America's Pension Shithole?
Illinois lawmakers on Tuesday expressed interest and skepticism in an idea that the U.S. state should sell $107 billion of bonds to address its huge unfunded pension liability.Opinions vary on this mega-bond sale proposal to shore up Illinois's public pension systems. Paris Schutz, a broadcaster at WTTW Chicago Tonight reports, $107 Billion Borrowing Plan Could Save State Pensions:
At a hearing before the Illinois House Personnel and Pensions Committee, Runhuan Feng, an associate professor of mathematics at the University of Illinois, laid out a plan for selling taxable 27-year, fixed-rate bonds to get the state’s five retirement systems to a 90-percent-funded level.
The bond plan, which was offered by a group representing workers and retirees in the Illinois State Universities Retirement System, would result in a $103 billion reduction in the state’s pension costs by 2045, according to Feng.
Committee Chairman Robert Martwick filed a bill for the bond sale, emphasizing that it was in early in the process and promising to bring in bond market and other experts to testify.
In order to become law, the bill would need to pass both Democrat-controlled chambers and be signed into law by the state governor, currently a Republican.
Illinois pension systems’ funded ratio was just under 40 percent in fiscal 2017, while the unfunded liability totaled $129 billion, according to a legislative commission. The state’s annual pension payment is projected to grow from $8.5 billion in fiscal 2019 to $19.6 billion in 2045 under the current funding system.
Some lawmakers questioned what the plan would do to Illinois’ credit ratings, which are already the lowest among the U.S. states, and if the huge borrowing would make future bond sales for capital projects impossible.
“Are we going to be tapped out completely?” asked Democratic State Representative Scott Drury.
Some lawmakers expressed interest if the bond sale came with additional ways to lower costs that would not violate public pension protections in the Illinois Constitution.
The state has already been a prolific issuer of taxable pension bonds, selling $3.7 billion in 2011, $3.5 billion in 2010, and $10 billion in 2003. The 2003 deal included $7.7 billion of bonds that will not mature until 2033 and $1.4 billion maturing in 2023.
The U.S. and Canadian Government Finance Officers Association has advised its state and local government members not to issue pension bonds, citing several risks that could arise from investing bond proceeds and increasing debt burdens.
It’s being called a “moon shot” proposal to solve the state’s worst-in-the-nation pension crisis.Indeed, as I have repeated many times, pensions are all about managing assets and liabilities. This means when pensions are chronically underfunded like in the case of Illinois' pension systems (40 percent funded, the worst-funded public pension system of any state), there's not much they can do except raise contributions, cut benefits or both to shore up their plans.
One state advocacy group is asking lawmakers to borrow massive amounts of money, on top of the debt the state already has. Why do they think it’s the best way to go?
The idea is to go to the bond market, borrow a whopping $107 billion and put it all into the state’s pension funds to get them healthy in one fell swoop. Right now they are short $130 billion of where they need to be, which is helping drive the state’s junk bond rating. The proposal is being pushed by the State University Annuitant’s Association and developed by University of Illinois professor Runhuan Feng, who presented the plan to skeptical lawmakers at a hearing Tuesday in Springfield.
Feng says the state can borrow that money at an interest rate of 5 percent. If historical trends hold up, it can invest that money in the pension funds and get a return of 7 percent, generating a 2-percent profit and saving taxpayers $100 billion over the next 27 years. Feng acknowledges that a lot of chips would have to fall the right way for this plan to work.
“I do realize there’s risk, that’s why we ran a relatively conservative scenario to argue that there is an interest rate arbitrage you can take advantage of,” he said. “And studies show that historically there has been a 2-percent rate based on the tax authorities.”
The testimony was met with a lot of skepticism from lawmakers who wonder what might happen in the case of an economic downturn, and if annual 7-percent returns fail to materialize. Also, would lenders even pony up $100 billion, especially with the state right now not being the most popular of investments? The Civic Federation’s Laurence Msall says no state has even attempted half this amount of borrowing, but because the crisis is so severe, the plan deserves a look.
“No other state in the United States has ever attempted to borrow over $100 billion, no states borrow half that amount, not even California or New York,” Msall said. “And when they borrow that amount, they don’t use it for pensions, they use it to make investments that are going to last longer than the length of the bonds. So, this is an extraordinary idea, it’s one that is only beginning to be vetted, and the burden’s on the promoters to tell us how this could actually be done.”
Gov. Bruce Rauner’s office seemed ho-hum on the idea, through a spokesperson saying: “Pension reform has to save taxpayers money. We ought to start with a constitutional proposal to reform current pensions, like something similar to the so-called ‘consideration model’ first proposed by Senate President Cullerton.”
Other ideas thrown around at Tuesday’s hearing included borrowing this money to pay buyouts to retirees in lieu of receiving yearly pensions. Remember, the Illinois Supreme Court ruled three years ago the state can’t cut or trim benefits.
