Introduction: The challenges facing public pension funds have become pressing concerns for many cities across America. As funding gaps widen and risky investments are pursued, the consequences may lead to dire situations for residents and their communities. This article explores the complex dynamics of public pensions, revealing how these financial commitments can transform cities into unlivable spaces.
“It’s like going to the ATM in Vegas and then going to the roulette wheel and it comes up red and you go back to the ATM.”
This insightful comment was made by Steve Mermell, who recently retired as the city manager of Pasadena, California. His experience offers a vivid illustration of how borrowing to enhance pension fund returns can lead to substantial financial losses.
An article in the Wall Street Journal highlighted that public pension funds are critically underfunded. As a consequence, many of these funds are increasingly borrowing money to invest in the markets, aimed at boosting returns to bridge massive funding gaps.
Public-sector retirement plans typically offer defined benefits, where pension payouts depend on an employee’s salary and years of service. Conversely, private employers usually use defined-contribution plans, such as 401(k)s, where benefits hinge on market performance.
For those fortunate enough to receive a public pension, the returns can be quite favorable if one lives long enough. However, private-sector workers may find their retirement savings run dry sooner than expected.
Indeed, pension funds have the option to address funding shortfalls by increasing contributions from both the government and employees. Yet, such proposals often meet fierce resistance from public-employee unions. As a result, many funds resort to riskier investments to seek greater returns. What could possibly go wrong?
The late Robert Citron could certainly provide insights on this matter, having learned the hard way that even the best-laid plans can ultimately backfire.
Something Special
Almost two decades ago, while consulting for a county sanitation district, I encountered a rather dour individual whose thoughts rarely strayed from his impending retirement. One morning, amidst coffee and donuts, he recounted how he was approaching a pivotal milestone. In six months, he would reach two significant benchmarks: his 55th birthday and 36 years of service.
He excitedly explained that once he turned 55, the retirement formula would shift from a factor of 2 to 2.5. Thus, after 36 years of working with the district, he would effectively receive 90 percent of his final year’s salary for the remainder of his life. He had carefully set his retirement date to coincide with this advantageous moment.
This grumpy retiree was part of the California Public Employees’ Retirement System (CalPERS), the largest public pension fund in the nation, which employs 2,843 full-time equivalent staff to manage it.
At last count, CalPERS had over 2 million members, some of whom contributed significantly to the public sector, while others may have lingered without much effort. Regardless, all had set their sights on the lucrative rewards of pension benefits.
Fast forward to now, and CalPERS has decided to incorporate leverage for the very first time in its nearly 90-year existence. Whether this will pan out positively remains to be seen, yet fund managers are certainly faced with an uphill battle.
Legacy Costs
Currently, CalPERS claims to possess about two-thirds of the necessary funds to fulfill promised benefits to state and local government workers. However, this figure is based on an optimistic investment return assumption of 7 percent annually—historically, returns have been significantly lower.
Over the past two decades, CalPERS has achieved an average annual return of only 5.5 percent. By revising the investment return assumption down to this actual average, the unfunded liabilities could swell from $160 billion to more than $200 billion. Hence, CalPERS’ strategy now is to leverage its returns.
In the case of Pasadena, funding the local pension plan for police and firefighters has been a prolonged struggle. In 1999, to stay ahead of inflation-adjusted benefits, the city borrowed $102 million through municipal bonds for pension obligations.
The idea was straightforward: Invest the borrowed money to earn returns immediately while repaying the bond over time. However, the stock market crashed during the dot-com bust from 2001-03, forcing the city to keep making bond payments at interest rates exceeding 6 percent.
In 2004, Pasadena resorted to yet another pension obligation bond, only to be hit by another stock market downturn between 2007-09. The city’s legacy pension costs remained, leading to ongoing financial strain. The Wall Street Journal noted:
“The local police and fire pension plan has been closed for nearly 50 years. Pension recipients have dwindled to fewer than 180. But the city still owes about $135 million in bond debt on the plan. Payments on it are expected to be about $6 million in 2022.”
This situation is undoubtedly a mess. Following Pasadena’s closure of its local pension plan, management has now been transferred to CalPERS. Adding insult to injury, Pasadena’s annual contributions to CalPERS have doubled since 2015, reaching around $70 million last year—more than the city spends on transportation.
How Public Pensions Turn Cities into Unlivable Hellholes
It is indisputable that gambling with public funds is a reckless endeavor. Still, many pension funds, CalPERS included, are employing leverage in an attempt to amplify returns.
Recent analysis by Municipal Market Analytics utilizing Bloomberg data showed that over 100 city, county, state, and other governments borrowed against their pension funds last year—double the highest previous count.
Taxpayers, acting as the financial backers of these pension funds, are the ones left holding the bag. When public pension funds underperform, local governments are forced to fill the financial shortfall, often by slashing other essential services or raising taxes.
Pension obligations are a significant burden on state and local finances. There exists a considerable cohort of public workers who have been promised unsustainable retirements.
These extravagant commitments must be re-evaluated. One can see the aftermath of these unfulfilled promises in virtually every U.S. city with a history stretching back more than sixty years. By consistently diverting funds from crucial services, the livability of cities is rapidly deteriorating.
Your neighbor, retired for over 25 years, may frequently lament the poor state of streets and sidewalks and the inadequacy of resources to address growing homeless encampments. However, it is often overlooked that the funds they receive are drawn from resources that should instead be allocated for essential municipal services. Those generous promises made decades ago have resulted in a tragic erosion of community well-being.
Conclusion: The mismanagement and risky gambles associated with public pensions are forcing many communities into cycles of decline. As cities grapple with unfunded obligations, the quality of life for their residents suffers. To avert an increasingly dire future, a reevaluation of these pension commitments and their broader impact on municipal health is essential.
[Editor’s note: A significant wave of municipal and corporate bankruptcies is approaching. The longer the bear market persists, the greater the potential fallout. It’s crucial to safeguard your retirement by considering conventional, practical steps that everyday Americans can adopt to secure their wealth and financial privacy. These measures are detailed in the Financial First Aid Kit. To learn more about this important publication and how to obtain a copy, click here today!]
Sincerely,
MN Gordon
for Economic Prism
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