as their pensions robust,” she said. “Instead, they underfunded the plans, leaving today’s taxpayers to pay for services that were rendered 30 years ago.”
Start with Transparency
Mitchell and Friedberg strongly believe that governments need to be more open with employees, citizens and investors about how they handle their pension plans. In turn, those stakeholders need to engage.
“I think the place to start is to begin with transparency,” Mitchell said, citing federal regulations that require corporate plans to report their financial promises and set aside money to meet those obligations. But decentralization means the federal government has no power to compel states to report liabilities and assets or to follow similar protocols.
Mitchell reiterated the point that, ultimately, everyone will pay. She referred to a recent study that contended property owners will be held responsible for unfunded liability through what could be considered a “stealth tax.”
“Twenty percent of your property value is already going to be liable to be covering these state and local pension shortfalls,” Mitchell said. “So, you can sell and move out of Chicago or Detroit, but there’s already that capitalization of the underfunding in the value of your house.”
Friedberg said insolvency comes down to constitutional issues. Citizens need to start asking the right questions, because it’s easy for politicians to “pass the buck.”
Sharing a personal example, Friedberg noted that her home city of Charlottesville, Virginia, operates its own pension fund for police and municipal workers.
“There’s not much information about it, so it’s hard to know [how it’s performing],” she said. “I’d be happier if the city of Charlottesville didn’t have to do this very complicated financial operation of running a pension fund.”
The professors agree that many of the proposed solutions being floated are unlikely to fill the pension hole because the only way to get bigger investment returns is to take on greater risk. The stock market is just too volatile for that.
“There’s no magic investments that states can make here to recoup the money. Just like we saw with the financial crisis, high risk means that at some point there are going to be big declines and they won’t be able to pay their bills,” Friedberg said. “The other problem with bonds is it pushes the problem off to the future, then it makes it harder to understand what the future obligations are.”
Join The Discussion
24 Comments So Far
wolfgang harms wolfgang harms
Olivia Mitchell’s idea of a strong incentive for later retirement is certainly a partial solution. We also need to address the underlying problem of too many older people vs contributing workers.
Increasing the younger working population would be easy by allowing large scale immigration. The USA has the best infra structure and every worker creates more value, more tax revenue, and more GDP.
Instead of closing our borders to a cocoon we should attract 300 million immigrants. This would assure long term survival as the richest nation.
Arthur Shatz
Another solution would be to gradually phase out defined benefit plans and convert them into defined contribution plans. DB plans have failed in both the public and private sectors because no one’s nose is held to the grindstone to be sure they are properly funded. What ever happened to the concept of fiduciary responsibility? The PBGC is even in bad shape. Let’s relegate these dinosaurs to the past where they belong.
Robert Hooper
So I read far enough that my head exploded and I had to start typing. MANY although NOT enough plans in the public sector were close to fully funded (I believe there is no such thing as FULLY funded due to market and economic and demographic trends over time) but the crazy risks in housing and banking that were allowed to manifest as business decisions by congress is 100% responsible for that situation resulting in 60-70 percent funded ratios. Blame greedy banks…blame Congress for not doing its job… blame actuaries for not using fresh batteries in the calculator after the crash. Those same investment controls are now leaving or gone under Trump, so look for another crash soon!!.
DB plans are completely better for society and for individuals if properly managed. adequately funded DC plans dont produce enough income certainty and frankly are a fee gift to the investment industry, the main lobby group against the DB world. THEY WANT THAT CASH themselves for income… Where does Arthur Shatz work?? ()wouldn’t that be interesting?). There is a move to make DB plans evil, due to the unfunded liabilities created by GSBY changes and the desire to lessen the political and business influence that funds can have AS SHAREHOLDERS.
There is so much going on behind the curtain with this discussion. The Pension itself is usually on a 30 year glide path to funded status and if the manager is not doing what New Jersey did, and IGNORE the ARC contribution recommendation, stability will come back. Adding other post retirement benefits INTO the soup makes for nice numbers, but they are distinctly separate issues. Pre funding of healthcare and other OPEB is wise, but look at the Post Office to see how much of a political tool it has become. in a lot of plans up to 75% of the benefit is paid by interest and earnings…. that is a significant amount of glue that is holding our economy together. Maybe China would like to buy our retirement system also????
