July 30, 2010

Blame the Fed for the Pension Crisis Because They Engineered It

As the stock market bubbled ever higher in the 1990s, managers of pension plans ratcheted up their expectations of future "permanent" growth, giving politicos the go-ahead to ramp up pension pay-outs. From 2002 to 2008, pension payments to retirees grew 56%, triple the inflation rate. In essence, pension plans, which were once constructed on the long-term expectation of 4-5% returns on capital, now based future earnings and pay-outs on the stock market's "average return" of 8% annually. As any reasonable person might have foreseen, the bubblicious stock market of the 1990s was not a "new permanent plateau" but, in fact, a bubble which imploded. Real returns in the past decade have been literally half what was anticipated and, as a result, state and local governments are having to make up the difference with cash out of general fund tax receipts.

84% of state and local employees retain defined benefit coverage, compared to 21% of private sector workers.

Low-wage public-sector workers also had better access to retirement plans: 74% were eligible, compared with 40% in the private sector. - The Public Sector “Haves” Get Richer Benefits Too…, The Swine Line, July 28, 2010

Having public pensions being so superior and far better than private retirement savings — and the inevitable backlash this would produce — is one of the unavoidable adjustments similar to falling house prices. This huge gap of public employees being so much better compensated than private employees became visible about a year ago even in just ordinary news reports in the papers, for those that read widely. Just like falling house prices, this will be adjusted, sometimes by drastic action (similar to a foreclosure being drastic). The bottom line is that taxpayers cannot be expected to make public employees far more comfortable than themselves. - Hal Horvath, Pension Envy, Pension Crisis, On Point Radio, July 28, 2010

Private sector defined benefit (DB) plans, private sector defined contribution (DC) plans, and state and local pension plans have all suffered declines of over 25 percent of their 2007 values, but that is simply another way of stating that the three types of plans (in aggregate) had basically the same portfolio composition at the end of 2007. The one exception is the federal government's civilian retirement plan, which (for the DB portion) is similar to Social Security insofar as the investments are completely in non-marketable government debt issues ... To date, the most immediate effects of the stock market crash have been on DC participants planning to retire in the next few years. However, all DC participants observe, when reading their quarterly statements or checking on-line balances, that they have incurred dramatic losses ... The extent to which the 2008 stock market crash affected pension participants obviously depends on the extent to which those participants were invested in the stock market before the crash. We use data from the Federal Reserve Board's Flow of Funds Accounts to measure the aggregate change in pension assets across the four broad categories of plans: private sector DB, private sector DC, state and local, and federal civilian. Of these, all but the federal civilian employee plan were greatly exposed to the drop in equity prices. This distinction is reflected in the approach to funding pensions before 2008; all but the federal civilian plan relied on equity exposure to achieve funding targets, which allowed lower contribution rates. - How will the stock market crash affect the choice of pension plans?, National Tax Journal, September 1, 2009

Only 9% of all private sector workers are now represented by a union, less than half the percentage of two decades ago. Meanwhile, the proportion of state and local workers with union representation has held steady over the same time, at about 43%... Government pensions are generally much richer than those offered by corporations. The average public sector employee now collects an annual pension benefit of 60% after 30 years on the job or 75% if he is one of the one-fifth or so of workers who are not eligible to collect Social Security benefits. Of the corporate employers that still offer traditional pensions, the average benefit is equal to 45% of salary after 30 years... Just as important, about 80% of government retirees receive pensions that are increased each year to keep pace with the cost of living, a feature which protects pensions against the effects of inflation and that can increase the value of a typical pension by hundreds of thousands of dollars over a person's retirement. But such inflation protection is nonexistent in corporate plans. - Bankrupt Public Pensions: A Time Bomb That Will Explode, AnchorRising.com, May 16, 2005

Corporations have been moving away in massive numbers from the defined benefit programs that governments had emulated. In 2008, just 48,000 companies in the U.S. offered pension programs -- down from 150,000 in 1988. Instead of maintaining costly pensions and committing to a lifetime of defined benefits for retirees, companies contributed to mobile retirement accounts, such as 401(k)s. The nation's workforce has also changed. By January 2010, for the first time, public employees made up the largest percentage of union workers. Several recent studies show that at least some public employees now make more than their private-sector counterparts, although that is not true across the board. - Public Pay, Benefits Set Off New 'Civil War', Star Tribune, February 13, 2011

For decades, public sector unions have peddled the fantasy that government employees were paid less than their counterparts in the private sector. In fact, the pay disparity is the other way around. Government workers, especially at the federal level, make salaries that are scandalously higher than those paid to private sector workers. And let's not forget private sector workers not only have to be sufficiently productive to earn their paychecks, they also must pay the taxes that support the more generous jobs in the public sector. - Want to Get Rich? Work for Feds, Washington Examiner, April 29, 2010