Unfortunately, Illinois' Supreme Court has ruled benefits cannot be cut and public-sector unions and the government don't want to pay more into their public pensions, and taxpayers don't want to pay more in property taxes, so the only politically expedient option seems to be to borrow billions in the bond market to shore up the state‘s woeful pension system.
But while some are sold on the idea of borrowing over $100 billion to shore up Illinois' public pensions in "one fell swoop", others are less enamored by this proposal. Robert Reed of the Chicago Tribune reports, Proposed $107 billion bond isn't the cure for Illinois' public pension crisis:
A big, bold plan to save the state’s debt-strapped public pension funds is being floated this week in Springfield. But don’t get your hopes up.Unfortunately, after years of state government mismanagement and terrible governance on the part of Illinois' public pensions, the state is desperate to slay its pension dragon once and for all.
It’s not the cure to Illinois’ festering financial crisis.
An influential state employee advocacy group, the State Universities Annuitants Association, is urging Illinois to issue $107 billion in bonds to pay off shortfalls in the state’s five leading pension funds.
Yep, that’s a whopping $107 billion — backed by taxpayers who will be on the hook, especially if this deal goes bad. And the odds of that occurring look pretty good.
“It’s a big gamble,” says Howard Cure, director of municipal bond credit research for Evercore Wealth Management in New York.
While full details of this plan are expected to be unveiled Tuesday before a state panel, bond and public finance experts are already highly skeptical. They’re concerned it will add to Illinois’ pension burdens — now estimated at $130 billion in unfunded liabilities and growing — and further hinder the state’s sorry overall financial health.
Let’s start with the bond market.
At $107 billion in 27-year fixed-rate bonds, it would be the largest amount of debt the state ever sought from investors. Bond experts wonder if Illinois — with its record of political dysfunction, inability to pay its bills in a timely way and $25 billion in general obligation debt — will attract enough hungry investors.
One way to lure wary backers is to spice up the bonds and sell them at above-market interest rates. Such a premium would likely attract risk-taking investors, probably from overseas funds, or deep-pocketed individuals hoping to make a killing.
But higher rates are tougher to pay off and investors’ bond payments must be paid on time, says Evercore’s Cure. Missing a debt payment means riling angry bondholders, who could quickly sue the state or take other legal actions to recoup their investments, he adds.
Laurence Msall, president of the Civic Federation — a nonpartisan government research group — says his organization has “serious concerns and reservations” about the proposed bond effort too.
On top of the gargantuan amount, the bond is limited to pensions and not linked to any comprehensive financial plan for improving state finances, Msall asserts. The bond’s size could also impede the state’s ability to seek borrowing or bond financing for infrastructure or other basic needs, he says.
Despite these somber concerns, no one should be beating up on the State Universities Annuitants Association, which represents more than 200,000 current and retired employees, for leading this charge.
The group believes many initial concerns will be addressed when it reveals the details of its plan to the General Assembly committee exploring public pension matters. It will argue that its refinancing proposal will lop $103 billion off state pension costs through 2045 while increasing the pensions’ funding levels to 90 percent.
Rep. Robert Martwick, the Chicago Democrat who heads the House pension committee, has no position on the bond plan but wants it to become part of a larger pension reform debate. In the coming weeks, the $107 billion initiative will be fully discussed by finance experts, labor and taxpayer advocates, he stresses.
Of course, when it comes to Illinois’ public pension crisis, there’s no shortage of issues to chew over.
Government leaders have been doing that for way too many years with few results, mainly because of state underfunding of pensions, feisty union opposition and a provision in the state constitution that prohibits any structural changes to the funds or benefits.
Those who want to totally dump public pension plans haven’t had any better luck getting around that provision.
It’s a nasty trick bag because, in the meantime, the amount of public pension liabilities keeps stacking up and strapped taxpayers are increasingly responsible for paying more.
It’s a mess.
But this big, bold but flawed bond plan isn’t the solution to the public pension crisis.
We can’t be that desperate.
My biggest issue with this mega-bond sale is it does nothing to address the structural deficiencies plaguing Illinois' pension systems.
Importantly, even if the state manages to sell these pension bonds, if they don't address lousy governance that has played a big part in the chronic deficit of these public pensions, all they're doing is buying some time without doing anything to cut pension costs and bolster them so they're sustainable over the long run.
But in order to improve governance, the state needs to hire professional pension fund managers who know how to manage money internally to cut costs, and to do this they need a competitive compensation scheme. In other words, no government interference in the oversight of these state pensions. They need to nominate an independent, qualified board to oversee these public pensions (ie., the Canadian pension governance model). They should also almagamate them all into one large state pension plan.
Better governance is only part of the remedy, however. The other missing link is adopting a shared-risk model which explicitly states these plans are jointly sponsored by the unions and the state and they will equally bear the risk of the plans when they are underfunded.