Drew Lindhoff
Social Security funding problems were mentioned in the article, and for decades, the rich and famous and their corporations have been trying to kill the program along with the more recent program, Medicare. The reason why is obvious, when you take into consideration that the Trump companies alone pay around $79,000,000.00 per year in required monthly employer payments into both programs. Companies have tried to cut their losses by employing robots instead of people (GM employs 50,000 robots), and farming-out jobs to foreign sweat shops. You don’t have to pay Social Security, Medicare or any other benefits for a robot employee or a foreign worker. Yet, still they want to do even more to kill these two very valuable “little people” oriented programs, because of their sheer personal greed, and because they abhor spending money on anything that doesn’t benefit them both personally and directly. These are corporations and rich and famous folks who are worth billions of dollars, who as people don’t want to spend the small monthly pittance required of individuals, and who as corporations and businesses don’t want to spend the very same money that they will surely be paid back to them at a later date by the senior consumers covered by the two programs. The same theology goes for the funding of pensions. Do you really suppose that a CEO with a $250,000,000.00 golden parachute needs to be a member of a pension plan? On the other hand, do you suppose that one of his line workers might just benefit from a pension plan that he or she could actually count on to be there when they retire? I rest my case.
Robert Arvanitis
Mr. Lindhoff
You misunderstand the terms under which Social Security was created.
Say there are 10 people. One is needy. The CORRECT response is to take 10¢ from each of the nine who are OK, and give 90¢ to the needy person. Instead, in order to HIDE the redistribution, FDR took $1 from each of the nine, and gave 90¢ to ALL 10! The NET effect is the same, but the dollar-swapping is deceptive, solely to mask what’s really happening. That’s the only reason SS is “universal.”
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More fundamentally, play actuary for a moment. (ignore low interest discount and very low mortality. Consider all years equal.)
One is in school until say, 20. One works for another 45 years. Then one retires for 25 years. That’s 45 years producing, 90 years total.
SO we expect personal discipline; if one earns say 90,000 a year in the earning years, they should LIVE at the level of only 45,000. Half the earnings go to pay off their student years (OR pay for their progeny), and also to fund their own retirement. It is NOT society’s problem that no one does that. “Eat, drink and be merry, for tomorrow the taxpayers foot the bill.” Really?
Gus Muldoon
As usual in academia, the real root of this situation is not mentioned. The problem is the corrupt alliance between public sector unions (including teachers unions which are rarely mentioned) and the elected officials they support. The elected officials, of course, return the favor and provide more and more benefits to public workers at the taxpayer’s expense. It is simple overspending and lack of political courage.
It should also go without saying that Social Security and Medicare are Ponzi schemes! It’s obvious. No amount of socialist Three Card Monte can hide that fact in the long run. This country will only survive when the vast majority of its people are given the opportunity to provide for their own retirement and health care.
Michael Magin
In the UK the management of ‘defined benefit schemes’ is partially structured by Central Government but unfortunately it originally focused on the ‘control of assets’, and later on the ‘control of the liabilities’ when schemes reported deficits and were required by law to put in to place a ‘recovery scheme’.
What UK legislation does not do to is to require basic rules on the management of the liabilities (by the Scheme managers/trustees) when there is no reported deficit! The employer is, at their discretion, allowed to take ‘pension holidays, or ‘kick problems in to the future’. What is missing is the control of those discretionary decisions where pension benefits are given for reasons such as ‘sweetening’ reorganization arrangements, additional benefits to certain ’employees’, early retirement – all of which are usually excluded from the Actuary’s liability valuation model.
What is needed (amongst other things) are immediate employer contributions for liabilities taken on outside the the liability valuation model used to establish the current contribution rates. So, for example, if the model assumed an annual pay rise of 2%, an actual pay rise of 2.5% would require an immediate contribution equal to the value of the increased value of the liabilities (or a complete re-assessment of the scheme with the necessary changes to contribution rates). Kicking the ‘non-standard’ in to the future pool is just a recipe for disaster.
Transparency is an obvious – and identified in the article – but guidance as to appropriate mortality tables and liability valuation rates (principles) are also required. Spouse pension benefits are potentially a tricky area! Another issue which I have recognised, is the potential for abuse when there are ‘schemes within schemes’ reserved for senior management – is this an issue in the US? At times, it seems to me that Pareto operates within the schedule of individual pension liabilities
within a scheme, and the number of beneficiaries!
