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QOTD: Public Unions December 13, 2010

Posted by David Bookstaber in Government, Pensions, Unions.
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Governor Tim Pawlenty in today’s WSJ:

The moral case for unions—protecting working families from exploitation—does not apply to public employment. Government employees today are among the most protected, well-paid employees in the country. Ironically, public-sector unions have become the exploiters, and working families once again need someone to stand up for them.

An editorial provides supporting information:

Twelve states including North Carolina and Virginia don’t allow government workers collective bargaining rights, and another 12 allow it only for some unions. These states by and large have managed to hold down their pension liabilities better than have those where public employee unions essentially run the government—see Illinois, New Jersey and California.

Public Pension Fund Update October 13, 2010

Posted by David Bookstaber in Finance, Pensions.
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Andrew Biggs estimated a $3 trillion shortfall in funding of state pension funds.  The WSJ reports that a study from the Kellogg School of Management has put the municipal shortfall at $574 billion.

Most governments use the expected rate of return on a pension fund’s assets—typically around 8%—to discount liabilities. Critics say this accounting method say liabilities should be discounted based on much lower Treasury note yields.

The higher the discount rate, the smaller the liability. Thus, lowering the discount rate could mean governments would have to contribute more to pension funds—with the money coming from taxpayers or employees.

One of the study’s authors, Kellogg professor Joshua Rauh, said in an interview that current accounting rules encourage pension funds to take investment risks and “taxpayers are bearing the burden of that risk.”

Another Pension Problem: Portability September 7, 2010

Posted by David Bookstaber in Education, Pensions, Unions.
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Pensions can create enormous employment frictions when they are structured as unvested deferred compensation. This friction is often a bad thing, which is why the private employment sector generally sticks to 401k pensions, which are both fully portable and mostly vested throughout an individual’s employment.

The public sector, on the other hand, has preserved the worst characteristics of old-school pensions. Perhaps the best example comes from the persistently parochial public teacher unions, which bizarrely insist on defined-benefit pensions that do not vest at all for 20-30 years and do not port to any other employers. Bill McGurn expands on this today:

Because their pensions are not portable, teachers lose big if they move to another school system, switch careers, or try to cash out. [A recent report, Better Benefits: Reforming Teacher Pensions for a Changing Work Force,] cites a 2008 survey in which nearly four out of five teachers agreed with the statement that “too many veteran teachers who are burned out stay because they do not want to walk away from the benefits and service time they have accrued.”

Another Problem Inflation Would Help June 13, 2010

Posted by David Bookstaber in Economic Policy, Finance, Pensions.
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Public pension liabilities are the millstone dragging governments into the depths of a sea of red ink, deficits, and even bankruptcy. In a sad twist on this mixed metaphor, it is the pensioners who have managed to tie the millstone to the necks of the “little ones” — the younger generations working to pay increasing taxes to fund exorbitant pension benefits that were promised but never funded.

A few governments have discovered that they might be able to relieve a bit of the weight by reducing “cost-of-living adjustments” (COLA) — especially when those have historically had little or no relation to actual changes in the cost of living. For example, the WSJ notes that Colorado’s pension system had been granting a fixed 3.5% COLA every year to beneficiaries. If the COLA for defined-benefit pensions can be reduced below the rate of inflation, then inflation would gradually erode the real cost of the crushing unfunded pensions.

Of course, only the federal government has the power to inflate the dollar. But faced with a deluge states and municipalities sinking into insolvency under the weight of pension obligations, this would be yet another motive to nudge inflation higher.

(Predictably, pension beneficiaries are using every possible legal maneuver to prevent this. If only they had been so attentive when their unions and politicians were crafting extravagant future benefits to be borne by future generations.)

Public Pension Fund Update March 22, 2010

Posted by David Bookstaber in Pensions.
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Andrew Biggs has an excellent assessment of state pension funds. The sad news for taxpayers:

My research indicates that overall underfunding tops $3 trillion.

Vested pension benefits are constitutionally guaranteed in eight states and protected by law in two dozen more. And in most every state politics makes accrued benefits impossible to cut.

He also notes that the responsible way to fund defined-benefit pensions is one in which taxpayers are not on the hook for the rosy assumptions politicians make about future market returns. Especially since markets provide assets (e.g., treasury bonds) that can be purchased to fully cover pension liabilities with zero risk.

“Seniors Living on Fixed Incomes” March 14, 2010

Posted by David Bookstaber in Government Spending, Pensions, Retirement.

“Senior citizens living on fixed incomes” is a common refrain of the powerful pensioners’ special interest groups, and it seems to never go rebutted. It’s practically the slogan of The Most Selfish Generation: The Baby Boomers who are willing to pile debt upon their children and grandchildren in order to enjoy 30+ years of healthy and unproductive “retirement.”