One-third of the 2009 stimulus money went to state and local governments--an obvious payoff to the public employee unions which gave hundreds of millions of dollars to Democrats and got hundreds of billions of dollars in return, to insulate public employee unions from the effects of the recession which has affected everyone else. - Michael Barone, The Case Against the Public Employee Unions, Washington Examiner, April 20, 2010

Obama cannot be reelected in 2012 unless union pockets are full of taxpayer money and dues from members who are coerced to join them (and voting union members who think he will give them stuff!). Frankly, Obama and those behind him want to create chaos because they know chaos will lead to civil unrest. The people driving the unions want civil unrest because then people look to government to literally save them. Believe me, what is going on in the Middle East is connected to what is happening here—they are the same agitators. Some of these union leaders were in Egypt helping the Revolution along! As we go into the next tumultuous weeks, keep in mind, the enemy of the Tea Party is not your average apolitical local teacher, fireman or policeman, but the union leaders who are using regular folks as their foils for changing our form of government. Pensions are simply a pretense for creating division and strife. Progressives (Socialists, Marxists, whatever you want to call them) know this is the best chance they have had in a century to “change” America and it is slipping away from them—Obama has less than two years (we hope it’s only two) to get it done! They know that, and they are desperate. I repeat, this is not about pensions! This is about creating civil unrest and pitting neighbor against neighbor to bring America, as we know it and love it, to its knees! - Unions to 'Storm' Annapolis on March 14th - Counter Protest Scheduled, Right Coast Conservative, March 13, 2011

We will have world government whether or not we like it. The only question is whether world government will be achieved by conquest or consent. - James Paul Warburg, Monopoly Banker, Testimony before the U.S. Senate Committee on Foreign Relations, February 17, 1950 (Warburg was an agent of the Rockefeller-JP Morgan-Rothschild banking bloc and son of Paul Warburg, chief architect of the Federal Reserve Corporation, an unconstitutional private bank monopoly set up for cartel hegemony.)

Blame the Fed for the Pension Crisis

Seeking Alpha
May 24, 2010

A key player in the nation's unfolding pension debacle is rarely fingered--The Federal Reserve.

If you reckon state and local government have created their own guaranteed-to-go-bankrupt pension problem, you'd be half-right: the Federal Reserve's policies of the past two decades are the crumbling foundation beneath the nation's unsustainable pension plans.

Here's a precis of how the nation's local government pension plans were set to implode.
  1. Public unions formed an unholy alliance with elected officials (in effect, an oligarchy) to establish politically untouchable protected fiefdoms.

    In a typical labor-management nexus, labor negotiates with capital for a slice of the profits from the enterprise. In local government, the unions lavishly funded the election campaigns of state and local politicos, who then awarded unions lavish pensions and other benefits. There was no "push-back" against union demand except elections, and the unions stupendous "investment" in buying politicos ensured elections were never a threat to the fiefdom's rising share of the tax swag.

    Here is an MSM (mainstream media) summary of the public-union/politico oligarchy: The Bankrupting of America: We have a ruinous collaboration of elected officials and unionized public workers.

  2. As the stock market bubbled ever higher in the 1990s, managers of pension plans ratcheted up their expectations of future "permanent" growth, giving politicos the go-ahead to ramp up pension pay-outs.

    In essence, pension plans, which were once constructed on the long-term expectation of 4-5% returns on capital, now based future earnings and pay-outs on the stock market's "average return" of 8% annually.

    As any reasonable person might have foreseen, the bubblicious stock market of the 1990s was not a "new permanent plateau" but, in fact, a bubble which imploded. Real returns in the past decade have been literally half what was anticipated and, as a result, state and local governments are having to make up the difference with cash out of general fund tax receipts.
Going for broke in L.A.?
Currently, Riordan says, the city is struggling to meet its pension obligations, and that's assuming it will receive 8% annually on the money invested on retirees' behalf. In fact, the average return over the past decade has been just 4%.
As tax receipts plummet in the "slow-growth," jobless recession, then state and local governments are forced to gut their programs to fund the oligarchy / fiefdom's pension promises.

Pension issue balloons with soaring costs:
Los Angeles officials say Riordan's prediction is overstated. But pension costs are soaring to $800 million, tripling during the last decade, as Los Angeles faces years of projected budget deficits even with deep cuts in services and staff.
Since the pension pay-outs were based on plump stock market returns, the pension plan managers had no alternative but to gamble in the stock market on a massive scale. With "safe" bonds paying so little in the Fed's low-interest universe, the only way to get an 8% yield was to speculate in real estate or stocks. As the sharpy behind the three-card-monte card table could have told you, the pension fund sheep got sheared along with all the other marks:
The main driver of higher pension costs is the stock market crash. CalPERS gets about 75% of its revenue from investment earnings. Its portfolio peaked at $260 billion in 2007, fell to $160 billion last year and now is about $204 billion.
Now that the stock market is setting up for a long-term crash, CalPERS will be lucky to have $100 billion in its coffers in two years. And that won't be enough to fund the bloated promises made in the go-go 1990s:
A political issue is the benefit increases enacted a decade ago, when pension systems had surpluses during a strong economy. A major increase for state workers, SB400 in 1999, even included retirees.