In the past I have recommended a distinction between ‘actual salary’ and pensionable salary’ but it was always knocked back because the decision-maker is often a higher-paid beneficiary in the scheme. This has lead me to consider the need for external/independent Scheme trustees – but who gives up power?
Alex Wirth
@Gus Muldoon, I could not agree more. It is shameful that there is no mention of the serious moral hazard issues of politicians choosing pensions for public sector unions who can forcibly extract union member dues used to support politicians promising larger pensions.
Bill Allen
It i
Bill Allen
It is amazing to me that there is no mention in this otherwise excellent article about the primary cause of
the problem which is the symbiotic relationship formed
between politicians and public sector labor unions which
goes like this—you get out the vote for me and when elected i will take good care of you.
FDR who was a supporter of unions in private sector warned against unions in government stating that there would be no one to represent taxpayers.
the politicians being what they are granted overly generous benefits to the unions and then did not fund them properly after setting absurd assumptions on investment returns.
You can look at any of the major problems in government today and trace them back to our incompetent federal government or State and municipal
governments—and after all these years when the problem has been clear they are not dealing with it.
if you research a State like new jersey which has strong
public unions and gutless politicians you will understand
why they are funded at 37% of where they should be–
and the pay and benefits are well above private sector.
add to this most of the other States and municipalities
an you have the 4 trillion dollar problem.
Ronald Stein
It’s frustrating and appalling that the “courts” are actually saying that future generations will continue to be legally responsible for DEFINED BENEFITS established by previous generations! Are the courts really supporting taxation on younger generations without representation?
The general public’s concerns about those that are under-compensated and entitled to retirements may be valid concerns, but life is not fair. Their beliefs are now imbedded onto their children, who are unable to vote today, who will bear the costs of many enacted “Defined retirement benefit” pension programs. These folks have no empathy for their children and for future generations who did not vote for these programs, but will bear the taxation on them to fund generous programs elected by their elders.
There may be some similarities with other inter-generational inequities, but the younger generations will at some time participate in Social Security and Medicare, but they will NEVER participate in the defined benefit pensions for their elders that they must bear the funding responsibilities.
It’s time for a lawsuit that claims inter-generational inequity on financing “defined retirement benefit” pensions is unconstitutional. How can a judge claim that promises made by elected officials that require youths who have no voting power to pay those promises is fair???
Stephen Douglas
Robert Arvanitis
” if one earns say 90,000 a year in the earning years, they should LIVE at the level of only 45,000.”
If one earns $45,000 a year in the earning years, what then?
“Say there are 10 people. One is needy. The CORRECT response is to take 10¢ from each of the nine who are OK, and give 90¢ to the needy person.”
Some might disagree that that is the correct response, but it is already happening in the public sector.
The lower level public workers earn wages similar to equivalent private sector workers. With pensions and retiree health benefits, though, they usually have a much higher total compensation.
The professionals and highly educated public workers have wages much lower than equivalent private workers, and, the higher pensions are not sufficient to compensate for the lower wages.
Between these two extremes, logically, are thousands of public sector workers whose lower wages are roughly offset by higher pensions and benefits, so their total compensation on average is nearly equal to the private sector.
Basically, the higher paid public workers are subsidizing those earning $45,000 a year, or less.
Stephen Douglas
It’s not only in America…
“Looking at the top and bottom of the pay scale we see divergence between public and private pay. Public sector pay is estimated to be 10.8% above private sector pay at the bottom of the earnings distribution (5th decile), but 13.2% below private sector pay at the higher end of the earnings distribution (95th decile), when using an identically specified quantile regression model excluding organisation size.”
“In the quantile regression model which includes organisation size, the same trend exists across the earnings distribution but shows lower earnings in the public sector at each quantile.”
(UK Office for National Statistics, “Analysis of factors affecting earnings using Annual Survey of Hours and Earnings: 2016”
Robert Arvanitis
Stephen Douglas -Real answer to rhetorical questions:
We are blessed with the life and health of Western Civilization in the 21st century. We enjoy both extended childhood AND early retirement. That is unlike our ancestors who worked from the time they could walk and worked until they died.
