2010 April 17 Saturday
Jim Chanos: Greece Is Prelude For Other Governments

Hedge fund billionaire Jim Chanos says the financial crisis in Greece is a prelude to what's in store for other governments which have promised far more than they can deliver.

You know they came in and discovered the hole in the budget deficit and discovered a lot of the off balance sheet stuff that was not of their doing. And he's taking the politically unpopular step of extending the retirement age and cutting government wages not knowing if it's going to be enough and so far the market is pretty skeptical, but I think the Greek government is being more courageous than some of the other western-European governments who aren't addressing these issues and are going to be facing these same problems like Greece down the road. So Greece is a prelude to the problems that a lot of other countries will face that have made promises to their people without the ability to pay for them.

Not just other countries. The Pew Center on the States finds that the US states have $1 trillion in unfunded pension and health care liabilities. The states are in worse shape than they officially state because they assume ludicrous rates of return on their investments. The lowest assumed annual return rate is 7.25% for North Carolina and South Carolina. The highest at 8.5% is used by 5 states (CO, CT, IL, MN, NH). This is delusional. Click thru on that link to figure out whether you need to plan to move to another state.

The interview with Chanos is worth reading for his comments about proper uses of credit default swaps.

States do not want to get realistic on rates of return because they can't afford higher pension fund contributions that would come from more realistic assumptions. This article reports that states are increasing their risks in order to try to get higher rates of return. This will end in tears for the taxpayers.

A growing number of experts say that governments need to lower the assumptions they make about rates of return, to reflect today’s market conditions.

But plan officials say they cannot.

“Nobody wants to adjust the rate, because liabilities would explode,” said Trent May, chief investment officer of Wyoming’s state pension fund.

The $30 billion Colorado state pension fund is one of a tiny number of government plans to disclose how much difference even a slight change in its projected rate of return could make. Colorado has been assuming its investments will earn 8.5 percent annually, on average, and on that basis it reported a $17.9 billion shortfall in its most recent annual report.

But the state also disclosed what would happen if it lowered its investment assumption just half a percentage point, to 8 percent. Though it might be more likely to achieve that return, Colorado would earn less over time on its investments. So at 8 percent, the plan’s shortfall would actually jump to $21.4 billion. Contributions would need to increase to keep pace.

More realistic assumptions lead one finance prof to estimate the states are $3 trillion underfunded. The article includes an estimate that the Chicago area government pension funds are underfunded by over $5800 per resident. So the potential obligations you can get stuck with in a high tax area are huge.

But as NPR and others noted, that $1 trillion figure is unrealistically low. Experts like Joshua Rauh, an associate professor of finance at the Kellogg School of Management at Northwestern University, say pension funds are using exaggerated assumptions about investment returns. "Our calculation is that it's more like $3 trillion underfunded," Rauh told NPR.

The 2010s will feature a series of financial crises that will intensify until the crisis is large and continuous. Peak Oil is going to cause tax revenues to decline and investments to produce negative returns.

What I want to know: Can US states cut benefits for people already retired? US cities can go bankrupt and get out of pension obligations that way. States can default on debt. But can states get out of retiree pension and health care obligations? Will Congress eventually pass legislation that provides a mechanism for states to shed obligations?

Update: Newly elected governor Chris Christie of New Jersey wants to figure out ways to cut retirement benefits for existing state workers.

Facing unfunded liabilities of $90 billion in pension and medical plans, Mr. Christie worked with lawmakers to change retirement benefits for new workers and to require all new state employees to pay 1.5% of their medical insurance costs. Until now they were paying nothing.

He wants to go further. "We need to move forward to try to make some changes in the pension system for current employees," he says. "There's all kinds of problems in doing that, some legal. . . . You can't take away vested benefits, but the argument of whether increases going forward are actually vested or not is an interesting legal issue that we're going to attempt to challenge. . . ." He adds that the current retirement age for state employees, 62, "needs to be moved up further."

The State of New Jersey is one of the fiscal basket cases. California gets more attention. But if you look at the Pew Center on the States pension fund report you will see that California gets higher grades on pension soundness than New Jersey. Pension costs are a major portion of total state costs. So this measure is a good indication of the fiscal soundness of the states.

Share |      By Randall Parker at 2010 April 17 12:44 PM  Economics Sovereign Crises

kurt9 said at April 17, 2010 1:02 PM:

"Can US states cut benefits for people already retired? US cities can go bankrupt and get out of pension obligations that way. States can default on debt. But can states get out of retiree pension and health care obligations? Will Congress eventually pass legislation that provides a mechanism for states to shed obligations?"

We will find out when California goes bankrupt in the near future. My guess is that the state pension funds that go bankrupt will get rolled into the Ferderal pension guarantee fund, the same one that bankrupt private company funds go into, which guarantees pensions up to around $55-60K per year. This will be the ultimate fate of the UAW as well.

I see this as the most likely scenario because this set up is already established and has been used for private pension fund bankruptcies (for example, United Airlines). This is the only way to "wind down" the pension fund crisis.

Wolf-Dog said at April 17, 2010 11:25 PM:

If states like Colorado, etc, assume that their investments will earn eat least 8 % per year, this is tantamount to bubble mentality, because without a corresponding 8 % annual long term economic growth, such investment income is impossible. (Only top hedge funds can achieve this, but when they do, this is always at the expense of other investors who are tricked.)

A Gentle,Bearded Left-Winger. said at April 18, 2010 1:24 AM:

The problem is two fold:
1/. Average American incomes have stagnated since 1968 (before the time when most living US citizens were born!).Since taxes and other contributions are an excise off average incomes, they too, have stagnated.
2/. Further to the stagnation of average incomes (I won't even pontificate about how incomes have polarized to the extremely wealthy who seen their personal soar), huge swathes of US industry have been substituted by industry in China and elsewhere, thus ring-fencing that added value to foreigners.

Both of these two points were, of course, the deliberate and inevitable fruit of neo-liberal 'free market' economic doctrine that took hold of the US political class in the 70s and 80s.
The prime movers were the shit-cunts who write for the The Economist and Wall Street Journal (whores paid for by the globalists whom they enrich). Ass-clown, shit-eating politicians wishing to appear 'clever' fell for it hook, line and sinker.
Well I suppose middle-class Californians who voted for the cunts can whore out the daughters to BangBros - so the coroprate globalists can masturbate over multiple dick-entries, in exchange for a few dimes.

Big bill said at April 18, 2010 12:15 PM:

You know, I am pleased that Gentle, Bearded Left-Wingers are coming around! Tell me, Oh Bearded One, what would you prescribe for our President's Goldman Sachs retinue ( but not for the President, of course, since he is a mere Babe in the Woods who (like George III) is being led astray by his nefarious advisors).

Jerry Martinosn said at April 23, 2010 1:38 AM:

A government signing an employment contract that has a huge underfunded liability (I'll use the legally recognized Black-Sholes for assuming risk-adjusted returns) is taking out a loan. It is no different than a general obligation bond. I don't recall a 2/3 vote for local governments approving an underfunded pension plan. Therefore such agreements between state&local entities in the state of California were unconstitutional. There's no reason for the public employee unions to expect the taxpayers to fund something that was part of illegal agreement. The employees who were mislead about this have nothing but their union bosses to blame for deluding them.

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