Pensions Aren't Bankrupting (Most) States

Discussion in 'Economy' started by Toro, Mar 7, 2011.

  1. Toro
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    Toro Diamond Member

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    Why employee pensions aren't bankrupting states | McClatchy

    Some states, counties and cities are in trouble, however.
     
  2. Wry Catcher
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    Wry Catcher Platinum Member

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    Facts won't mollify the envy and hate fueled tea party or dissuade the GOP from its agenda. American citizens employed in local, state or federal government and union members of all kind are their targets.

    Wages must be capped and benefits curtailed even as the costs for fuel, medical care, food and credit continues to rise, and the profits of corporations and industry skyrocket to new heights. Why? Because the power elite in America would have us believe it is all the fault of greedy employees, the lazy underclass and the illegal immigrants.

    Kid yourselves not, a class war exists in America today and while it has not yet met on the battlefield the offensive has begun in rhetoric filled with hate and fear; their goal, to divide working Americans and to take the focus off of those who rape and pillage and pollute.

    Who are we being told to hate and fear?
    People of color;
    Gays and Lesbians;
    Muslims;
    Liberals and progressives;
    The poor;
    Immigrants;
    Dissidents;
    Labor unions;
    Teachers;
    Your neighbors and friends.
     
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  3. PoliticalChic
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    PoliticalChic Diamond Member

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    "Some states, counties and cities are in trouble, however."
    Is that what's called 'duck and cover'?

    What's truly funny is how the left begins its trope, and the folks on the left buy it like it's on sale.

    Who was it, Saint Michael Moore, who said, 'the country's not broke' to take the heat off the unions in Wisconsin, and sure enough, McClatchy tries to make it true....

    "Levin describes the latest rambling of Michael Moore as the elementary school version of the Communist Manifesto. Moore says that there’s plenty of money in the US, that we aren’t going broke at all."http://www.therightscoop.com/mark-levin-rips-half-wit-michael-moore/

    1. To get an idea of the characteristics of public fiscal calculations, take a look at state budgets. State, unlike federal, budgets, cannot run as deficits. “Virtually all states have balanced budget requirements, so they must take actions to close these deficits.” (State Budget Deficits for Fiscal Year 2004 are Huge and Growing, Revised 1/23/03) So, what to do?

    Simple: conjecture a better world! Read McClatchy!

    a. In 2008, states reported that their public-employee pensions were underfunded by a total of $438 billion. But independent estimates say the underfunding is closer to $3 trillion. Why? The states make up estimates of return at unbelievable levels: the median investment return factored in by state pensions is 8% a year! AEI - The Market Value of Public-Sector Pension Deficits

    b. “The official state estimate in underfunded pension liabilities to New Jersey’s public workers stands at $46 billion. It is one of the highest liabilities in the nation, averaging $5,200 per capita. The estimate is based on an assumed rate of return on pension assets of 8.25 percent –“ National Taxpayers Union - Overvalued and Underfunded: New Jersey

    c. Now, what happens if the state cannot pay the pensions? Taxpayers are legally obligated to make up any difference between what’s been promised and what can actually be paid. Pension Pulse: Pension Woes May Deepen Financial Crisis

    Or...how about we float the idea that the state, and the nation, aren't in debt trouble...Yeah- that's the ticket: soak the rich....whoever they are.

    Now, let's do a review of the numbers:

    2. Let’s see all of the debt in one place!
    a. National debt $13 trillion
    b. State and Local debt $2.5 trillion
    c. State and Local pensions (underfunded) $3 trillion
    d. Social Security $7.7 trillion*
    e. Medicare $ 38 trillion*
    f. Total US debt $64.2 trillion
    g. Total GDP of entire world $61.0 trillion
    *covers commitments for 75 years
    b., c. The Other National Debt - Kevin D. Williamson - National Review Online
    d., e. The 81% Tax Increase - Forbes.com
    f. 65 Trillion - U.S. Financial Obligations Exceed The Entire World's GDP
    g. Silver: Declining supply, increasing demand - Precious Metals - Resource Investor

    You guys are such pushovers.
     
