Tuesday, February 22, 2011

Wisconsin’s Public Pension Problems?

Dan Bigman of Forbes wants to remind you Wisconsin’s Public Pension Problems Are Your Problem, Too. But are they really or is this more fear mongering? Zach Carter of the Huffington Post reports, Wisconsin's Pension Fund Among Nation's Healthiest:
While Wisconsin Gov. Scott Walker (R) has painted a dire picture of his state's pension obligations, Wisconsin's pension fund for public employees is among the nation's strongest, according to a report by the nonpartisan Pew Research Center*.

The Pew report, issued last year, concluded that Wisconsin is a "national leader in managing its long-term liabilities for both pension and retiree health care." Walker has cited the fund's lack of sustainability as grounds for his plan to revoke collective bargaining rights for state employees, but that proposal has sparked outrage among state employees and drawn tens of thousands of protesters to the state's capitol.

"We're going to ask our state and local workers ... to pay a little bit more, to sacrifice, to help to balance this budget," Walker said in a Sunday interview with Fox News' Chris Wallace, adding that he would be forced to lay off 5,000 to 6,000 state employees if his budget plan was not approved, as well as a comparable number of local public employees.

But the Wisconsin pension fund is simply not in fiscal trouble. Its managers weren't burned by subprime mortgage assets or mortgage-backed securities as the housing bubble collapsed. The fund also relies on an automated dividend system, which pays out benefits in years the system is making gains while restricting payouts in years when it takes losses. And while the pension fund had a rough year during 2008 due to stock market losses, it remains robust, both in terms of fundamental financial stability and in comparison to other state pension programs.

According to the Pew study, Wisconsin had about $77 billion in total pension liabilities in 2008. But according to that same Pew study, those liabilities were 99.67 percent "funded," giving Wisconsin one of the four-highest of such ratios in the nation. Other states had funding ratios as low as 54 percent. For comparison, expert analysts and the Government Accountability Office consider an 80 percent level to be a good benchmark for pension fund stability, while Fitch Ratings considers 70 percent adequate.

Pension accounting relies on a very long-term outlook. When the state calculates its pension liabilities, it adds up the total expected pension expenditures for the entire lifetimes of everybody currently receiving a pension and all employees expected to receive pensions. That outlook routinely eclipses 30 years, depending on the ages of state employees. A $77 billion liability is only a problem if the state has no realistic way of meeting those expenses over that 30-plus year timeframe. But the Wisconsin pension system actually does have the vast majority of that money -- in fact, in 2008, the pension fund had 99.67 percent percent of that $77 billion total on hand. If all of the assets in the fund had simply been sold at market values on June 30, the resulting cash would have been enough to pay 99.67 percent of the state's total pension payouts for decades to come.

According to the Wisconsin pension fund's own 2010 annual report, the system had $69.1 billion in total assets at June 30, 2010, while paying out $3.7 billion in benefits over the course of the previous year. The value of those assets has since risen. According to Dave Stella, secretary of the Wisconsin Department of Employee Trust Funds, the retirement system's assets were worth $79.8 billion at the end of last month. The most recent solvency test for the fund was conducted for the fund's operations at Dec. 31, 2009. At the time, the funding ratio was 99.8 percent. The next solvency test is scheduled for June of this year.

So while Wisconsin does face a $137 million budget shortfall this year, the source of that fiscal trouble is not the state's pension fund. Under the current plan, Walker hopes to generate $30 million this year by raising taxes on public employees -- the governor refers to this as increasing the "contribution" that state employees make to their pension funds.

But Walker could make the state's pension system bear the costs of a broader state budget shortfall -- one created almost entirely by lower tax revenues resulting from the economic downturn -- without raising taxes on public workers or eliminating public bargaining rights. All he has to do is cut a few ties with the financial-services industry.

According to the pension fund's 2010 report, the fund spends about 84 percent of its management costs on outside help -- highly-compensated fund managers who work for private-sector financial firms. While Wisconsin has made a concerted effort to bring more of its fund management in-house, it could do more.

In 2009, roughly half of the pension fund's total assets were managed by state employees, who were paid a total of $28.4 million for their work. By contrast, outside Wall Street professionals were paid $194.7 million to manage the other half of the fund's assets. Cutting Wall Street pay, or simply moving more fund management in-house, could easily generate the $30 million in new taxes Walker wants to assess on state employees.

Wisconsin accounts for its pension fund assets using "mark-to-market" accounting. That means that while the state often expects to hold its assets indefinitely, collecting interest payments until the assets expire, it can't simply add up those expected interest payments to determine the value of an asset. Instead, the fund can only say that the asset is worth what other investors are willing to pay for it at a given moment. If investors want to pay less than the future interest payments, that's too bad for Wisconsin.

While some accounting experts say this market-oriented accounting is a more honest and accurate way to represent asset values than other methods, U.S. corporations are often allowed much more lenient accounting standards. During the financial crisis, for instance, many banks balked at the suggestion that they be required to account for subprime mortgage bonds at the prices that people were actually willing to pay for them. Instead, they argued, banks should be allowed to account for these items based on secret company economic models. If Wisconsin and other pension funds were simply cut the same slack that the government cut for Wall Street, it's easy to imagine pension fund worries easing, even in states whose pension situations are more dire.

[*Correction: Sarah Jorgenson of The Pew Charitable Trusts sent me this correction: We saw your Wisconsin pensions article today and wanted to flag an inacurracy. Zach Carter of the Huffington Post misattributed Pew's report, "The Trillion Dollar Gap," to The Pew Research Center. The report was issued by The Pew Center on the States, a division of The Pew Charitable Trusts. The Pew Research Center is a separate, independent subsidiary.]

I agree with Mr. Carter, public pension funds should be cut some slack but in some cases like in Oklahoma where state Treasurer Ken Miller warned that state pensions are at a "crisis level", more drastic reforms need to be taken.

I also agree that Wisconsin's pension fund is in decent shape and they should move more assets
in-house to save some fees. On that front, I noticed that Wisconsin's public pension fund recently made its first investment in a hedge fund, allocating $100 million to Capula Investment Management. This might be because they don't have internal expertise to implement such a strategy but they can cut fees elsewhere.

'll also recall that Wisconsin leveraged up its bond portfolio, a strategy that others were tinkering with. If done properly, it can be a source of leveraged beta by ramping up fixed income to get equity-like returns, but it can also present additional risks that will come back to haunt them. Pensions should carefully think through the ramifications of implementing such a strategy.

Finally, state workers across the US are understandably worried about what's going on in Wisconsin (watch video below). As labour unrest spreads, expect some major showdowns ahead. This has the potential to get very ugly, very quickly.

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