Is spiking the biggest problem for public pensions?
The crisis that public pensions face over funding shortfalls is becoming increasingly important in the media. Add to that some concerns about the generous benefits that some public retirees receive. As state after state struggles with new controls on benefits and takes steps to address plan shortfalls, the issues become mired in more and more complexity.
There is one issue in the pension storm that is easy to understand; that is the issue of “pension spiking,” or an employee taking sometimes illegal steps to inflate the final salary on which their pension is based. California State Controller John Chiang has gone so far as to call spiking a “form of public theft.”
The Federal Reserve Bank of Cleveland defines pension spiking as:
The practice of inflating employees’ salaries to increase their benefit base. This can be accomplished through a last-day “promotion,” where the employee receives a new title and a salary far above what he earned in the previous 364 days, or where an employee nearing retirement receives the lion’s share of available overtime.
Here is a particularly crazy example of spiking from Bloomberg. In this case the employee has included every conceivable form of compensation into their salary total for their pension calculation:
Robb Quincey made $460,000 last year as city manager of Upland, California, a middle-class suburb east of Los Angeles at the foot of the San Gabriel Mountains. His duties included overseeing 325 employees, a police department with 25 cars, four fire stations and a library for the community of 76,000.
Last year, Quincey, 51, negotiated a new contract in which the city agreed to add reimbursements for his car, housing and other costs directly into his paycheck, according to public records. When he retired, the combined payments would be counted in his final year’s salary and used as the basis for calculating his pension for life.
The State Budget Crisis Task Force weighs in
Much as the Simpson-Bowles report aspired to be the foremost guide to reducing the federal deficit, the Volcker-Ravitch report on the state budget crisis that was released yesterday hopes to serve a similar purpose for state government spending. Paul Volcker, the former Fed chairman, and Richard Ravitch, who helped New York City work itself out of bankruptcy, led the State Budget Crisis Task Force, the group that produced this report. The task force also included two former U.S. Treasury Secretaries as members. The bottom line of the report is that there is less money to go around and that states should become better managers of the shrinking economic pie:
The United States Constitution leaves to states the responsibility for most domestic governmental functions: states and their localities largely finance and build public infrastructure, educate our children, maintain public safety, and implement the social safety net. State and local governments spend $2.5 trillion annually and employ over 19 million workers – 15 percent of the national total and 6 times as many workers as the federal government…
…States are grappling with unprecedented fiscal crises. Even before the 2008 financial collapse, many states faced long-term structural problems. Many economists believe that in the aftermath of the crisis, the economy will grow sluggishly for years as it works off the excesses of the credit and real estate bubbles and endures slow employment growth. Tax revenues are recovering slowly and remain well below their pre-crisis trends.
Basically states, once flush with revenues, have overpromised benefits to their retirees, set aside too little in reserves to cover their liabilities, mismanaged their books and sat idly by while their tax base eroded as a result of changes in consumer behavior. The two big issues for state budgets are public pensions and Medicaid, both of which are somewhat out of the states’ control. Although states assume about half the cost of Medicaid, decisions about the program are made at the federal level. States must apply to Washington for an exemption to make changes to their program. Pension benefits are enshrined in contracts and are generally governed by a state’s constitution. Making changes to pensions, outside of bankruptcy, is either impossible or would require constitutional amendments.
Stockton wants to end generous healthcare benefits for its retirees
Some residents of Stockton, California are upset over the city’s decision to eliminate free healthcare benefits for public retirees. Michael Fitzgerald, a columnist for the Record, Stockton’s newspaper, wrote last week about the policy change:
The lavish perk that did the most to bankrupt Stockton is free lifetime medical care for some retired city employees and spouses. Now retirees are suing to keep it free.
And a commenter said in response:
Stockton hits the wall
LA trader: “if stockton was a surprise, i dont know where you’ve been for the last 3 months.” Still, a LOT of stockton bonds put out to bid
— Taylor Riggs (@TaylorRiggs_BB) June 27, 2012
The City Council of Stockton, California voted this week to adopt a “pendency budget” in preparation for filing for Chapter 9 bankruptcy, which will place the city under the protection of the bankruptcy court and stay all legal actions against it. This maneuver gives the city some breathing room to come to an agreement with its creditors, especially bondholders and retirees, over how to reduce what the city owes them. This comes after months of Stockton being under a state-imposed “mediation period” in which these kinds of negotiations were voluntary.
The big pension liability adjustment
The Government Accounting Standards Board voted Monday to toughen pension reporting standards, a slight accounting change that has significant repercussions for muniland. Reuters’ Lisa Lambert reports how data that was formerly buried in the footnotes of financial statements will have to be made more prominent:
State and local governments will have to post their net pension liability – the difference between the projected benefit payments and the assets set aside to cover those payments – up front on financial statements, under the changes.
