Will Collapsing US Pensions Fuel Next Crisis?

Jeff Reeves of MarketWatch opines, Collapsing pensions will fuel America’s next financial crisis:

Washington has a knack for ignoring long-term financial shortfalls and painting overly rosy scenarios about the future to make their numbers work in the here and now.

Case in point: Donald Trump’s unrealistic projection that the U.S. economy will grow at 3% this year, when the latest GDP forecasts have actually been reduced to 1.8% by a number of economists.

Then there is Social Security. Many politicians are just too intimidated, uninformed or complacent to tackle the unsustainability of Social Security — which by the latest tally will see its trust fund go to zero just 17 years from now, in 2034.

But while fudging GDP numbers is dangerous for America’s economic outlook and the demise of Social Security in two decades is a serious long-term concern, America faces a mathematical problem that dwarfs both of these items: A pending pension crisis that could leave millions of Americans high and dry in the very near future.

Sure, it would be difficult for many if the U.S. economy stumbles under misguided Trump policies. And yes, the idea of even modest cuts to Social Security in the coming decades could serious affect millions of seniors. But take a look South Carolina’s government pension plan, which covers roughly 550,000 people — one out of nine state residents — but is a staggering $24.1 billion in the red..

This is not a distant concern, but a system already in crisis.

Younger workers are being asked to do much more to support the pensions of retirees. An analysis by the The Post and Courier of Charleston noted recently that “Government workers and their employers have seen five hikes in their pension plan contributions since 2012, and there’s no end in sight.” (Most now contribute 8.66% of their pay, vs. 6.5% before the changes.) At the same time, the pension fund has been chasing more stocks and alternative investments instead of relying on stable investments like bonds that may be much less volatile but generate only meager returns.

And if that’s not troubling enough, South Carolina’s pension fund is far from alone.

The Michigan Public School Employees Retirement System pension fund is $26.7 billion underfunded, and mind-blowingly has paid out more benefits than it has actual assets in 41 of the last 42 years, according to some estimates. The Mackinac Center for Public Policy has estimated that, as a result, more than a third of Michigan’s school payroll expenses go to retirees, not those people actually teaching children in a classroom.

It’s not just government employee pensions at risk, either.

Legislators are debating help for roughly 100,000 coal miners who face serious cuts in pension payments and health coverage thanks to a nearly $6 billion shortfall in the plan for the United Mine Workers of America. And the Teamsters just got permission to slash benefits by as much as 30% for some 400,000 participants because its Central States plan is so deep in the hole.

It’s a very disturbing trend, and according to one organization nearly one million working and retired Americans are covered by pension plans at risk of collapse — and many more plans face shortfalls that could become equally problematic if action isn’t taken immediately.

The problem is only going to get worse as payouts remain bloated and investment returns remain hard to come by. With global growth minimal and the interest-rate environment still quite low by historical norms even in the face of recent Federal Reserve moves, the situation is quite urgent.

The looming problems with Social Security make things even more disturbing. If older Americans never bothered to build up much in the way of retirement savings because they were expecting their pension to be there, then Social Security is quite literally the only way for them to make ends meet.

And if you really want to terrify yourself, think about what would happen to the U.S. economy if older, low-income pensioners suddenly have 5% or 10% less to spend on necessities. According to data from 2013, the average household income of someone older than 75 is $34,097 and their average expenses exceed that, at $34,382. If their benefits are cut, their spending will assuredly fall — and that reduction in spending on food, energy and other staples won’t be replaced.

That’s the crisis I fear most: a dramatic reduction in benefits to millions of pensioners, the failure of Social Security to bridge the gap and a substantial decline in consumer spending as a result. Then it’s not just older Americans tightening their belts, but younger Americans facing a tough job market as restaurants and retailers start cutting back, too.

There’s also a serious concern about whether simply cutting benefits or boosting contributions is enough as global growth slows and fixed-income investments yield significantly lower than in recent years. As I wrote a few months ago, some investment experts expect as little as 4% annual returns in U.S. equities, and bonds to yield less than 2% for many years to come.

So what do we do?

Unfortunately, there are no easy answers. Pension reform — as with Social Security reform — is most equitably approached as a combination of benefit cuts, increased contributions and higher eligibility ages. But since those solutions tend to offend all stakeholders, it is difficult to get past the inertia.

However, America is rapidly approaching a point of no return.

Say what you will about the solvency of Social Security, and the imperative of acting on admittedly imperfect calculations that still give us a good 15 to 20 years until the trust runs dry. But the millions of Americans relying on underfunded pension plans have an urgent need for reform in 2017.

And if they don’t get it, it could have serious effects on the American economy for decades.

Please repeat after me: The global (not just American) pension crisis is deflationary because it exacerbates income inequality and will condemn hundreds of millions of workers to pension poverty.

Of course, the US pension crisis is nothing new to readers of this blog. I've been writing about it for years but now that the chicken has come to roost, financial journalists are sounding the alarm too.

I recently discussed America's crumbling pension future and followed that comment up with how the PBGC is running out of cash. It's high time the administration and Congress take a fresh look at the Pension Protection Act (PPA) of 2006 and do something to tackle the ongoing retirement crisis.

