Will the Real Debt Crisis Please Stand Up?

Landon Thomas Jr. and Niki Kitsantonis of the NYT report, Patchwork Pension Plan Adds to Greek Debt Woes:
Vasia Veremi may be only 28, but as a hairdresser in Athens, she is keenly aware that, under a current law that treats her job as hazardous to her health, she has the right to retire with a full pension at age 50.

“I use a hundred different chemicals every day — dyes, ammonia, you name it,” she said. “You think there’s no risk in that?”

“People should be able to retire at a decent age,” Ms. Veremi added. “We are not made to live 150 years.”

Perhaps not, but it is still difficult to explain to outsiders why the Greek government has identified at least 580 job categories deemed to be hazardous enough to merit retiring early — at age 50 for women and 55 for men.

Greece’s patchwork system of early retirement has contributed to the out-of-control state spending that has led to Europe’s sovereign debt crisis. Its pension promises will grow sharply in coming years, and investors can see the country has not set aside enough to cover those costs, making it harder for Greece to borrow at a reasonable rate.

As a consequence of decades of bargains struck between strong unions and weak governments, Greece has promised early retirement to about 700,000 employees, or 14 percent of its work force, giving it an average retirement age of 61, one of the lowest in Europe.

The law includes dangerous jobs like coal mining and bomb disposal. But it also covers radio and television presenters, who are thought to be at risk from the bacteria on their microphones, and musicians playing wind instruments, who must contend with gastric reflux as they puff and blow.

And Greece may be an early indicator of troubles to come. Bigger countries like Germany, France, Spain and Italy have relied for decades on a munificent state financed by a range of stiff taxes to keep the political peace. Now, governments are being pressed to re-examine their commitments to generous pensions over extended retirements because the downturn has suddenly pushed at least part of these hidden costs to the surface.

The situation in the United States is different but also painful. The government will face its own fiscal reckoning, analysts say, as 78 million baby boomers begin drawing on Social Security and Medicare programs to support them in retirement. Without some combination of higher taxes, benefit reductions or an increase in the retirement age, both programs will run short of money to make their promised payments within the next few decades. And many American states are woefully behind on funding their pension obligations for public employees.

In Europe, the conflict has already erupted on the streets, with workers demanding that generous retirement policies be kept while governments press to pare pensions and raise retirement ages because taxpayers cannot bear any additional weight and creditors will no longer finance excessive borrowing.

The problem goes well beyond how to keep up payments and deal with budget deficits resulting from the financial crisis. Because of generous promises, unfunded pension liabilities in Europe far outweigh the stated debt that governments owe creditors, which have caught Greece and several other weak European nations in a borrowing vise.

According to research by Jagadeesh Gokhale, an economist at the Cato Institute in Washington, bringing Greece’s pension obligations onto its balance sheet would show that the government’s debt is in reality equal to 875 percent of its gross domestic product, which is the broadest measure of a nation’s economic output. That would be the highest debt level among the 16 nations that use the euro, and far above Greece’s official debt level of 113 percent.

Other countries have obscured their total obligations as well. In France, where the official debt level is 76 percent of economic output, total debt rises to 549 percent once all of its current pension promises are taken into account. And in Germany, the current debt level of 69 percent would soar to 418 percent.

Mr. Gokhale, like many other economists, says he believes that this is a more appropriate way to assess a country’s debt level because it underscores the extent to which the cost of providing for rapidly aging populations, if left unchanged, will add to already troubling debt burdens.

“You have to look ahead and see how pension expenditures are rising in comparison to the revenues needed to finance them,” he said. “It’s not just Greece; all major European countries are facing pension shortfalls. It is a very difficult challenge because it involves selling pain to current voters.”

He estimates that to fully finance future pension obligations, the average European country would need to set aside 8 percent of its economic output each year, a practical impossibility given that raising already high taxes so much would impose a crushing economic burden.

Mr. Gokhale has done a similar calculation for the United States and estimates that the truest measure of federal government debt, incorporating Medicare, Medicaid, Social Security and other obligations, is $79 trillion, or about 500 percent of the nation’s output. Currently, its public debt is equal to about 60 percent of its domestic output.

Many of these liabilities will not be coming due for decades. But as most developed countries experience having fewer workers to cover pensions and health care bills for the elderly, their ability to borrow more is rapidly approaching its limits.

