What went wrong with state pensions

With all the tiring drivel about Presidential politics, let’s look at something closer to home.  How is it that the public worker and teacher pensions are going so far set?  A recent economic paper by Andonov, Bauer and Cremers shows the problem is when unaccountable public pension managers meet federal rules they do dumb things, game the system.  We the taxpayers and the retirees pay.

            A pension fund is a promise to pay out an income stream in the future—debt, if you will.  That’s how it works with your annuities or a private pension.  Corporate bond yields or some other conservative measure is used to discount future liabilities.  As your annuity or a pension fund matures and more people are at or near retirement, it should be invested even more conservatively.  You don’t want your money to evaporate at age 70 when you can’t make it back. 

            But public pensions are allowed by the Government Accounting Standards Board to discount their liabilities by the expected return on their assets.  That means that the liabilities look lower/better if expected earnings are guessed high.  Guess/project 10% rather than 5% return and you only have to put in half as much.  Now with public funds there are only 2 sources of funding—ask employees to contribute more or soak the taxpayers.  The first is like going to war with the best funded unions on earth.  The second is politically unpopular.  So what to do?  The public fund managers choose to project in-your-dreams returns, thus making the liabilities look small and the fund more solvent. 

            And what happens when government bureaucrats invest aggressively to justify those projections?  They underperform private pension investing by half a percent a year.  Thus, many states have pension funds with pitiful public pension projections.  This is why Illinois and California are such basket cases in state finances.  Oklahoma had 90 years of Democrats who had the attitude of “Oh, we’ll just go raise taxes in the future.”  The state still has $10 billion unfunded liabilities for teachers and public workers.  But that’s down from $16B because COLAs have been forgone and other funding has been found.  (And new teachers must live with defined contribution plans.)  But the easy part is over.  Either taxpayers will cough up or taxpayers will tell retirees to live with less (about one-fourth less).  None of this is pleasant.  And it could have been avoided if GASB had not had special rules for public pensions.  That needs to change in the future.