I recently attended a seminar about public pension reform led by Chuck Reed, former San Jose mayor and current board member of the Retirement Security Initiative.
Back in 2012, Reed led the effort to pass a pension reform measure for San Jose. Today, he paints a dire picture of the underfunded pension situation across the United States, not just for those on public pensions, but for all retirees. Reed says a solution is difficult to find because it would require compromise from the same people who caused the problem in the first place: politicians, union leaders and even rating agencies.
Police and firefighters in numerous cities can retire after 30 years of service and collect 90 percent of their salaries for the rest of their lives.
While that may sound overly generous, do not blame the employees. After all, it was the city leaders who offered such benefits to them – mostly because it is much easier to offer future benefits (which have a much smaller impact on a city’s current budget) than to raise current salaries. Then city financiers compounded the problem by assuming unrealistic growth estimates for their pension funds.
Next we have public employee union leaders, who (with very few exceptions) take the position that the only thing the municipality has to do to cover the costs is to shift funding away from other priorities.
This tunnel vision regarding pension reform is totally unrealistic. The only choices a city has are to cut services, raise taxes, cut benefits to retirees or cut payments to its bond investors. In many jurisdictions, no single approach is sufficient at this point because pensions have been underfunded for so long. The simplistic “cut a few services” just won’t suffice. Detroit serves as a stern warning in this regard.
Ratings agencies, hardly neutral actors, often mislead bond investors. This became clear in 2008, when they rated bonds from Lehman Brothers as investment grade a week before the company went bankrupt. The ratings agencies did it again in 2013 with their investment-grade rating of Puerto Rico bonds, ignoring the fact that the government was using them to cover their pension obligations (an unsustainable financial strategy).
Ultimately bondholders were forced to give up some of their principal, known in financial parlance as “taking a haircut.”
If the federal government ever gets around to prosecuting some of the financial leaders who brought about the financial collapse of 2008 through their reckless risk-taking, bond rating agency leaders certainly deserve at least a dishonorable mention.
You might think that underfunded public pension liabilities are a problem only for public employees, but unfortunately we are all going to pay a price.
Suppose you end up retiring in a city that is forced to cut services or raise taxes to fix its public pension problem: The quality of your life is going to be impacted whether or not you are a public pensioner. Also, if you are a private-sector retiree, you probably will be depending to a large extent on your investment portfolio to support you.
Municipal bonds used to be the investment of choice for a safe, decent return. You need to do a lot more due diligence today to ensure that your portfolio is appropriately balanced for safety and for growth.
What can we do to improve the situation? Reed suggests evaluating the extent to which pensions are underfunded in our own local city or town. The ease with which we uncover the data will indicate how transparently that municipality and its leadership are managing the problem.
During elections, we should interrogate candidates on their understanding of and their position on this topic. Even though they may not have caused the problem, they should still be held accountable to solve it, not kick it down the road like their predecessors.
The underfunded pension problem will only get worse and worse the longer we fail to address it.