Again, this means when the plans are underfunded, contribution rates need to be raised, benefits cut or both. There is simply no way arround this which is why Illinois' constitution needs to be changed to allow for cuts in benefits if they are needed to shore up these plans.
And I'm not talking drastic cuts, a partial or full removal of cost-of-living adjustments (ie. inflation protection) for a brief period makes perfect sense.
One thing Illinois shouldn't do is lose its pension mind like Kentucky did and switch workers to 401(k)s. This is the dumbest proposal many politicians come up with to gain support from private sector voters but this too will only create a much bigger problem down the road.
Public defined-benefit pensions, when run well and topped out properly by the state, are absolutely worth it and their economic benefits to governments and the economy are often underestimated.
But my claim is based on the assumption that Illinois and other states suffering a similar fate are able to introduce the right governance in these plans.
Don't hold your breath. There are powerful groups in the financial services industry who don't want to change the status quo because many of them are perfectly content with lousy governance as long as they can keep milking the public pension cow.
One last note. I didn't mean to be provocative with my title but the only real difference between Illinois' pension system and the Greek pension system is that Illinois has the capability to borrow billions from the bond market. If Greek politicians were able to do this when the crisis hit, they'd jump on that option faster than you can say "OPA!".
But borrowing billions to shore up public pensions comes at a cost, one that will severely constrain Illinois' already stretched public finances for years or decades to come.
This is why I keep warning you, public pensions matter and the pension crisis is deflationary and will hamper economic growth over the long run.
Lastly, even though Illinois is a big pension shithole, it has a lot of company. There are many other large and small states that aren't too far behind and my biggest fear is when the next crisis hits, many of them will be in a worse position and at that time, they won't be able to borrow at reasonable rates to fund their chronically underfunded public pensions.
You can watch a WTTW Chicago Tonight clip on this mega-bond sale here.
Below, Illinois' lawmakers at odds over pension reform as the state's pension crisis is a problem that can no longer be ignored. Unfortunately, the moonshot pension gamble being proposed doesn't address the underlying structural deficiencies plaguing Illinois' public pension systems which is why I doubt America's pension shithole will be much better off after they borrow billions to shore up these plans.
And in his first State of the Union address, President Trump spoke of shared American values and dreams, while calling for more stringent immigration rules and touting the economy. Judy Woodruff leads analysis of the president’s speech, as well as the Democratic response by Rep. Joe Kennedy.
Noticeably absent in this speech was any discussion on America's ongoing pension crisis. Put simply, you can't make America great again without making public pensions great again!
Update: A wise reader of my blog shared this with me (added emphasis is mine):
US public sector pension plans aren't really pension plans. They are clever ways to unjustly enrich public servants at public expense. To achieve this end, the plans have adopted unsustainable funding and accounting practices made possible by inadequate actuarial and accounting standards. The weakest plans are well past the point of no return. The end game will likely begin in the next recession.I agreed with him that the pension storm cometh, not on shifting workers to DC or target benefit plans, and asked him his thoughts on a federal bailout, possibly emitting 50-year Treasuries to wipe out public and even private pension deficits. He replied (added emphasis is mine):
The way the courts interpret the pension promise may be legally sound but it is economically absurd. The states are told that, once they allow employees to participate in a pension plan, they cannot reduce the pensions employees have earned prior to the change (reasonable), nor can they reduce the pensions that employees will earn throughout the remainder of their careers (absurd). This being the case (and I believe that Jerry Brown is challenging this interpretation in California, now that he has decided not to seek reelection), the only way to fix a pension plan that has become too expensive due to low interest rates, increasing life expectancies and/or ill-advised pension negotiations (for example, agreeing to pension "spiking") is to dismiss all of the employees (if the court permits states to fire those it can no longer afford to employ) and start again with a DC plan or a Target Benefit plan.
It comes as no surprise that the proposal to borrow $107 billion to take a flier in the stock market enjoys the support of public sector unions. They bear none of the risk and collect all of the money. As long as they can keep the game going, they win and the public is left holding the bag.
I can't predict what the federal government will do. I can't see the argument for bailing out Illinois, or Illinois' public servants. How would one explain this to voters in the states that did not similarly mismanage their public pensions? Why should public servants in Illinois be unjustly enriched at the expense of taxpayers in other states?I realize his views won't sit well with Illinois' powerful public-sector unions but he does raise many valid points that need careful consideration. I thank him for sharing his thoughts.
At some point, you need to let the plans fail and the courts decide who should pay for it. The courts created the problem, along with dishonest politicians and greedy public sector unions. Let them solve the problems they created, and live with the consequences.
If the reckoning comes during a period of economic distress, the federal government and the Federal Reserve Board can experiment with fiscal and monetary policies and look for remedies that help everyone, not just public servants. They should avoid "trickle down" remedies, like bailing out public service pension plans in the hopes that selfless spending by retired public servants will keep the economy afloat. Government employees understandably favour this kind of approach. No one else does.
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