Just like healthcare, when it comes to pensions, things are far from perfect in America. We have academics teaming up with Wall Street titans peddling a revolutionary retirement plan but the only revolutionary plan that I recommend to my neighbors down south is to follow the model of the soon to be enhanced Canada Pension Plan whose assets are managed by the Canada Pension Plan Investment Board.

The major hurdle in adopting an enhanced Social Security where assets are managed at arms length from the government is the lack of proper pension governance. In the US, there is way too much political interference, all because the status quo governance benefits Wall Street and its big bonuses.

The power elite down south don't want to adopt the Canadian pension model where assets are managed primarily in-house, it doesn't benefit them.

This is the dire predicament of the US pension industry where one measure after another keeps placing a Band-Aid over a metastasized tumor, extending and hoping the problem will go away.

It won't, it will only get worse. Never mind the Trump rally, never mind the Fed and "gradual" rate hikes, when interest rates make new secular lows -- and mark my words, they will -- global pensions will get clobbered and many chronically underfunded US pensions are going to face insurmountable pension deficits.

What happens then? A sovereign debt crisis like Greece which will slash the pension payouts of retirees who worked in the public sector? Not quite. Unlike Greece, the US prints the word's reserve currency so it will never suffer a sovereign debt crisis (but will suffer many mini debt ceiling crises).

What will happen and is already happening at the state, city and local level is these pensions obligations will continue eating away at most of the budgets, forcing politicians to increase property taxes or worse still, cut benefits when taxpayers come at them with pitchforks.

I've been warning people of the global pension crisis since I started writing this blog back in June 2008, but the crisis started way before that, it actually began during the tech crash of 2000.

"Leo, you're being too cynical, the Fed is on top of it, Fed Chair Yellen, President Trump and Wall Street will save pensions, they need to so Wall Street can keep milking the pension cow."

If you believe that, you're delusional. There are significant structural issues that need to be addressed or else US public and private pensions will collapse and hinder economic growth for decades to come.

I'm not mincing my words. Emitting pension obligation bonds, raising property taxes, tinkering with the discount rate and retirement age, or worse still, shifting out of DB into DC plans, will do nothing to cure America's pension cancer. And don't kid yourselves, it is a cancer which will profoundly impact the US economy.

Now, you may think I'm too apocalyptic in my doomsday scenario and I'll admit that nothing is imminent but trust me, US pensions are on a collision course and they pose serious systemic risk to the US economy and global financial system longer term (for many reasons).

And if you think I'm too much of a doomsayer, let me introduce you to a friend of mine who thinks humankind is facing extinction in the not too distant future. Last night he told me flat out he doesn't read my blog any longer because "we've peaked on conventional oil in 2005 and tar sands, shale oil and alternative energy won't save us but the financial system is the major risk now and we are all doomed."

He even sent me links to blogs like Our Finite World, Economic Undertow, Surplus Energy Economics, and the Collapse of Industrial Civilization. He also sent me PDF files on The Perfect Storm: Energy, Finance, and the End of Growth and Financial System Supply-Chain Cross-Contagion: a study in global systemic collapse.

Surprisingly, he's a pretty upbeat fellow who enjoys every day of his life and is thankful for the life he has had thus far but tells me "we are all screwed, every one of us, even the top 0.00001%."

So maybe collapsing US pensions won't fuel the next major crisis. Maybe we are all losing the forest for the trees, unable to see the bigger ecological calamity which will spell not only the end of pensions, but the end of humankind.

Maybe but I prefer to be a little more optimistic than my buddy and hope that we find a way to keep this planet alive, safe and secure for many generations to come.

Below, watch yesterday's FOMC Press release where Fed Chair Janet Yellen explains the decision to hike rates gradually, going over the latest FOMC statement. You can read her opening statement here.

I quite enjoyed the exchange with Bloomberg's Kathleen Hays who confronted a startled Yellen on why the Fed is hiking rates with GDP and real wages sliding (not to mention soaring credit card debt). I actually agreed with Neel Kashkari, the lone dissenter who voted against his FOMC colleagues, concerned this decision will fuel more inequality (which is deflationary).

Also, if the Fed hikes more often than what the market anticipates, it risks fueling the 2017 US dollar crisis I warned of late last year. That too will be a deflationary disaster.

My take? The Fed is well aware that global deflation is coming and is trying to raise rates now while it can to have enough bullets to confront the next financial crisis which is on its way (needs ammunition to lower rates in the future).

The bond market will have none of this, it knows what's coming ahead, which is why I keep telling people to load up on US long bonds (TLT) at these levels and thank me later this year.

I also embedded a discussion with Dr. Charles Hall of the Dept. of the SUNY-Environmental and Forest Biology. He is the primary creator behind the concept of EROEI in the field of biophysical economics. He also co-wrote the book “Energy and the Wealth of Nations“.

A very interesting discussion and if you listen to Dr. Hall, you'll realize collapsing pensions, the Fed and the bond market don't really matter. We have much bigger problems to deal with.