In its 2009 annual report on Greece, the International Monetary Fund warned that the government’s excessive pension and health payments to the elderly would result in a debt level of 800 percent of its output by 2050 if left unchecked, similar to the figures Mr. Gokhale calculated. That is a theoretical number, of course: international creditors, who are already balking at lending Greece more money, would require changes in government programs well before Athens borrowed that much.

“The pension crisis is the biggest single test of Greece’s willingness to tackle longstanding reform,” said Kevin Featherstone, an expert on the Greek political economy at the London School of Economics. “Any meaningful reform must lead to reduced benefits for workers — the government needs to show that it can overcome union pressure.”

Greece has proposed raising its average retirement age to 63, and that may be just a beginning.

The French president, Nicolas Sarkozy, has met with union leaders and broached the prospect of raising the normal retirement age from 60. Spain has gone further, proposing to raise the retirement age to 67, from 65. In the face of union opposition, however, the government is wavering.

Pensions have become a divisive topic not just among workers and governments, but among governments within Europe. Germany, which has taken politically difficult steps to increase its retirement age to 67 while reducing benefits, is serving as the most stubborn taskmaster on fiscal matters for Greece.

Greece’s pension problem far outweighs the finagling with its accounts that it relied upon in the early 1990s to get its official deficit figures low enough to qualify to join the euro club. A recent report by the European Commission found that the amount Greece spends on pensions and health care for its aging population, if left unchecked, would soar to about 37 percent of its economic output by 2060 from just over 20 percent today, making it the highest level in Europe.

“Projected pension expenditures are expected to double,” said Manos Matsaganis, a professor at the University of Athens and author of numerous papers on Greece’s pension system. “That is unsustainable.” Still, the millions who have come to rely on these payouts will not give up their pensions easily. “Nobody thinks they have to be the one to sacrifice,” Mr. Matsaganis said.

That’s certainly true of Christos Bourdakis, a retired government accountant. Sitting in a dusty union hall in Athens, he is in no mood to offer any concession on his pension, regardless of the severity of the crisis.

He is a full-throated proponent of a system that pays him a yearly gross pension of 30,000 euros, or $41,000, more than he was making when he retired 13 years ago at the age of 60. He has even written a book in defense of it, “The Guide to Granting Civil Service Pensions in Greece.”

“We have to protect our standard of living,” Mr. Bourdakis said. “The pensioners should not have to pay for the crisis created by the bankers.”

Unfortunately, pensioners are already paying for the crisis created by bankers and so will the rest of the population as liabilities mushroom over the next few decades. In the UK, the National Audit Office estimates that the amount of money paid as pensions to many workers in the public sector could more than triple in the next 50 years:

Its report on unfunded public sector schemes says they will pay out £79bn by 2060, compared with £25bn this year.

The rise will be due to increased longevity and increases in the real earnings of public sector workers.

But the NAO warns that annual pension payments will be much higher if the public sector workforce increases.

"The Treasury has not assessed the impact of different assumptions about the size of the public service workforce, despite it being a critical driver of pension costs," it said.

More pensioners

The NAO's report, the first of two, looks at the costs of the so-called "pay as you go" public sector pension schemes, in which pensioners are paid out of taxation rather than the proceeds of an underlying investment fund.

The biggest four schemes of this type are those of the civil service, the armed forces, and the NHS and teachers schemes for England and Wales.

They account for 75% of all payments from unfunded public sector schemes.

Last March the schemes covered 6.5 million people - 2.75 million staff, 1.59 million former employees who had not yet retired, and 2.13 million pensioners.

The report found that total payments to pensioners made by those schemes rose by 38%, from £14bn in 1999-2000 to £19.3bn in 2008-09.

The main reason for the increase was the 23% rise in the number of pensioners during that time as more people retired.

Employee contributions also rose strongly over the same period, by 56% to £4.4bn, thanks to higher contribution rates and more staff making contributions.

'Heroic' assumption

The NAO, on the basis of figures supplied by the Government Actuary's department, estimates that cash payments to pensioners will rise further, from an estimated £25.4bn in 2009-10 to £79.1bn in 2059-60.