At risk of losing actuarial credentials for a rough approximation: today we are only about half as engaged; we must therefore live below our means.
To deny this, is to say let the one who makes 90k spend it all, and the one who makes 45k likewise spend it all, because some putative tax on the “wealthy” will keep both grasshoppers in comfort when they cease work with two or three decades of life left.
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Before any strawmen appear – we have social welfare for the needy. But the point is that it must be openly disclosed, not buried in schemes like OASDHI or obamacare. It must also be means tested, not universal.
Those are minimum conditions so that our redistribution does least damage to free markets, the source of vital price signals to the economy.
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Anticipating a further reply, I first ask: How much of GDP ought government control? Pace Sander, Ocasio-Cortez et al. there is a point at which government is unaffordable and destructive.
Robert Arvanitis
PS: Government employees are overpaid – all in, and adjusting for credentials, risk, effort, security, benefits and everything else.
Proof is that no one leaves a government job for the private sector UNLESS it’s after acquiring enough influence to peddle.
(For that latter case, ask me about the surtax cure to revolving doors.)
Wes Gray
Gus Muldoon and others put their finger on it . For decades Democrat politicians have bought the votes of the government unions . It is a National disgrace!
Stephen Douglas
Robert Arvanitis
“…no one leaves a government job for the private sector…”
They do it all the time. Fewer than twenty percent of public retirees are career employees (30 years or more.) Most public employees don’t even stay long enough to vest in a pension, usually five years. Average length of service for retirees is about twenty years, so they spent another twenty or more in the private sector, before or after the public sector. There are a huge number of private sector workers now who have earned a partial pension and are just waiting for retirement age to collect. The average tenure for public jobs is about eight years.
Stephen Douglas
Robert Arvanitis,
How long has it been, if ever, since the free market has ever been free?
Public workers, in every state and probably every OECD country, have a virtual floor under their incomes. A floor that doesn’t exist for private sector workers at the mercy of the free market. Also a ceiling. Public sector workers are grossly underrepresented in the top one percent of income earners, or even the top ten percent.
Income disparity is a huge problem, and growing, except in the public sector.
Our ancestors worked until they died (except for the select few) because they had no choice. Two hundred years ago in this country over eighty percent of workers were required to produce food for the country. It is now about two percent. Automation is taking over more American jobs than outsourcing is. We don’t need to work longer, in fact it is counterproductive, if all we are doing is “make-work” jobs to satisfy the so-called Christian work ethic.
We don’t need jobs. We need food, shelter, clothing, etc. Some of us may actually earn enough to save half for retirement. Other, very hard-working conscientious workers can’t.
Robert Arvanitis
Real answers to rhetorical questions:
Free markets create vital information for the allocation of assets. American markets are freest in the world – I reckon about 85% or so. Social policies, regulation, welfare, cronyism, together trim about 1½ standard deviations.
The USSR always made too many size 18 boots and never enough size 8 shoes. Their system had only about 11% latitude, from the illegal (!) “blat,” run by the “tolkach.” That’s why they were able to function at all, and stagger on until 1989.
Markets are in fact quite free. IF someone gets rich from technology or entertainment or such, then you have no objection. Income disparity is no issue of itself. Better we all get rich unequally, etc.
IF someone gets rich from cronyism and corruption, then we must fire the entire FTC and the civil side of Justice, and hire staff who will do the job.
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Fair answers to polemical questions:
Speaking of new hires at FTC/Justice – In a free market, public work is no different than private employment. The accountant employed by government is no more noble than one in a corporation. And based on their market value, they should be paid the same. Likewise a private accountant is no more at the mercy of free markets than a government accountant. Or if they are, it’s because the government accountants have wangled unfair protections through the civil service system. Taxpayers would be far better off if government employees were held to performance standards and readily terminated.
Public sector workers are most certainly not underrepresented in the income brackets. You ignore the fact that people like the Clintons, Obamas, Pelosis, Reids and all the rest prosper greatly from exploiting their positions. They are the “entrepreneurial” class of the deep state. Instead of technology and entertainment, they produce the truly innovative maneuvers that enrich the cronies (see markets, above) who in turn enrich them.