For the record: None of us working citizens has unlimited income, and unlike retirees we don’t have guaranteed fixed incomes from the federal government in the form of social security, medicare, and (in many cases) government-backed pensions. Nor do we have disposable time that we could devote to earning extra income to make up a shortfall, as do retirees.

Why Are Public Pension Funds Special? July 16, 2009

Posted by David Bookstaber in Pensions.
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Terrance Slattery, President of the National Association of State Retirement Administrators, protests criticism of public pension plans’ refusal to mark their funding levels using the rigorous actuarial standards accepted in the private sector. He correctly notes what makes public pension funds different: “their sponsoring entities [i.e., taxpayer-funded governments] are going concerns, not subject to takeover or going out of business.” But this is precisely why they must be held to high accounting standards. Politicians and public employee unions have every incentive to encourage wildly optimistic actuarial assumptions: Current costs of pension benefits look cheaper, and if the future isn’t as rosy as they project then taxpayers are still on the hook for paying their full benefits. Heads they win, tails taxpayers lose.

QOTD: The Public Pension Shakedown April 20, 2009

Posted by David Bookstaber in Pensions.
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The pension fund scandal exposes the myth of the superior virtue of the public and nonprofit worlds. Greed is universal. And the opportunity for corruption is enormous when political discretion is tied to vast sums of public money.

That’s today’s WSJ editorial page.  I’ve railed against the inherent hazards of public pensions frequently.  Another highlight from the WSJ’s piece:

It has also become routine for politicians to inject their pension funds into partisan debates that have nothing to do with the sound management of retiree money.

How about a cap on public pensions? April 2, 2009

Posted by David Bookstaber in Pensions.

The more we learn about public pensions, the more we shake our heads in disbelief.  Adding insult to injury, taxpayers whose own individual retirement savings have been savaged in the markets are being forced to pony up more money to replace mismanaged funds for public pensioners, whose lifetime retirement benefits are guaranteed by the government.  A recent Boston Globe editorial echoes the outrage.

Public pension systems have been so grossly abused that I propose a retroactive cap: No individual should be allowed to collect more than $100k per year in combined government-backed retirement benefits (i.e., the total value of cash pension payments, subsidies, and healthcare).

Or, following the current custom of righting all wrongs through the tax code, how about a 90% federal tax on all government-source pension benefits that exceed $100k per year?

Public Pension Scam Update March 4, 2009

Posted by David Bookstaber in Pensions, Unions.

I’ve previously explained how unions and politicians conspire to surreptitiously rob taxpayers using the obfuscation of pension costs. Indeed, as one blogger said, “Government employees live in a different world,” something that becomes more evident during an economic downtorun.  Richard Epstein rehearses the intricate details of this ongoing scam:

So what happens in bad times? First, no public employee loses either a job or a dollar in pension benefits. Ordinary citizens lose two ways: jobs are cut–unemployment in California just hit 10%–and taxes are raised. What makes this pill all the more bitter is that unions happily wave the libertarian banner of freedom of contract to lock in the status quo. Public unions point to court cases that require the state to honor its employment contracts just like other agreements. Translation: The downturn is everyone else’s problem.

This seductive plea of contractual probity ignores the dubious mechanisms that put these obligations into place. State collective bargaining agreements give unions monopoly power; state legislative maneuvers, often backed by pro-union legislators, sweeten the deals already made. These pension deals are never negotiated at arm’s length in competitive markets between parties who are free to go elsewhere. Instead, a monopoly union extracts its compensation packages from government officials, many of whom depend on union support to hold public office. These contracts are the kind of self-dealing arrangements that would never be tolerated between a corporation and its key officials. And the subsequent sweeteners simply take property from the majority of citizens who can neither block the transaction nor withhold their tax dollars.

Unfortunately, there is today no mechanism in place that allows frustrated citizens to challenge the validity of these agreements either before or after they are put into effect.

Trust Funds of the World: Unite! December 29, 2008

Posted by David Bookstaber in Economic Policy, Finance, Pensions.

State and local government pension funds contain several trillion dollars in assets.  I have previously highlighted the significant hazards of public defined-benefit pensions, but I neglected to note a particularly terrifying one: Many of these funds are overseen by novices.

Some time ago the WSJ reported on Stanford’s “Committee on Fund Governance” forum report:

Some recommendations are so elementary they seem hardly worth stating. One suggests trustees educate themselves about their duties. “A fund should identify and disclose its leadership structure,” reads another. Many funds profess to follow these and other principles. Yet Mr. Clapman says his group found “a very large percentage [of funds] are not doing one or more of” the report’s recommendations.

There is no reason for every trust to get involved in investment management when the only thing that varies between funds is how much they owe and when.  They’re all trying to do the same thing — and all for public benefit — so there should be huge economies of scale to merging their funds.  A number of UK endowments realized this and joined a cooperative called OXIP (Oxford Investment Partners).  Vanguard is a cooperative investment company in the US that offers similar outsourcing of investment management.

