This page contains a single entry from the blog posted on January 22, 2011 10:46 AM. The previous post in this blog was Scary thought for air travelers. The next post in this blog is Howler of the Week. Many more can be found on the main index page or by looking through the archives.

E-mail, Feeds, 'n' Stuff

Saturday, January 22, 2011

Sky is not falling on state and local government finance

So say these folks. Let's hope they're right. I wouldn't bet on it.

Comments (13)

The authors note that post-employment health care obligations for public employees are not contractually protected the way pension benefits are so we should be less concerned; they further state that those obligations can be reduced by simply renegotiating contracts with public employee unions so they are less generous, thereby solving the long-term problem.

While technically correct, that strategy is almost impossible to actually implement. For example, TriMet has given away the store on benefits over the past two decades and the agency now has the most costly firnge benefits in the entire industry. Management is finally trying to rein in the costs, but is getting virtually nowhere. Union negotiators don't get paid to give thing back.

As OPEB costs pile up, the real effect on current budgets grows. At some point you can't hide it.

"Economists generally support use of the riskless rate in valuing state and local pension liabilities because the constitutions and laws of most states prevent major changes in pension promises to current employees or retirees"

Courts have mistakenly applied older court rulings about pension guarantees (cannot be diminished) that pertained to wholly unfunded plans where there were no investments of any kind and applied them to plans that have individual accounts and that are invested in risky stocks and secretive vulture funds. There should be one, and only one, set of rules governing investment trusts -- which make no distinction whatsoever whether the plan participants obtained their income from government employment or otherwise. This would isolate out the complete nonsense of extending to public employees, and public employees alone, any immunity from private risk for the private investment of their earnings long past the time when such money became their own to do with as the damn well please.

Just because the reach of Congress was not extended as fully to government plans as to private plans, thereby establishing mandatory rules only as to private plans, is not itself a justification for states to circumvent state prohibitions on equal privileges and immunities and graft huge favors specific to public employees into all manner of special laws. The status of "public employee" should be wholly irrelevant to everything except the employment itself, and cease the instant the employment relationship is terminated.

It is preposterous that state officials (the PERB specifically) can demand that local governments make any post-employment boost in public employee pay ("employer contributions") long after they have received their pay checks. The conduct should instead be subject to the same rules that were applied to Wilshire Credit/Jeffrey Grayson/Andy Wiederhorn. We have transformed "public employee," and laws favorable to them, into one giant exception to federal anti-racketeering laws, for almost the exact conduct. Except that we have added the twist of making a mess of the law itself under the guise of promoting the "legitimate" public purpose of overtly favoring the purely private (private investment) interests of public employees as a describable class worthy of special "riskless" favors.

They are wrong, and that you can bet on.

This analysis is at a macro level, but the problems are at a micro level. That is, as a whole the problem may be manageable but it is not manageable for certain specific governmental units, and they are big ones like California, New York, Illinois, New Jersey, Ohio etc. Interesting enough, California now looks like it is making the strongest effort to correct itself, with Gov. Brown proposing drastic cuts and wanting to take tax increases to the voters. New Jersey, well we have already discussed how Gov. Christie is balancing the budget by simply not making payments.

On the discount rate, the use of 8% instead of 2-3% is preposterous. If you make the same assumption about your 401k Plan, don't expect to be able to retire before your 95th birthday. In the real world, as opposed to the ones Politicians inhabit simply assuming away a problem does not really make it go away, although it can kick it down the road. Denial is not that river in Egypt.

I question the assertion that states and localities will simply renege on retiree health care promises. That, and "when the recovery gets here, everything will be fine."

A small number of state and local government units, some of them very large will renege on post retirement health care promises and pension benefits.

The "why" is fairly simple. Taxpayers will not be willing to suffer the tax increases or cuts in basic services to fund those liabilities. Elected officials, at least those that want to continue in office will tell them they do not have to. (again, see Gov. Christie but also Illinois and others)

The "how" is a bit more problematic. Here is one scenario.

The Federal Government will amend the Bankruptcy Code to allow a "partial bankruptcy" by state and local governmental units. Under this partial bankruptcy, bond interest and principal will be fully protected (or maybe a small haircut allowed for political reasons. The reasons for this are (1) bond holders tend to be Conservatives, and many Conservatives will be the elected officials who want to declare bankruptcy and more importantly (2) keeping bond holders whole will be necessary to preserve access to credit markets. Otherwise the Federal Gov and/or the Federal Reserve will have to be their lenders, and we know that is not going to happen. Preservation of bond holders has happened in Europe in bailouts of Greece and Ireland, for the same reason.

The partial bankruptcy will allow State and Local Governmental units to abrogate contracts, including post retirement health care and pensions. Because of sovereignty reasons, the elected officials will serve as their own Bankruptcy Trustees, and thus be able to make unilateral decisions and impose any settlements on the retired employees.