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    Last edited: Mar 7, 2011
  4. PoliticalChic
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    PoliticalChic Diamond Member

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    WryBoy...sometimes I expect you to think for yourself....but, obviously, not every time.

    "there's simply no evidence that state pensions are the current burden to public finances"

    Is this the hill you want to die on?
     
  5. Toro
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    These "independent assessments" are done by economists who disagree with how the actuarial liability is calculated. The ideological right would like to have you believe that by referring to these economists as "independent," it implies that those calculating actuarial liabilities are somehow compromised. But this is false. In fact, the actuarial discount rate that pensions use to calculate the level of funding comes from both extensive study and experience, and is widely accepted in the actuarial profession. It is the economists making this argument, not the actuaries, who are out of the mainstream. It is the mainstream actuaries who have looked at over a century of data to calculate the discount rates who are in line with mainstream thought.

    Here is one problem with the AEI economist's argument

    "Finance theory" once held that bonds should yield at a lower rate than stocks. Why? Because academics argued that bonds were less risky than stocks. Of course, this thinking has changed over time, both in academia and in practice, as investors came to realize that stocks had a growth component, and thus the yield on stocks should be lower since capital retained within the corporation was invested at a higher rate of growth. And since 1957, except for brief periods of extreme panic, the yield on stocks has been below the yield on bonds.

    "Finance theory" has had spectacular failures as of late. Finance theory articulates that markets are efficient, and that the "right" price is the price in the market. This leads to a circular argument - the market price is the right price so the right price is the market price. This is best embodied in the Efficient Market Hypothesis, which states that all prices reflect known information. It was under this false premise that lead most economists to believe that home prices were fairly valued in 2006, even though many of us in the investment business thought the economists making this argument were nuts, relying on fundamentally flawed models and assumptions to support their arguments. We were right. The economists were wrong.

    So according to "finance theory," because pension funds are guaranteed, they should be discounted at the guaranteed rate of return. This, like the EMH, is fundamentally flawed thinking.

    First, the academic assumes that because the benefits are guaranteed and states cannot declare bankruptcy, they are riskless. This is false. It assumes that the only risk is bankruptcy. It is not. First, because states cannot declare bankruptcy now, does not mean they will not be able to in the future. It also assumes that geopolitical events do not affect the status of a state. What if a state breaks into two? What if a state leaves the union? What if Russia fires nuclear missiles at us? Sounds far-fetched? Sure. But so did 20 Arabs with box-cutters turning the world on its head on Sept 10, 2001.

    More benignly, and again exposing the flaw in the economists' thinking, is the risk of inflation. An economist, premised on the EMH, would argue that inflation expectations embedded in market prices are correct. Inflation expectations in the market are now low. An economist would say that is an accurate forecast of future inflation. But what if it is not? Economists are notoriously bad at forecasting anything. That's not to pick on economists - we are all notoriously bad at forecasting anything - but the risk of inflation and volatility of future liabilities, i.e. adjustments for inflation-indexing, etc., are very real because future inflation is inherently unknowable.

    There are practical problems with the economists' arguments. The biggest one is that it would to 1.) lead to dramatic over-funding of pension plans, and 2.) lead to higher taxes, both of which are inefficient.

    The reason why actuaries use a higher discount rate is because asset returns are higher. The AEI economist notes in his paper that this effectively leads to a mismatch in the volatility of assets and liabilities. But this is only a problem if the pension fund has to be liquidated right now. In real life, that never happens. In real life, pension funds are long-lived institutions. The effects of long duration assets are enormous.

    Let's take the AEI economist at his word. Let's take a look at two scenarios. First, we follow what the economist says and discount the liabilities at the risk-free rate, which is about 4%. Since by implication this requires investing in nothing but government bonds since we are matching "low-risk" assets with "low-risk" liabilities, our return will be 4%. If the pension fund is fully-funded and has $100 million in assets, in 50 years, the pension plan will be worth $610 million compounded at 4% per year.

    Now, let's follow the advice of the actuary who recommends we discount liabilities at 8%. A plan that invests in assets to earn 8% a year will invest in stocks and bonds and other assets. Over long periods of time, stocks have earned 10% per year while a basket of corporate and government bonds have earned ~6% per year. So the 8% per year that government (and corporate) pension funds have earned is fairly accurate as a discount rate. After 50 years, $100 million invested at 8% will be worth $4.59 billion.