A typical state worker can retire after 40 years of service with a pension equal to their final pay. The formula for the Highway Patrol, 3 percent of final pay for each year served at age 50, became a statewide trendsetter for police and firefighters.
In the usual gaming, favored by gutless politicos desperate to cling to their diminishing power to channel tax funds to their cronies and masters, elected officials are setting aside their pension fund contributions until next year, in the hopes that "growth" will magically save them next year. As this article explains, that is a vain hope without foundation in the real world:

Why economic growth isn't enough to fix budgets:
But under the laws now dominating government budgets, many expenditures essentially are or will be growing faster than both revenues and the rest of the economy. In fact, in many areas of the budget, automatic expenditure growth matches or outstrips revenue growth under almost any conceivable rate of economic growth.

Now, so much spending growth is built into permanent or mandatory programs that they essentially absorb much or all revenue growth. Meanwhile, we've also cut taxes, widening the gap between available revenues and growing spending levels.

Consider government retirement programs. Most are effectively "wage-indexed" insofar as a 10 percent higher growth rate of wages doesn't just raise taxes on those wages, it also raises the annual benefits of all future retirees by 10%. Meanwhile, in most retirement systems, employees stop working at fixed ages, even though for decades Americans have been living longer.

Today, so much of government spending is devoted to health and retirement programs that their growing costs tend to swamp gains we might achieve in holding down the ever-smaller portion of the budget devoted to discretionary spending. Still other programs add to the problem, such as tax subsidies for employee benefits, the cost of which grows automatically without any new legislation.
In other words, the entire system of state and local government is now based on the same 8% "permanent high growth" of the 1990s speculative market. Funding increases are wired in, regardless of how much tax revenues fall. That is a recipe for insolvency.

Now we get to the heart of the matter. Which institution engineered and enabled the heady stock market bubble of the 1990s that created the illusion of "permanent high returns" and growth of tax receipts? The Federal Reserve.

The Greenspan-era Federal Reserve's policy of low interest rates, abundant liquidity and lax oversight directly created the incentives and the wherewithal for malinvestment and speculation on a scale heretofore unknown. Under the phony guise of "boosting productivity and home ownership" with essentially free money and splendid opportunities for embezzlement, fraud and gaming of the system, the Fed studiously avoided any policy which might have offered some modest restraint on the asset bubbles it inflated.

As the dot-com era market foamed into an unmistakable bubble, wiser heads implored Greenspan to increase the margin requirement for borrowing funds to play the market--he steadfastly refused. Whatever barriers remained to rampant speculation were dismantled under the false banner of deregulation in the service of free enterprise.

Thus the Glass-Steagall divide between commercial and investment banking was effectively dismantled in 1980 (under President Carter) and the late 1990s (under President Clinton). (So much for the blame being placed solely on the evil Republican lackeys of the bankers-- the "liberal" Democrats were just as craven and slavish.)

Thanks to these long-standing Fed policies favoring exponential expansion of credit and low interest rates, pensions funds were forced into speculating in the stock market to "reach" for their required return on capital.

This certainly suited Wall Street and the deeply politicized leaders of the supposedly independent Federal Reserve, but it set in motion a set of policies, expectations and incentives which fatally undermined pension plans.

In a richly ironic playing out of unintended consequence, the Fed's "zero interest rate policy" (ZIRP) and endless creation of credit for speculation in asset bubbles will in effect bankrupt all the states and local governments which foolishly based their pension plans on 8% yield in a low-inflation environment.

But one last pernicious Fed-created self-destruct awaits pension managers scrambling for both safety and yield. As they pour into long-term Treasuries based on low inflation and low interest rates as far as the eye can see, the pension fund managers will find their remaining capital decimated as interest rates rise later this decade.

The Fed's policy of pushing zero interest rates and abundant credit has undermined not just pension plans and local government, but the entire U.S. economy. Asset bubbles and incentives for embezzlement, fraud and gaming the system are not productive. While Bernanke et al. issue ponderous promises that the "nascent recovery" is not just a house of cards flying apart in the rising wind of global volatility and malinvestment, high above his head the chickens are coming home to roost at the Fed.

A Hole They Dug for Themselves

The crisis in state budgets is not an accident, and it wasn't unforeseeable.

