- - Tuesday, May 17, 2016


Most state and local governments provide defined-benefit pensions to their employees. An employee earns his or her pension benefits over many years of employment, and then receives the benefits throughout retirement. It is “Pension 101” that the employer should set aside enough money throughout the employee’s years of service to ensure that the money will be there to pay the pension benefits during retirement.

Unfortunately, many state and local governments have been cheating big-time. They have not been setting aside nearly enough each year to fund their pension commitments. The resulting shortfall can be staggeringly large.

According to a recent report by the Federal Reserve Board, state and local governments have $1.7 trillion of unfunded pension liabilities — up a whopping 22.4 percent from just a year earlier. To put this into perspective, state and local governments have $3.0 trillion of municipal debt — incurred to fund things like schools, highways and other infrastructure.

Elected officials are primarily to blame for this problem by allowing it to go unattended for so long. If the appropriate pension contributions had been made annually, the true cost of the pensions would have been factored into each year’s budget. Doing so would have required that taxes be increased, funds be diverted from other programs, or pension benefits be negotiated to more affordable levels. These options are always unpalatable, but they are the only responsible ones.

Instead, many elected officials have been kicking the can down the road for years, which is bad for everyone else. Future officials inherit a far greater challenge, public employees cannot count on receiving their well-deserved pension benefits, and taxpayers are potentially facing a very big bill.

According to Pew Research, as of 2013, the states with the least funded pension plans were Illinois (39.3 percent funded), Kentucky (44.2 percent), Connecticut (48.4 percent) and Alaska (52.3 percent). In contrast, the state pension plans for Oregon, North Carolina, Wisconsin, South Dakota and Tennessee were 93.6 percent or more funded. The recent Fed report indicates that as a group, state and local pension funds were only 68.2 percent funded at the end of 2015.

If you kick the can long enough, you run out of road. It is no coincidence that municipal bond defaults — a historic rarity — have recently occurred in Detroit, Puerto Rico, Stockton and San Bernardino. Even Chicago — one of our largest and most vibrant cities — faces a worrisome risk of default over the next few years.

If elected officials act responsibly, it is not too late to get pensions back onto a reasonable footing. Unfortunately, as the debate in Washington about Puerto Rico perfectly illustrates, many officials are still looking for an easy way out.

Puerto Rico’s pension plans are only 7 percent funded, resulting in some $47.6 billion of pension liability compared to $70 billion of municipal debt. The Obama administration has relentlessly pressed Congress to enact legislation that would explicitly allow Puerto Rico’s pension liabilities to leapfrog all its municipal bonds, even the portion that has a constitutional priority over all other liabilities. Republican Reps. Sean Duffy of Wisconsin and Rob Bishop of Utah are sponsoring legislation in the House that would do just that.

Proponents of such legislation falsely proclaim that its enactment would be irrelevant to the market for non-Puerto Rico bonds. This does not pass the “straight-face” test.

Suppose the proposed legislation is enacted, and thereafter, say, Chicago — whose citizens, unlike those of Puerto Rico, send voting members to Congress and vote for president — were to get into dire financial straits. Surely Congress would not deny Chicago and its public employees the benefits that Congress has bestowed on Puerto Rico and its public employees.

Upon the enactment of the proposed legislation, any prudent investor would assign significantly greater risk to all municipal credits. As a result, municipal finance will be more costly for all municipalities and will be shut off sooner for municipalities that are struggling.

The Obama administration wants to give Puerto Rico a “get out of jail free card” by retroactively subordinating bonds to pension liabilities — the rule of law be damned. That approach would be both counterproductive and illegal. If Congress plays along, every municipal bond issuer in the country will pay the price going forward, and state and local pensions will be even less likely to become properly funded.

William M. Isaac, a former chairman of the Federal Deposit Insurance Corp., is a senior managing director at FTI Consulting.

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