    So let's review. Here are the values of the pension funds after 50 years following the advice of the economists and actuaries.

    Scenario 1, listen to the AEI economist and invest at 4% - $610 million.
    Scenario 2, listen to the actuaries and invest at 8% - $4.59 billion.

    Now, which is better?

    I don't know about you, but I'd take scenario 2. The employees will be richer and taxpayers will be taxed less.

    Now, the economist will say "The $610 million is guaranteed, the $4.59 billion is not." True. Sort of. It won't be guaranteed if inflation jumps. The value of the government bonds will plummet. Scenario 2 will produce a higher real return than Scenario 1 in a higher inflation scenario, and will do a much better job at protecting the plan assets. The odds of having 750%, or $4 billion, more in scenario 2 is relatively high as long as the American economy grows at the rate it has for two centuries.

    The AEI economist also appears to have made a flawed assessment of the probabilities of pension funds meeting their actuarial returns. He uses Monte Carlo analysis to calculate the probability of pension funds earning their actuarial return. Frankly, I have no idea what his methodologies are, but the fact that he calculates that a fully funded pension only has a 40% chance of meeting its obligations makes me think he is using flawed assumptions. There is a theory in finance that assumes the expected rate of return from stocks for any one individual is 0%, simply because the market is bigger than any one individual. Like sitting at a roulette table, the market will eventually take your money since your losses will outstrip your gains in any one time period. My guess this is in his assumptions. If fully-funded pension plans only have a 40% chance of meeting all their obligations, the economy is in serious trouble. In reality, if the economy grows at trend, the odds of a fully funded plan being able to meet all its obligations are extremely high.

    Economic and finance theories have been found to be enormously flawed over the past decade. Following the advice of these economists on pension funds would be extremely damaging as it would unnecessarily cost pension plans - and taxpayers - enormous amounts of money.
     
    Last edited: Mar 8, 2011
  6. william the wie
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    william the wie Gold Member

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    Toro, the cities and states that are in trouble are generally in trouble to the degree that they are reliable democratic strongholds that use public sector unions to maintain that power. The dots are very easy to connect on that one. Public sector unions exist to help the Democratic Party win elections period dot. Get the unions out of partisan politics and the problem goes away.
     
  7. Toro
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    William

    You might be right, I don't know. I've never done a political analysis of the states.

    I don't want to leave the impression that all jurisdictions are fine. Some are in dire straights. Here in Florida, even though the state is in good shape, many cities and counties in the state are in trouble.
     
  8. Wry Catcher
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    Wry Catcher Platinum Member

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    I love it when you post something I did not write, it gives me added confidence that the point I did make is spot on.

    In fact pensions are a burden to many state governments, but not the only reason state governments are in fiscal trouble. Public employees are a scapegoat, even as the unions that represent them have and continue to make concessions in collective barganing venues.

    Crime in fact has become a greater burden in California. The law and order movement which superseded rehabilitation and treatement has flooded state prisons with inmates at great cost to the California taxpayer. Prisons are very expensive to build and to run; medical costs for prisoners alone cost taxpayer millions each year and incarcerating younger persons for relatively minor felonies (i.e. drug transportation or sales, auto theft) has created career criminals and gang problems beyond our control.

    I honestly don't believe you understand the real problems facing our states, or their cause.
     
  9. chikenwing
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    "there's simply no evidence that state pensions are the current burden to public finances"


    So it must have been a big lie,year after year when the state,and local governments have been using the rising cost of pensions as one of the main causes for tax increases year after year.School taxes being at the top of the list for annual double digit increases.

    How can it be both??
     
  10. PoliticalChic
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    PoliticalChic Diamond Member

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    Toro, I love it.
    There are very few who can post as thoroughly and as calmly as you do re: the realm of economics.

    Excellent exposition.

    But, of course, you threw in the towel in the OP with modifiers such as 'most states....' and 'some states are in trouble...'
     
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    Last edited: Mar 7, 2011

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