But outsourcing investment management does not go far enough.  Any ongoing exposure by taxpayers to pension obligations is dangerous and unjustifiable. Taxpayers, shareholders, creditors, and employees have no business carrying the risk that pensions will be underfunded or mismanaged, or that investments will not perform as projected.

Defined-benefit pensions should buy annuities to cover their liabilities. For a small fee this transfers the risks of longevity, investment performance, and investment management to third an insurance company which is formed and regulated precisely to handle those risks.  (As an added bonus, buying annuities from an insurance company makes it nearly impossible to obscure the present value of pension benefits being promised.)

The status quo is outrageous: The same government officials who offer pension benefits to government employees get to pick the models that predict how long pensioners will live and how well investments will perform.  These perennially optimistic projections make the pension obligations look cheap, but some taxpayer money is still taken and put in a trust fund to invest against those obligations.  Of course, these funds are under government control, which means they are constantly threatened with political abuse.  Meanwhile, the trustees are not investment experts, so they have to pay for a staff, which has to pay for consultants, which recommend funds of funds, which invest in individual funds.  Every party in this investment management chain collects fees, but none of them guarantees anything.  So when the trust fund comes up short the taxpayers have to cough up yet more money to cover pensions promised long ago, and nobody is held to account for the failure of the trust to meet its obligations.

If governments were not allowed to run their own pension fund scam, they could still offer defined-benefit pensions: They would just have to provide them by purchasing (up front) annuities from insurance companies.

Dead-Weight Government February 24, 2008

Posted by David Bookstaber in Economic Policy, Government, Pensions, Retirement, Taxation, Unions.
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When you drive from Delaware into New Jersey, you don’t really see any differences.  If you move from New Jersey to Delaware you don’t experience a significant decline in government services.  But New Jersey has among the highest tax burdens in the nation, while next-door Delware has among the lowest.

If higher taxes aren’t buying better government services, then what do high-tax governments like New Jersey do with all of their extra tax revenue?  Apparently the answer is that they buy votes.  More specifically, public union votes:

Public workers and teachers can retire at age 55 after 25 years with a pension of 60% of salary — indexed to inflation. Police and firefighters can retire at 65% of salary at any age after 25 years of service and 70% after 30 years.

Not that we should be surprised at American democracies degenerating into this sort of patronage government.  But isn’t it depressing to think of all those public resources going to bankroll lives of leisure for union members instead of something virtuous?

The Public Pension Pay Problem October 29, 2007

Posted by David Bookstaber in Finance, Government, Pensions.
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The WSJ outlines a predicament facing public pension funds: With many billions of dollars in assets, the effect of the fund managers on this public welfare can be enormous.  But government entities have a hard time paying the going rate for financial talent — successful private fund managers with billions in assets will certainly make seven figures each year, but the highest public-sector salaries are traditionally in the low six figures (often customarily bounded by the salary paid to the governor).

My philosophy is that government shouldn’t be in the business of money management.  Pension liabilities should be outsourced to insurance and investment management companies.  After all, it’s a competitive private industry.  There’s no reason to think that government could do it better (and there’s bountiful evidence that political meddling drives performance down).  And there is no reason for taxpayers to shoulder the risk of underfunded defined-benefit liabilities, which occurs frequently in public pension systems.

Of course, governments will pay for good money management one way or another.   If they outsource it the politically unpalatable salaries will be disguised behind management fees, but they will still be there.

The Overdue Death of Pensions August 6, 2006

Posted by David Bookstaber in Economic Policy, Finance, Government Spending, Pensions, Regulation, Retirement.

The Wall Street Journal expounds on the latest legislation to overhaul private pensions, noting, “the idea of a single company guaranteeing retirement payments for decades is no longer practical, if it ever was.”  Frankly, that is an understatement.

Defined-benefit pensions are annuities.  Annuities are an insurance product.  Unless you happen to work for an insurer, your employer has never been regulated as an insurer or rated for the health of its reserves.  What business does an airline or car manufacturer have writing insurance for its employees?  Yet that is what all these private companies were doing with their defined-benefit pensions.

It would have been fine if they had literally been funding a deferred annuity written by a proper insurer.  But as we know they neither fully funded their pensions nor did they offer the sort of portability that would come with a true annuity contract.

Fortunately, that scam seems to be coming to an end.  But there is still the matter of government defined-benefit pensions: Many federal, state, and local government agencies offer these to their employees.  I suppose that since they are being backed by governments they do not suffer the same credit risks associated with private companies.  Many agencies also collude to provide some degree of pension portability, so an employee can switch jobs without losing his benefits.

But government pensions still suffer from the underfunding hazard — with the cost and risk being dumped on taxpayers.  I suspect pensions will persist in government if for no other reason than that they are a convenient way to hide the cost to taxpayers of benefits provided to one of the classically strong special interests: government employees.  For this reason, taxpayers should demand that governments fully price and fund their pensions.  Or better yet: abolish them and let people buy their own annuities if they want.