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Finally, you set out a few non-sequiturs and appeals to populist sympathies, but you STILL haven’t answered the highly relevant question: how big can government get before it tips fatally into socialism?
And you STILL haven’t asked how a surtax fixes revolving doors!
Stephen Douglas
“…how big can government get before it tips fatally into socialism?
And you STILL haven’t asked how a surtax fixes revolving doors!”
Those are your questions not mine. Answer them if you will.
The article is about unfunded pension liabilities. As the authors say, “It seems like there’s enough blame to point to everyone,”
The easy answer is what Gus Muldoon, and yourself, apparently, seem to imply; that public pensions and/or public sector pay are excessive. That may be one factor, in some cases. But the problems are much deeper. And simple reduction of all pensions is not the answer.
“I think it is undercutting the competitiveness of the public sector as a place of employment,” Friedberg said. “It was already the case that pay was often lower for comparable jobs, especially for high-skilled workers. The promise of the pension benefit was supposed to make up for that. If that promise is no longer being fulfilled, talented people will certainly go elsewhere.”
Robert Arvanitis
Let’s review the bidding. The problem is the devil’s bargain between politicians and public unions – the unaffordable quid-pro-quo. Politicians dishonestly overpromise then hide the deficits to reward public unions for their contributions and support.
I offered demographic context to the problem. You took issue with me. Your very first complaint was that it’s unreasonable for someone at about median wage to have to save for their retirement.
Since then, every time I unraveled a mystery of economics for you, you divagated to avoid dealing with the issue.
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You profess great sympathy for public employees but are unprepared to discuss the economic costs, and other impacts.
The share of GDP and revolving door problems are not MY questions. They are the consequences of your professed sympathies.
I know how to quantify the challenges so we can discuss the trade-offs intelligently. Perhaps you are not be so equipped.
Stephen Douglas
” the unaffordable quid-pro-quo. ”
Is in large part now unaffordable because of failure to properly fund pensions. Not just for public workers, but for private pensions as well.
Pension reform is absolutely necessary, as the article indicates. Pension reduction is not the same thing, although it has been part of the solution, and will be more so in the future.
To simply imply that all public workers are overpaid, or overpensioned, or both, is not true, and doesn’t help solve the problem.
Robert Arvanitis
It’s unaffordable because politicians DO pay too much! That’s the entire point here.
They pay too much and HIDE the overpayment by deliberately underfunding. That way public employees get a benefit in return for helping left politicos get elected, BUT it is hidden from the public.
ENOUGH public employees are over-benefited that the “blue” states run by leftists are all going bankrupt.
Public unions are an abominations. We must follow FDR’s advice and not allow them. Jobs, both public and private, much be at will and subject to performance reviews.
Donald P Galamaga
This “Time Bomb” did not happen in a vacuum. It was started by an instrument of public policy, The Federal Reserve, and implemented by a series of responses to a major Federal Reserve policy by so called investment experts and Governors, General Treasurers, and municipal administrators, eager to shift the burden of negative outcomes to other than themselves and collaborators such as actuaries, ratings agencies especially involved with faulty debt bundles, auditors with less than transparent management letters involving political supervisors, legislatures faced with less than accurate information seeking self preservation and action and internecine relationships between state and municipal investment officers with equity experts and hedge funds, who saw their claims of confidentiality involving investment costs borne hook, line and sinker by said investors and their advisory committees.
