Tuesday, July 20, 2010

Social Security to Tackle State Pension Woes?

Mary Williams Walsh of the NYT reports, Facing Pension Woes, Maine Looks to Social Security:

Lawmakers in Maine have found an unusual tool for tackling their state’s pension woes: Social Security.

Just as workers in the private sector participate in Social Security in addition to any pension plan at their companies, most states put their workers in the federal program along with providing a state pension.

Maine and a handful of others, however, have long been holdouts, relying solely on their state pension plans. In addition, most states have excluded some workers — often teachers, firefighters and police — from the national retirement system and its associated costs, 6.2 percent of payroll for the employer and an equal amount for the worker.

Now, Maine legislators have prepared a detailed plan for shifting state employees into Social Security and are considering whether to adopt it. They acknowledge it will not solve their problem in the short term but see long-term advantages.

Some variation on this idea could ultimately appeal to other states grappling with their own exploding pension costs and, in extreme cases, quietly looking for help from Washington. In troubled states, some employees have wondered whether they might be allowed to begin paying in and collecting from the federal system even before they have contributed a career’s worth of taxes.

The potential effect on the Social Security program is hard to estimate. Maine’s proposal would mean new members and a small additional source of payroll tax revenue for the federal system.

Even if it fully embraces the proposal, Maine will have to come up with a considerable sum to sustain its existing pension plan, presumably through some combination of taxes and service cuts. After a phase-in period, Social Security would cover part of state retirees’ benefits, with the state pension as the remainder. Many pension plans in corporate America coordinate their benefits in this way.

The proposal has the advantage of not reducing promised benefits, guaranteed by the constitution in many states. The change would not be cheap, but it would reduce the role of Maine’s pension fund and thus the risk of having to suddenly cover giant losses down the road.

A Social Security spokesman said the agency did not expect many of the holdout states to join, citing the cost of participation. The only other state known to have talked recently about adding Social Security is Louisiana.

More than six million public employees work outside the Social Security system, including roughly 1.7 million teachers in California, Illinois and Texas, and nearly two million employees of all types in Alaska, Colorado, Massachusetts, Nevada and Ohio, as well as Louisiana and Maine. For years, these and other states have insisted they could provide richer pensions at a lower cost, both to workers and taxpayers, because of investments.

Some of those states’ pension plans now have shortfalls so large that they need outsize contributions. Virtually all state pension funds have had big losses in the last two years, but the go-it-alone states appear especially vulnerable.

Not only are these states trying to provide richer benefits with smaller contributions than the payroll tax for Social Security, but they have promised to do it for workers who can retire 10 and sometimes 20 years younger.

With pension costs ballooning and taxpayers lashing out, many workers in states with deeply underfunded plans fear their benefits will be cut. Those being asked to put more into their pension funds complain they feel caught up in Ponzi schemes. Some wish they had been part of Social Security after all.

“Had I known back then, I would not have stayed in Illinois,” said John Gebhardt, a university employee in that state, which keeps teachers and university personnel out of Social Security. He has even offered to pay both his own and his employer’s payroll tax to join Social Security, but was told no.

Maine lawmakers who support shifting state workers into Social Security say they believe it would be fairer. Social Security may not be sexy, but it is portable.

A recent study in Maine underscored the penalty paid by the mobile work force. Only one in five state employees stays around long enough to get a full pension. The majority leave, taking neither a pension nor any Social Security credits with them. This practice, not investment gains, has sustained the state’s pension system.

“The current system is immoral,” said Peter Mills, who, as a state senator, started the push to join Social Security. “It takes younger people and feeds off of them. You can withdraw from teaching at age 40 and realize you’ve got nothing to look ahead to for your old age.”

Dallas L. Salisbury, president of the Employee Benefit Research Institute, said he was surprised by how few public workers ever got pensions in Maine, where he provided advice on a pension overhaul. He said he checked and found similar turnover in other states.

Whether Maine joins Social Security or not, painful choices must be made. The state pension fund lost $2.25 billion in 2008, and taxpayers will have to replace the lost money. But they have less time to do so than most states, thanks to tough financing rules in the constitution. Projections show that Maine will not have enough money to do much else in the coming years if it adheres to those rules.

“It’s going to rip the guts out of our budget,” said Mr. Mills. “I don’t think you can find a budgetary parallel in my lifetime, and I’m 67.”

Unlike laggard states, including Illinois and New Jersey, Maine had in recent years been making its required pension contributions annually, and it avoided the common mistake of sweetening benefits when markets were strong.

Its looming fiscal crisis stems primarily from investment losses, points out Sandy Matheson, executive director of the state plan. “Maine is almost like a petri dish,” she said, showing how things can go awry even if a state is responsible.

Mr. Mills, a Republican, initially envisioned shifting workers into Social Security and a 401(k) plan. But he now views Social Security combined with a traditional pension as a safer option. That puts him on common ground with Democrats in the statehouse.