“The pension liability will appear on the face of the financial statements for the first time. That’s going to create the appearance of a weaker financial position,” said Robert H. Attmore, GASB chairman, who said the board intended to “peel back the veil so things are more transparent and there’s more information for policy makers.”
Are public pension shortfalls self-inflicted wounds?
A new white paper by Chris Tobe, a chartered financial analyst and a former trustee for the Kentucky Retirement System, asks: “Did the SEC and S&P let 14 states destroy their Pensions?” Tobe’s question shifts the blame for public pension shortfalls from generously compensated public workers to legislators, the credit-rating agencies and the SEC. His thesis is that some states’ legislators knowingly failed to make required annual payments to the pension fund and instead spent the money on current services such as teachers’ salaries and new roads. Tobe further alleges that credit-rating agencies and the SEC were asleep at the wheel about the problem and bear some of the blame.
State pension funds have an estimated $900 million shortfall, according to the Center for Budget Research. I think Tobe is looking in the right corners for the culprits. Public workers do have generous retirement plans, and the financial crisis certainly created enormous losses for pension funds. But these losses, in many cases, were layered on top of plans that were already poorly funded. From Tobe’s white paper:
The current political rhetoric on public pensions that blames gold plated benefits and high investment assumptions misses the most basic fundamental problem. The dirty little secret of at least 14 states is that politicians have misled the public as both political parties have conspired to secretly borrow $100’s of billions from their pensions.
Public pensions are exempt from ERISA, so there is no direct federal regulation, and state regulation of public pensions has proven itself ineffective at best in most states. As states borrow money through the municipal bond market there are regulators and independent reviewers who are supposed to provide investors with an honest view of state finances. These are the only watchdogs. This paper asks why both the SEC and S&P and Moody’s fell down on this job.
State and local government hiring will never recover
Throughout the recovery, public-sector employment figures have been dismal. Even though recent data suggests that government job losses might have peaked, there is an ugly accounting change looming that could prove a permanent deterrent to a large rebound in government hiring.
The accounting change is being driven by the Government Accounting Standards Board (GASB) and relates to pension liabilities. Governments will soon be required to report their pension liabilities alongside their other liabilities, like long-term debt, on their financial statements. Currently governments are allowed to bury their unfunded pension liabilities in the footnotes of their financial statements. When they calculate their financial ratios, they are also not required to include future liabilities owed to retirees.
With pension costs expected to take up larger and larger amounts of tax revenues, politicians will have no excuse to ignore their ballooning pension problems. What has long been an unpleasant fact for budget officers will soon become a very visible sign to government officials, the public and investors that pension burdens are very heavy and that adding employees means long-term fiscal burdens that many governments don’t have the fiscal space to take on.
Greece is not Germany, and California is not Vermont
Last week Gillian Tett of the Financial Times picked up Meredith Whitney’s municipal bond doomsday flag and started waving it for an international audience. Her article, entitled “Pension gap spells trouble for muni bonds,” broadly painted the entire municipal bond market as having unacknowledged, long-term issues. Her closing line seemed to be a call for investors to shift their concerns from European sovereign debt to the debt of muniland:
Fiscal woes, in other words, are not just a matter for the eurozone; investors had better keep watching that American periphery too.
I agree with Ms. Tett that it is important for investors to dig down into the affairs of municipal bond issuers. Like the nations of the European Union, the quality of fiscal management varies by state. The U.S. has a number of well-run Germanys and we also have a handful of Greeces.
Tapping the brakes on Illinois debt?
Illinois, the state in the weakest fiscal position, is planning two big bond deals in the first quarter of 2012. Next week they plan to raise $800 million in general obligation bonds to finance various transportation projects, followed by another $750 million later this winter in long-term bonds to fund construction projects.
Although the state is drowning in debt, unfunded pension liabilities and unpaid bills, these debt offerings are very restrained compared to the last two years when it borrowed to make obligatory payments to its heavily underwater pension system.
Rhode Island’s awful investment returns
It’s getting a little tiresome to hear all the adulation that’s being heaped on Gina Raimondo, the Rhode Island General Treasurer. She’s been praised in the Wall Street Journal, Time, and now CNBC as some sort of fiscal Joan of Arc who rescued the state’s public pension system from insolvency. I’ll give Raimondo credit for leading the charge to reduce benefits to Rhode Island public workers and increasing their retirement age, but she’s far from a pioneer in making tweaks to state pension plans – 17 other states have also made changes recently.
More importantly, the problems Raimondo addressed were not the biggest that the state faced. The main problem with Rhode Island’s pension system is that it has very poor investment returns on its $6.5 billion portfolio of assets. Over the past ten years the state’s investments returned 2.47 percent compared with the national median of 3.4 percent (page 6). These returns are in the lowest tier of state pension plans, and this chronic underperformance is causing a substantial shortage of assets to pay retirees.
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Resident Muniland expert
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