Let’s start with “Helicopter” Ben Bernanke, much lauded as the savior of big financial institution liquidity, by initiating a long , long, unparalleled era of extremely low or no Federal Funds interest rates bundled with massive purchases of questionably valid mortgage debt. The first immediate effect was a major league shift of costs and risk from the Federal Government to states, cities and towns along with individual savers and investors. For pension funds, this redefine prudent investments in a major way, as the traditional anchors of pension fund, U.S. Treasuries, no longer were the source of 3-7% basic income, from which pensions are basically paid and supported, along with a prudent mix of balanced strategies to allow for a combination of expected growth on the order of 7-7.5%, with not much perspiration on the part of investors, that is, if their entity is having no large other budget problems, placing pressures on some to take a small “vacation” from contributions to their pension funds or to declare early retirements without really figuring out the burden on pension funds, a long term obligation, for a short term means to plug a budget hole, without seeking more revenue from the public or company. That’s what happened most recently, over the past 10 years. Experts like Milton Friedman at Harvard and other warned continually about the burden this was placing on pension funds and recommended other avenues of approach be a Fed, not listening. I did the same thing in Rhode Island, when our General Treasurer at the time, now governor, during a downturn in the economy, used it as an opportunity to shift the blame for poor performance on the pension recipients and during a time, in other states, when in other states, discussion by other pressured publicly elected leaders and their consultants, from folks like Wharton, suggested that the only resolution to the problem was to shift from defined benefit pensions to the “freedom” of the defined contribution pension plan. That was nice, except that this was, what not really what it purported to be. People already retired, who had their COLA’s, they paid for and signed a contract with the state on the date of the retirement to that effect, effectively eliminated and all the contributions the made with their reduced pensions for a survivor reduced pension having their COLA eliminated as well. Active fund members, including all vested employees were shifted incrementally to a hybrid plan, with no immediate COLA after three years, as was the practice but to wait until the Pension plan was fully funded until a new COLA took over, which “Capped” the amount of the pension that a COLA could be calculated from, effectively making the new COLA a welfare program where persons who worked less or earned less could get a complete COLA while others who earned more or worked more or both could only earn a COLA up to the “Capped” base, a blatant taking from higher or longer working earners and giving to those earning less or working less.
Unions for active members sued, and some members who were retired had an association membership with AFSCME, which really provided no support to retirees. The state undertook a “bankrupt the plaintiffs strategy, with the assistance of David Boise, and insisted on a process of discovery that involved deposing nearly every individual plaintiff. A group representing non union retirees with their own money had to withdraw due to financial reasons. The result was proposal accepted by the unions to get 4 consecutive pay raises and teachers getting a new early childhood education program to replace dues paying teachers in a declining enrollment situation. Existing retirees got nothing but an immediate COLA cur starting January 1, 2013 and later one annual $500 check that didn’t count for base pension, and a year later another $500 check that did.
Reason why retirees “ate dirt” was that the union association convinced the state only to count a hastily run vote on the proposal of retirees, not including survivors with reduced benefits, who did not comprise a union majority of all retirees, to count all non votes as “Yes” votes. To make matters worse, many retirees got no ballot at all. The union lawyers got the state to agree on the vote process an that’s where we are today. Pre reform retirees, about 20,000 since 2013 are dying at the rate of 5%+/year and some continue to try to get new candidates for office to understand the injustice of their situation.
In conclusion, the issue about pension being defined benefit or contribution is a “straw man.” Years of public policy malfeasance need to be addressed. When President Obama created the famous Stimulus program of close to 3/4th of a trillion dollars, no one mentioned financing pension plans due to their loss of prudent Treasury investment returns, All Democrats ran Congress at the time and no one wanted to complain it seems. Our General Treasurer invested one sixth of the pension fund principal of 8 billion dollars with hedge funds, who had given her an award for pension reform and the hedge funds lost 500 million dollars. She was trying to deal with the loss of prudent investment returns. Calpers suffered the same fate. Federal Reserve policy was never brought to the fore as being responsible for a substantial portion of pension fund losses, especially those, like Rhode Island, on a slow roadpd to recovery at the time. What is needed now is a large Federal Loan at low or no interest rates to states and municiplaties with a plan to bring health back to their pension fund balances, with a payback period of 50-100 years to the Fed. This would avoid taxpayer obligations and put pension funds to work investing funds and locating present and past culpability, criminal or otherwise and fix those problems. A hard look must be taken before moving to defined contribution plans instead of defined benefit plans, atleast those who have labored for all of or most of their time making contribution with the understanding that they would be handled by the pension system. As the state of Oregon Supreme Court observed in rejecting cutting of COLA’s to existing retirees by their pension system. You cannot do this as the state has a fiduciary obligation to someone with who they have reinforced that understanding over years of work. They also told the state they would be open to make a similar finding of proportionality to vested employees, when the state completes study of what those proportions should be.
Finally, there is much question still about state AAA bond ratings for any public purpose, whose pension fund had to take drastic measures like cutting retiree and survivor benefits. How is that possible? In RI, retirees without a COLA ask that question and ask where their AG is on this matter or on other matter of pension recipient protection.