Are Pensions the Cause of States' Problems? - Analyst Blog

It is no secret that many of the State and Local governments are in severe fiscal trouble. In addition to the current difficulties, many are worried about the long-term implications of severely underfunded pension liabilities.

This has led many to place the blame for the states' fiscal position almost entirely at the feet of the schoolteachers, firemen, police, social workers, prison guards and other people who work for state and local governments. More specifically, “overly generous” pension plans are said to be the cause of the State's fiscal problems, rather than, say, the failure of State governments to make the contributions into the pension funds over time (or the failure to tax their citizens at high enough rates to generate the funds needed for the services people want from state and local governments).

Without a doubt, the defined benefit pensions that State and Local employees get are better than those that most in the private sector get, because a private sector defined benefit pension is a real rarity these days and is getting rarer. In the private sector, it is usually industries that are significantly unionized that get them, and there are fewer and fewer of those private-sector unionized jobs these days.

People want their politicians to be “tough on crime” and pass laws that require long prison sentences (i.e. "three strikes and you're out" laws), but forget that it costs more to keep a person in prison for a year that to send him to college for a year. Prison guards voluntarily go to prison every day, and the job is often very dangerous, yet people are aghast at the thought that they might make a middle class income and be able to retire before they reach age 65.

Are Retirees Bankrupting the System?

While clearly there are cases where pensions get inflated by allowing people to take massive amounts of overtime in the years just before they retire (and thus increase the base on which the retirement amounts are based), from reading much of the media one would think that your average state worker was calling it quits at age 40 with a secure retirement income well into the six figures. That really is not the case.

California is often held up as the poster child of a state where pension costs have spun out of control and resulted in a nearly bankrupt state government. So what are the facts about how much California State and Local government workers get when they retire? CalPERS is the largest State pension fund in the nation and is responsible for almost all of the pensions in the State. Here is what it has to say on the matter:

“About 25,000 CalPERS members retire each year. The average CalPERS member receives a monthly benefit allowance of $1,881 after retiring at age 60 with 19.9 years of service (service retirement). The average California Highway Patrol employee receives a monthly allowance of $4,280 after retiring at age 55 with 28 years of service. Approximately 41 percent of CalPERS retirees receive $12,000 per year or less in benefits. About 81 percent of retirees receive $36,000 per year or less, with 91 percent of CalPERS retirees receiving $54,000 or less per year.

"The vast majority of recent State retirement cost increases are due to market downturn, not to increased benefits. Nearly 80 percent of the increase in employer rates from 2002-04 was due to the two-year downturn in the economy that produced negative investment returns. As a percent of payroll, the State pays less per employee than it did 25 years ago for school employees, state miscellaneous employees, state industrial workers, state safety workers and state peace officer and firefighters.”

Is There Another Possible Reason?

Perhaps, just perhaps, these workers are being made into scapegoats for problems they didn't cause. State and Local pension funds are large institutional investors, and like most large institutional investors, they lost a lot of money during the financial meltdown. Some but not all of that has been recovered as the market has bounced back over the last two years.

However, not all the funds were in equities, and many of the state funds had large portfolios of the toxic mortgages that Wall Street was peddling during the housing boom. In 2010, the Wall Street Bonus pool reached $142 billion, or roughly 1% of GDP. To be fair, that is a worldwide total and many of the big Wall Street firms like Goldman Sachs (GS) and JPMorgan (JPM) are global operations.

That implies that lots of people on Wall Street are getting bonuses for a single year that are greater than an a retiree in the 10% highest percentile will receive in a lifetime.

I think it is going to be a rough year for the State and Local governments, especially now that the Federal help that has sustained them (a big part of the ARRA or Stimulus act) is drying up. It used to be that many municipal bonds were guaranteed by the likes of MBIA (MBI), but investors should now count that insurance as worthless -- with the possible exception of muni's guaranteed by Berkshire Hathaway (BRK.B) -- as the insurance companies are most likely insolvent (Ambac is already in bankruptcy). I would tend to avoid municipal bonds and stick instead with dividend-paying stocks for income.
 
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