State and local governments are running one of the largest Ponzi schemes in American history.
They’ve promised full pensions to their workers. But they aren’t putting aside enough money — or generating high enough returns — to fulfill those future obligations. Soon, they’ll have to cannibalize current workers’ pension contributions to pay retirees. Young and middle-aged government employees will likely never receive the retirement benefits they’re counting on.
It’s too late to prevent this crisis. But there’s still time to mitigate the financial fallout — by trimming benefits, raising contributions, and transitioning younger employees to 401(k)s and other defined-contribution plans.
Most importantly, it’s time to recognize that government officials are too short-sighted and underqualified to manage public pensions.
For decades, politicians have underfunded public pensions. They’ve decided to spend tax revenues today, rather than set them aside for future pension liabilities.
For instance, between 1985 and 2012, Illinois diverted $41 billion originally earmarked for pension contributions to other priorities. Simultaneously, the state promised increasingly generous retirement benefits to employees — a pledge it had no way of keeping.
Today, Illinois’ five pension systems face an unfunded liability of $137 billion. Closing that shortfall would require roughly $11,000 from every state resident — including children.
Illinois isn’t the only offender. According to a recent estimate from the RAND Corporation, state and local government pensions are underfunded by $4 to $6 trillion. A separate analysis by the American Legislative Exchange Council puts that funding shortfall at over $6 trillion.
Governments have masked the severity of the problem by assuming their investments will generate unrealistically high returns.
Consider CalPERS, the pension fund for California public-sector employees. The board predicts the fund will earn annual returns of 7% — even though it has averaged just a 4.4% annualized return over the past decade.
It is extremely unlikely that CalPERS will come close to its 7% target for the foreseeable future. Asset valuations are already near record highs, which means there’s little upside left before an inevitable correction.
Even when governments provide adequate funding to pensions, corrupt and incompetent officials often squander it. Consider the current plight of the Dallas Police and Fire Pension fund.
It lost $1.5 billion from 2013 to 2016 — largely because the chief administrator invested almost half of the fund’s capital in risky private equity and real estate investments.
No private pension-fund manager in his right mind would ever take such a high level of risk.
The Dallas fund’s administrator and several board members spent over $185,000 on extravagant travel in one year chasing risky real estate projects in Napa Valley and Hawaii — just one example of misbehavior that a watchdog group described as pervasive “absolute corruption.” Following the scandal, the formerly healthy pension plan was only 45% funded.
Government officials have dug themselves — and the workers who trusted them — into a hole. And there’s no way out. All we can do now is ease the pain.
World Of Pain
First, current retirees must tolerate a reduction in benefits. The average pension for a California public-sector worker who retires after a 30-year career is almost $69,000.
If that worker started his career in his early 20s and retired in his early 50s, he could easily live long enough to earn more from pension checks than he ever made from his salary.
That’s not sustainable. It’s better to take a haircut now — rather than let pension funds implode and leave retirees with nothing.
Second, taxpayers ought to demand that their state and local governments set aside a greater portion of tax revenue for pension contributions. Too often, governments underfund pensions one year and falsely promise to make up the contributions at a later date.
Third, the public sector must transition younger employees into defined-contribution retirement plans, such as the 401(k)s common in the private sector. These plans allow employees to manage their own retirement funds, instead of depending on a government pension check that may never come.
These reforms will help — but in all likelihood, the federal government will still have to bail out many pension funds. When that happens, taxpayers should kick public officials out of the pension business.
After all, these officials have turned pension funds into giant Ponzi schemes. Why in the world would we give them a second chance?
- Stein is a principal of Braeside Capital, L.P., a Dallas-based private investment partnership.
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