Friday, February 19, 2010

State Pension Programs Are Underfunded By $1 Trillion

Moses Kim argues that even in light of the modest indications of economic growth, the United States economy still remains in severe trouble, as indicated by high debt levels and low employment, among other things. The ultimate solution for the economy's problems may be far off, as many of them are being caused by the combination of the demographic issues caused the impending retirement of the Baby Boom Generation and by an ongoing tendency among politicians to spend at unsustainable levels. See the following post from Expected Returns.

Economic historians will no doubt look back on this era and wonder aloud how anyone could have possibly believed we were in an economic recovery. After all, economic recoveries simply don't occur with 10% annual deficit to GDP ratios, rising unemployment, long-term joblessness at record levels, and record rates of contraction in bank lending.

As we teeter on the brink of an economic implosion, the WSJ reports that municipalities are considering Chapter 9 Bankruptcy Filings. To even consider Chapter 9 bankruptcy, which carries with it huge implications for future debt issuance, municipalities must be in truly dire straits. Yet we are apparently humming along in an economic recovery based on a farcical 5.7% GDP figure that had me considering the existence of Santa Claus. Simply amazing.

If this were an ordinary business cycle recession, I would be much more bullish on the prospects for America. I would be buying stocks, real estate, and any number of assets in anticipation of a cyclical economic recovery. One of the main reasons I'm hesitant to is because of demographics. The coming wave of retirees will exacerbate our debt crisis at the private and public level.

Social Security is one obvious problem we must soon face head on. However, state pensions are in huge trouble too. The following report by Pew Center on the States details the crisis in underfunded state pensions.
A $1 trillion gap. That is what exists between the $3.35 trillion in pension, health care and other retirement benefits states have promised their current and retired workers as of fiscal year 2008 and the $2.35 trillion they have on hand to pay for them, according to a new report by the Pew Center on the States.

In fact, this figure likely underestimates the bill coming due for states’ public sector retirement benefit obligations: Because most states assess their retirement plans on June 30, our calculation does not fully reflect severe investment declines in pension funds in the second half of 2008 before the modest recovery in 2009.
As the report states, $1 trillion dollars could very well be an understatement of the current budget shortfall. These pensions rely heavily on gains in the stock market for funding. Dare we even consider the consequences to state pensions, and by extension states' budgets, if stocks were to decline meaningfully from here on out?

In order to cover this shortfall, states will have to raise taxes at a time people are struggling to get by. This includes property taxes, which is one of the reasons real estate will be under pressure for quite some time. Another reason related to demographics is that Boomers are sizing down, not sizing up like they were in middle age.

Stop the Spending!

Fundamentally, our fiscal problems are a product of excessive spending by politicians who are more concerned with reelection than long-term fiscal health. Most of our leaders did not take a stand against unions and the incredibly bloated public sector. We are now facing the consequences of the lack of political courage by our leaders.

I suggest you all watch this interview with the newly elected Republican Governor of New Jersey. We need more leaders like him with the courage to make the tough and correct choices. Notice the non-stop jabbering of the CNBC commentators to spend, spend, spend our way out of this crisis. When will we learn?

This post has been republished from Moses Kim's blog, Expected Returns.

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