State And Local Pension Plans Head Over A Fiscal Cliff Created By Bernanke And Obama

Oh what a tangled financial web we weave, when first we print money to achieve. Obama and Bernanke are clowns playing with our public finances. Is that Bernanke in a Black Helicopter dropping fiscal napalm? Did Bernanke and Obama intend to drastically increase the costs of funding the pensions of non-federal public sector workers? Had they considered the unintended consequences of near zero federal interest rates and increased taxes on the wealthy in regard to State and municipal pension plans?

One of the assumptions about the size of necessary contributions to State and local pension plans is that the plans will earn a minimum 8% safe return on their investments.   California’s CalPERS is the largest public pension fund in the nation, with investments valued at $236 billion. Its various retirement funds have 55% to 75% of the money needed for future retirees. Pension experts consider 80% to be a minimum safe funding level.
CalPERS uses a 7.5% safe return assumption to determine contributions necessary, but really only contributes 55% to 75% of the funds necessary. In the interest rate environment created by Bernanke, long term treasury rates will stay very low below 3%.  So a plan like CalPERS would have to find a safe return of 7.5% in the stock market, not from “safe” treasury bonds. But, Bernanke’s QE3 with its infinite promised life has caused a drop in stock prices, so the average earnings for stock appreciation is below zero. Obama’s planned tax increases on the wealthy would further remove buying power from the wealthy for stock purchases, while the baby boomers are adding less to pension stock funds and withdrawing more. Where’s the cash coming from to fuel a market rise?  (supply and demand). Ergo, CalPers is underfunded by at least $400 billion dollars or in other words California is bankrupt, shortly.

As an example of the State and local tax increases needed for the higher pension contributions required for government employees, we can look at an example in NY State in 2011, when public school districts had to adjust their safe rate of return from 8% to 7.5% based the NY Comptroller DiNapoli’s “vastly” improved 7.5% safe rate of return. The schools complained that “in 2010, with the 8% safe return rate, the pension cost was 6.2 percent of payroll and required schools to pay about $926 million. Now at 11 percent of payroll, the schools will have to pay nearly $1.7 billion, according to preliminary estimates.” The NY schools or really the NY taxpayers will discover that an honest safe rate of return for pension funds would be slightly above the 10 year treasury bond rate or very generously 3%. Doing the arithmetic:  a 5% (8% -3%) additional earnings rate that would be required, which is ten times greater than the 0.5% (8%-7.5%) additional earnings rate improvement decreed by the NY Comptroller’s pension reform (lowering the expected rate of return to 7.5%). So, using a 3% safe rate of return would require the schools to pay ten times the present cost increase of 4.8%(11%-6.2%) of payroll for an increased pension charge of 48% of payroll, which must be added to the prior 6.2%. Thus these schools’ taxpayers must contribute 54.2% of payroll for pension funds to be solvent. 

Did Obama and Bernanke intend to bankrupt State and municipal pension plans? With federal taxes going up and State and local taxes skyrocketing to pay the higher pension costs, where will the cash come from to raise stock prices? When will the rating agencies factor in this “unintended” consequence into State and local bond ratings? Can Helicopter Ben rescue all these underfunded plans before their insolvency is realized? The Hope and Change Promised Land that is coming into view is a barren and broke place. Are those state and local pensions really secure?   Which States will remain solvent?

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4 Responses

  1. n.n

    They followed the rainbow only to discover the promised pot of gold was missing.  It’s unfortunate that the rest of us have to, and had to, pay, directly and indirectly, for their fantastical hopes and dreams.

    Forward… into oblivion.

  2. Chris

    The middle-class people that save for their own retirement or are now retired on their own savings have been crushed by Bernanke.  CDs pay next to nothing.  Bernanke actually believes he can achieve the Fed mandate specified by Congress of “full employment and low inflation”.  The goals are in conflict with each other.  About 3 years ago Bernanke said he was “perplexed” by the slow rate of recovery.  Typical comment of a statistics nerd that does not know how to factor in human emotions into an economic model.  He always talks about “core inflation” as being “low”.  Core inflation is a foolish stat that does not include food or energy.  So the people that are hurting and are scared simply hunker down as best they can and withdraw from all parts of the economy that are not essential, such as new autos, dining out, vacations, and on and on.

    The only thing that will save CA, IL and NY will be major inflation after these parties trim their cost of living formulas.

    Bernanke will shortly be faced with a Hobson’s choice between massive inflation or tightening that will result in huge layoffs.


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