2006 August 17 Thursday
US States Balance Sheets Not As Good As They Claim

US states claim they are in great fiscal shape and they are upping spending in response.

NASHVILLE, Tenn. - Updated 4:30 p.m. - State balance sheets are the best they’ve looked in decades. States closed their fiscal 2006 books with nearly 25 percent more money than the previous year, according to the National Conference of State Legislatures' latest survey of states' fiscal conditions.

The extra revenue allowed 20 states to cut personal income taxes by $600 million; 24 states splurged more on K-12 education, and 25 states socked away more in their reserves for the current fiscal 2007 budget year, which for most states began July 1, NCSL said in a preliminary report released here Aug. 15 at the group’s annual meeting.  

In a surprise to some, education -- not Medicaid -- is expected to be the fastest-growing category of state spending in fiscal 2007, reversing a six-year trend. Corina Eckl, director of NCSL’s fiscal affairs programs, said that "most states think that this is an aberration" because of recent Medicaid cost reforms and that she expects health care costs to continue to climb. "This is a temporary situation," she said.

Sound like happy days for the states? Not so fast. The New York Times reports that state and local governments have unfunded pension liabilities that run into the hundreds of billions of dollars.

It is hard to know the extent of the problems, because there is no central regulator to gather data on public plans. Nor is the accounting for government pension plans uniform, so comparing one with another can be unreliable.

But by one estimate, state and local governments owe their current and future retirees roughly $375 billion more than they have committed to their pension funds.

And that may well understate the gap: Barclays Global Investments has calculated that if America’s state pension plans were required to use the same methods as corporations, the total value of the benefits they have promised would grow 22 percent, to $2.5 trillion. Only $1.7 trillion has been set aside to pay those benefits.

In this supposedly fat time for state governments their irresponsible elected leaders are letting their unfunded pension liabilities grow even larger.

It was a doomed approach, leaving New Jersey to struggle with a total pension shortfall that has ballooned to $18 billion. Its actuary has recommended a contribution of $1.8 billion for the coming year, but the state has found only $1.1 billion, so it will fall even farther behind.

Illinois also duplicated one of San Diego’s pension mistakes. It tried to make its municipal pension plan cheaper by stretching its funding schedule over 40 years — considerably longer than the 30 years that governmental accounting and actuarial standards permit, and more than five times what companies will get under a pension bill that has just passed Congress.

An attempt by the state of New Jersey to borrow and invest its way out of unfunded pension liabilities backfired spectacularly.

It must have seemed like a good idea at the time. Back in 1997, New Jersey borrowed $2.7 billion in pension obligation bonds to fill a gap in its plan funding. These bonds –- sometimes called POBs -- are general obligation debt much like any other municipal borrowing, but they're issued in order to put the proceeds into the pension funds, not the general government coffers. The issuing city, county, or state bets that the borrowed money can be invested to earn more than the interest rate that the bonds must pay.


Then came the market bust in 2000, followed by two years of depressing returns that turned what once looked like a winning strategy into a dud. Since 1997, New Jersey's POBs have averaged an annual return well below the 7.6% they owe in interest, according to State Treasurer John E. McCormac. And that's before factoring in whatever the state paid its investment bankers to get the deal done.

New Jersey's unfunded liability is at least $25 billion.

My suggestion: state governments should enact legislation that requires all state local government agreements with unions to have 90 day delays before they take effect. During the early part of the 90 day periods the governments must use independent analysts to calculate and publish on the web detailed future expected pension costs arising from the union agreements. This would give the public time to object to expensive labor agreements.

When SENS technologies start to take off these financial problems will become much worse.

The big stock market boom of the 1990s left city pension funds in great shape in 2000. But large city government pension funds have become underfunded in the last 6 years.

In a report titled "How Big U.S. Cities Are Faring With The Pension Fund Meltdown," Standard & Poor's Ratings Services highlights select pension and debt statistics of the 20 largest cities it rates. This data show that the mean funded ratio (the actuarial value of assets divided by the actuarial accrued liability) of the 20 cities, which had reached nearly 100% in 2000, has since dropped to 84%.

"The degree to which this trend will continue depends on a number of unpredictable variables, including investment performance, actuarial assumption changes, and potential increases in longevity," said Standard & Poor's credit analyst Parry Young. "Unfortunately, cities have varying degrees of control over these factors."

Defined benefit pension agreements should have clauses that increase the retirement date as longevity rises. Also, if the rate of longevity increase becomes as fast as time happens (what Aubrey de Grey calls "Actuarial Escape Velocity") then pension fund eligibility should end.

Update: New York City's pension fund isn't in great shape either.

The chief actuary, Robert C. North, has prepared a little-noticed set of alternative calculations showing that the gap in the pension funds could be as wide as $49 billion. That is nearly the size of the city’s entire annual budget and the equivalent of the city’s publicly disclosed outstanding debt.

The existence of a big gap between the city’s future obligations and the resources committed to meet them does not mean the pension funds are about to run out of money. But it does mean that New York City is promising its current employees future benefits it might not be able to provide without big tax increases or major budget cuts. When such a reckoning might occur, if at all, is hard to predict.

Pensions are now one of the city’s fastest-growing expenses. In recent years the city’s required contributions to its pension funds have more than quadrupled, to $4.7 billion this year from $1.1 billion in 2001.


Share |      By Randall Parker at 2006 August 17 07:15 PM  Economics Government Costs

Ivan Kirigin said at August 18, 2006 8:06 PM:

When SENS starts to take off, you'll get the opposite of what you think.

Rather than many weak years, you'll have many more capable years.

Think of the collective experience and knowledge of folks that are healthy rather than aging or dead.

I for one never plan to retire. Then again, it's many decades away, so what do i know...

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