It is possible that when this is enacted Congress will allow state and local retirees who are not otherwise eligible for Medicare to join the system, although not if Conservatives control the legislation. Remember, for Conservatives government has never created a single job (their words, not mine) so to them the 20+ million of government employees must not exist as real workers and do nothing but eat from the public trough and thus don't deserve any benefits,particularly if they are Union members.

I have to stop this now, it is time for my weekly injection of cynicism.

This was structural, not a garden variety business-cycle recession followed by a robust rebound. We aren't getting back to where we were -- indeed we couldn't return to pre-recession "norms" without making the very same mistakes and going through the meltdown process again. It will take many, many years for growth to occur in non-real estate and non-financial sectors that will even start to fill in output gaps (idiot federal, state and local governments throwing capital at developers doesn't help to hasten this day). In the meantime, unfunded post-employment liabililities explode.

We are advised to go back to the 1980's to assume 8 percent rates of return going forward. That long-term average historical return was driven largely by ten to fifteen percent yields on Treasury Bonds issued during the 1980's. If someone thinks those yields will occur going forward then one should also shudder a few times when thinking about the implications of quadrupling the cost of servicing $14 trillion dollars in US Government debt with a $20 trillion debt burden already clearly in sight. In the type of investment mix that a pension funds ought to have (heavily weighted towards bonds) 8 percent averages aren't going to happen except with conditions that lead to financial Armageddon for the Federal Government.

It's true that the overwhelming majority of state and local governments aren't going to default. Left unsaid, it's the only the largest and most reckless we need to be concerned about. And oh yes, those agencies, those pesky little agencies and authorities, like your Metro and our WMATA, they would never default (Oh Whoops!).

Very good comments by Newleaf

It is true that only a few units are likely to default, but the problem is the ripple effect. Greece and Ireland are extremely small relative to the entire European economic community, but their financial and fiscal collapse have brought about a large crisis in Europe, threatening the Euro itself. Imagine what will happen if a truly significant European economy requires a bailout.

Despite the dislike of government by many Conservative, effective, efficient and competent government, particularly at the state and local level is an essential requirement for a stable society and economic growth. Their potential collapse endangers the country much more than the failure of Lehman Brothers or AIG or even Fanny and Freddy.

It appears Congress anticipates the call for help and is going to act. This will force their hands to make some cuts, and reconfigure those obligations. Does this "emergency" create that window of opportunity that PERS could be renegotiated?


Interesting article on Norway and its high taxes, and the effect on businesses:


Sid, my read is that the Euro-Dollar section, EU bailout of Greece and Ireland was strategic; it had more to do with export-driven Germany's desire to keep the poor cousins in the currency coalition for the long haul, than anything else. If Greece and Ireland were to withdraw or be expelled, then the resurrected Deutsche Mark or a more narrowly drawn Euro, would be higher in value, cutting into Germany's exports.

Also note, for example, that the EU bailout of Ireland was implemented primarily through loans to its banks. The Irish government is left to fend for itself within limits prescribed as conditions of the financial system bailout. It's pretty hard-headed and hard-hearted stuff.

Interesting theory by Newleaf, and certainly a default by either Ireland or Greece would have harmed the EU and Germany. As far as the bailout to Ireland is concerned, the Irish guaranteed the debts of insolvent banks, and are now on the hook for the loans from the EU.

My point, to reiterate, is that the default by these very small economies threatened the entire EU, and that default by even a small number of state and local units threatens the economic stability and growth of the U. S.

To paraphrase Woody Allen: We have a choice to make. To allow any major state and local governments to default would be catastrophic for the country, to bail out any major state and local governments would be devastating to the economy. Let's hope we have the wisdom to make the right choice.

Let's hope that those in the decision making places do have the wisdom to make the right choice.

I make widgets. I lose one dollar for every widget I make and sell. How many widgets do I have to make before I break even or make a profit?
A) 100
B) 1,000
C) 1,000,000

A truer measure of liability is when a plan terminates. Under federal law a pension plan is deemed terminated when contributions can no longer be made to the plan. How much obligation would Oregon renege on if PERS is terminated?

ORS 238.600(2) still reads as follows:

(2) If the Public Employees Retirement System is terminated, or if contributions may no longer be made to the system, each member of the system has a nonforfeitable right to the benefits that the member has accrued as of the date of the termination, or as of the date that contributions may no longer be made to the system, to the extent that those benefits are funded.

There is nothing in the federal law that requires, or that can require, a state to offer any pension plan at all. Alternatively, the OEA can offer their own pension plan for members that wish to voluntarily participate.

Is there really any legitimate purpose for the state, any state, to operate any pension plan -- specifically plans that have an investment pool and individual accounts -- other than as an illegitimate way to circumvent ordinary obligations of trustees and to circumvent the natural assignment of risk for any generic capitalist enterprise?

One minor fix is the same one I surmised several years ago: Let individual public employees opt-out, both as to the pensions and as to any health care component of their pay. A public employee should not be either a captive investor or captive customer.

Clicky Web Analytics