As a proportion of the economy's total economic output, the Treasury estimates that these payments will rise from 1.7% now to 1.9% by 2018-19, before eventually falling back to 1.7% by 2059-60.

As well as assuming that women will live on average to 94.7 and men to 92.3, and that average public sector earnings will grow by 2% a year above inflation, the government is also assuming in its calculations that the public sector workforce will not grow.

That is despite a predicted 20% growth in the population over that time.

Edward Leigh MP, chairman of the Parliamentary committee of public accounts, said that particular assumption was "heroic".

"The projection that total annual payments to pensioners in these schemes will top £79bn by 2059-60 is frightening, although, at least as a proportion of forecast GDP, this does not represent an increase," he said.

"These figures must be used to inform an urgently needed national debate about public sector pension schemes for new entrants."

The NAO will publish a second report later this year which will look at the impact of recent changes to the pension schemes and put forward recommendations.

These involve the assumption that the cost of higher contributions in the future will fall on employees, with two-thirds of the higher costs being absorbed by lower payments to pensioners and one-third being paid for by higher contributions.

The above articles give you a glimpse of the real debt crisis which awaits developed nations in the coming decades. It isn't pretty, nor is it sustainable. Something has got to give or else all these public pensions will implode leaving many pensioners vulnerable during their retirement years. By then, it will be too late to protest. In fact, it's already too late.

***EBRI's Latest Confidence Survey****

The latest Employee Benefit Research Institute confidence survey (download brief) shows that Confidence Stabilizing, But Preparations Continue to Erode:

Executive Summary

20TH ANNUAL RCS: The 2010 Retirement Confidence Survey—the 20th annual wave of this survey—finds that the record-low confidence levels measured during the past two years of economic decline appear to have bottomed out. The percentage of workers very confident about having enough money for a comfortable retirement has stabilized at 16 percent, which is statistically equivalent to the 20-year low of 13 percent measured in 2009 (Fig. 1, pg. 7). Retiree confidence about having a financially secure retirement has also stabilized, with 19 percent saying now they are very confident (statistically equivalent to the 20 percent measured in 2009) (Fig. 2, pg. 8).

Worker confidence about paying for basic expenses in retirement has rebounded slightly, with 29 percent now saying they are very confident about having enough money to pay for basic expenses during retirement (up from 25 percent in 2009, but still down from 34 percent in 2008) (Fig. 3, pg. 9).

PREPARATIONS STILL ERODING: Fewer workers report that they and/or their spouse have saved for retirement (69 percent, down from 75 percent in 2009 but statistically equivalent to 72 percent in 2008) (Fig. 11, page 14). Moreover, fewer workers say that they and/or their spouse are currently saving for retirement (60 percent, down from 65 percent in 2009 but statistically equivalent to percentages measured in other years) (Fig. 13, pg. 15).

MORE PEOPLE HAVE NO SAVINGS AT ALL: An increased percentage of workers report they have virtually no savings and investments. Among RCS workers providing this type of information, 27 percent say they have less than $1,000 in savings (up from 20 percent in 2009). In total, more than half of workers (54 percent) report that the total value of their household’s savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000 (Fig. 14, pg. 16).

CLUELESS ABOUT SAVINGS GOALS: Many workers continue to be unaware of how much they need to save for retirement. Less than half of workers (46 percent) report they and/or their spouse have tried to calculate how much money they will need to have saved for a comfortable retirement by the time they retire (Fig. 23, pg. 22).

AMERICANS EXPECTING TO WORK LONGER: Although the age at which workers report they expect to retire shows little change from 2009, a longer-term look finds significant change. In particular, the percentage of workers who expect to retire after age 65 has increased over time, from 11 percent in 1991 to 14 percent in 1995, 19 percent in 2000, 24 percent in 2005, and 33 percent in 2010 (Fig. 29, pg. 28).

INSTITUTIONAL CONFIDENCE LAGGING: Americans continue to lack confidence in institutions. Just 19 percent of workers and 22 percent of retirees report they are very confident about banks, while 12 percent of workers and 13 per-cent of retirees say they are very confident about insurance companies (Fig. 19, pg. 19). They are most likely to express confidence in private employers (23 percent of workers and 27 percent of retirees very confident) and least likely to feel confidence in the federal government (11 percent of workers and 8 percent of retirees) (Fig. 20, pg. 20).