Reason Magazine
July 30, 2009

Everywhere you look, states are being crunched by fiscal emergencies that range from painful to excruciating. California, which has been paying bills with IOUs, is now preparing to close state parks and furlough state employees—which is what you have to do when your budget deficit is bigger than the entire budget of some states.

It's not alone.
"At least 39 states have imposed cuts that hurt vulnerable residents," trumpeted a recent report from the liberal Center on Budget and Policy Priorities. California, New York, and Delaware have approved income-tax increases, and Pennsylvania and Illinois are considering doing likewise.
We all know the reason for the squeeze: An unexpected, severe national recession has dried up revenues just when states need funds to help out-of-work citizens. That's true: You would expect the worst downturn in decades to have a negative effect on tax collections. But it's a long way from the whole truth.

The crisis in state budgets is not an accident, and it wasn't unforeseeable. For years, most states have spent like there's no tomorrow, and now tomorrow is here. They bring to mind the lament of Mickey Mantle, who said, "If I knew I was going to live this long, I'd have taken better care of myself."

If they had known the revenue flood wasn't a permanent fact of life, governors and legislators might have prepared for drought. Instead, like overstretched homeowners, they took on obligations they could meet only in the best-case scenario—which is not what has come to pass.

Over the last decade, state budgets have expanded rapidly. We have had good times and bad times, including a recession in 2001, but according to the National Association of State Budget Officers, this will be the first year since 1983 that total state outlays have not increased.

The days of wine and roses have been affordable due to a cascade of tax revenue. In state after state, the government's take has ballooned. Overall, the average person's state tax burden has risen by 42 percent since 1999—nearly 50 percent beyond what the state would have needed just to keep spending constant, with allowances for inflation.

Even low-tax states like Texas and Nevada have followed the same course. No one has been inclined to say, "Taxpayers don't need to send us more money. We've got plenty."

All that growth should have been enough to pay for essential programs and furnish ample reserves, allowing state governments to weather a downturn without major adjustments. But the states put a priority on burning through all the cash they could get. Last year, they spent about 77 percent more than they did 10 years before.

California illustrates the problem. Adam Summers of the libertarian Reason Foundation in Los Angeles has calculated that:
If it "had simply limited its spending increases to the 4.38 percent average annual increase in the state's consumer price index and population growth each years since fiscal year 1990-91, the state would be sitting on a $15 billion budget surplus right now."
Illinois is another problem child. The state's general fund appropriation is some two-thirds higher today than it would be if the state had just kept those outlays in line with inflation over the last two decades. That increase, as in California, is the difference between a gaping deficit and a comfortable surplus.

Then there is New York. Last fall, Democratic Gov. David Paterson called for an end to the "unsustainable growth in state spending" in recent years. Since the mid-90s, he noted, the state budget has doubled, outstripping the inflation rate by nearly twofold. And New York was not exactly notorious for its frugality 15 years ago.

Unlike the federal government, states can't simply run deficits indefinitely. For that reason, they have a powerful duty to pile up surpluses during fat years, which would allow them to make up the revenue that goes missing during lean years. But for many lawmakers, the future extends only to the next election. So any money they have, they feel an insatiable need to lavish on someone.

Politicians are happy to blame the recession for depriving citizens of programs they have come to expect. The recession didn't create the gap between state government commitments and state government resources. It only exposed it.

Public Pensions: Feeding, and Fixing, the Sausage Machine (Excerpt)

Federal Reserve Bank of Minneapolis
January 2011

...How pension funds got into this position is both simple (they got killed in the stock market) and complex (remember the sausage machine).

First, the easy and painful part. One of the most noteworthy actuarial assumptions in a pension plan is the return it expects to earn on invested assets (also called the discount rate because plans discount future liabilities as assets accrue). Most public pensions nationwide use a return benchmark of 8 percent, though they vary higher (Minnesota’s statewide plans use 8.5 percent) and lower (7.75 for the South Dakota Retirement System and several plans in Montana).

This assumption is noteworthy because the return on invested assets over 30 years tends to be very volatile, and small differences in the assumed return—say, between 7.5 percent and 8.5 percent—make a big difference in the calculation of unfunded liabilities. Many pension plans will be funded if they can achieve 8.5 percent returns, on average, for 30 years. But that’s a big and costly “if” because unfunded liabilities accrue if returns fall short, even if everything else in the sausage machine is running perfectly.

Pension advocates say the 8 percent benchmark is based on historical returns, but the fine print of any investor brochure points out that past returns are not a reliable indicator of future returns.

From a short-term view, that might actually be good, because the past decade has been particularly poor (see Chart 5). Since 2001, there have been four negative return years, which are a double whammy for pensions. In 2002, for example, the largest district pensions lost an average of 7 percent, which means actuarial returns fell short of their benchmark by about 15 percentage points...

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