The proposal may meet resistance, however, because it does not fill the gaping hole in the state’s pension fund.

A shift into the federal program is also hard to plan because Social Security has a financial imbalance — one that will worsen as the population ages. At some point, Congress is expected to either raise taxes or cut benefits.

Still, Social Security’s future is easier to predict than that of a state pension fund, because its pressure stems from broad demographic trends, not the vagaries of the stock market. Social Security keeps its reserves in conservative Treasury securities.

“You’ve got reviews taking place all over the country,” said Mr. Salisbury. Most places are asking painful questions about their investment strategies. But what Maine has discovered, he said, is just how expensive it really is to provide a guaranteed retirement benefit.

It's interesting to note how some states are now looking at Social Security as an answer to their pension woes. What I don't get is why weren't these state pension funds allocating more into "conservative Treasury securities" before the crisis hit?

Instead, they were taking stupid risks trying to achieve unrealistic returns based on rosy investment projections. Moreover, they were all being advised by the same pension consultants with absolutely no skin in the game, telling them to invest more in public equities and alternative investments like hedge funds, private equity, and real estate.

Pension funds are not just about making huge gains, it's also about protecting the portfolio against downside risk. And in a zero-interest rate (ZIRP) environment, good old government bonds are about the only thing that will protect you, especially if a protracted period of debt deflation is what lies ahead.

My theory is plain and simple: the Fed will do everything it takes (including buying stocks) to make sure this outcome never happens. Their policy is to keep interest rates at zero as long as possible, reflate risks assets, and hope that mild inflation creeps back into the economic system.

How does this work? You keep interest rates at zero for as long as possible, let banks borrow at next to nothing, and let them trade away in their prop desks, investing those funds in all sorts of risk assets all around the world that can deliver higher yields. What else? Banks can borrow at at historic low rates and develop their credit card business, locking in a nice spread as they fleece consumers. Unfortunately, with ZIRP, banking is all about trading and spreads and very little goes to actually lending money to businesses that need it.

Anyways, back to Social Security. Mary Williams Walsh of the NYT also reports that Social Security is paying roughly $50 million a year too much to people who collect state pensions but fail to declare that income.

No wonder a majority of Americans are losing confidence in Social Security. Susan Page of USA Today reports, Faith in Social Security system tanking:

Battered by high unemployment and record home foreclosures, most Americans seem to have lost faith in another fundamental part of their personal finances: Social Security.

A USA TODAY/Gallup Poll finds that a majority of retirees say they expect their current benefits to be cut, a dramatic increase in the number who hold that view. And a record six of 10 non-retirees predict Social Security won't be able to pay them benefits when they stop working.

Skepticism is highest among the youngest workers: Three-fourths of those 18 to 34 don't expect to get a Social Security check when they retire.

The public's views are more dire than the calculations of Social Security's trustees. Last year, they projected the system would begin running in the red in 2016, as the Baby Boom generation retired, and the trust fund would be exhausted in 2037.

Even then, Social Security — which celebrates its 75th anniversary next month — could finance about three-fourths of current benefits through the payroll tax.

The downbeat outlook reflects "all the attacks on Social Security that we have this total crisis in the program," says Alicia Munnell, director of the Center for Retirement Research at Boston College. What's more, she says, "the fear and distrust as a result of the financial collapse and the Great Recession has spilled over into people's expectations generally, that you can't count on anything."

Well-informed or not, public attitudes could affect the debate over what to do about Social Security, a subject that is likely to be raised when President Obama's deficit commission delivers its report in December.

"It makes it easier to make some of the changes that we are inevitably going to have to make," says Maya MacGuineas, president of the Committee for a Responsible Federal Budget. "We could make changes and still have people collecting more in benefits than they're expecting to see."

So far, however, resistance hasn't eased against steps such as raising the retirement age or increasing Social Security taxes. The only policy options that command majority support are imposing the payroll tax on all the wages of higher-income workers — the amount is now capped — and limiting benefits for wealthy retirees.

Confidence in Social Security has significantly eroded since 2005. The percentage of retirees who predict cuts has jumped by 24 points, even though benefit levels have never been cut for current retirees. In that time, the number of non-retirees who doubt they'll get benefits has risen by 10 points.

The poll of 1,020 adults, taken July 8-11, has a margin of error of +/–4 percentage points.

Most people are reeling following the 2008 financial crisis. They got screwed in the stock market, and they fear Social Security will not be there to support them during their retirement years. However misplaced those fears are, they're real, and states are now looking to tap into Social Security to deal with their pension woes?

They should first look at bolstering the governance of their public pension plans (read Forbes article, Self-Dealing Threatens Florida Pensions). Social Security is already stretched, and tackling state pension woes is the last thing it should be called upon to do.

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