Municipal pensions

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See also municipal bankruptcy, municipal securities and Municipal Securities Rulemaking Board.


HR 6484 - The Public Employee Pension Transparency Act

Sponsor: Rep Nunes, Devin [CA-21] (introduced 12/2/2010) Cosponsors (5) Latest Major Action: 12/2/2010 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

Congress may force more muni pension transparency

Nine groups representing state and local government employees slammed a House bill Wednesday that would penalize state and local governments that failed to meet disclosure and accounting requirements for public pension systems.

“This legislation represents a fundamental lack of understanding regarding the strong accounting rules and strict legal constraints already in place that require open and transparent governmental financial reporting and processes,” reads a release endorsed by the National Association of Counties, United States Conference of Mayors, National League of Cities, International City/County Management Association, National Association of State Auditors Comptrollers and Treasurers, Government Finance Officers Association, International Personnel Management Association for Human Resources, National Council on Teacher Retirement and the National Association of State Retirement Administrators.

The Public Employee Pension Transparency Act would require pension administrators to report pension funding status and contributions to the government, and forbid federal aid to distressed systems.

The legislation comes on the heels of recent scholarshipby Joshuah Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester that claims state and local governments face unfunded pension obligations of $574 billion.

The study also claims six major cities and several states are set to run out of assets to cover costs in the next decade.

The proposal, sponsored by Rep. Devin Nunes (R-CA), Rep. Paul Ryan (R-WI), and Rep. Darrell Issa (R-CA), would rescind federal tax breaks on municipal bonds for state and local governments that fail to comply with disclosure requirements.

“Unfortunately, the true level of unfunded liabilities associated with these plans … is being hidden thanks to unrealistic accounting standards,” Nunes said.

Keith Brainard, research director for the National Association of State Retirement Administrators, said the findings of Rauh and Novy-Marx rely on pessimistic asset assumptions at a time when interest rates are historically low.

“We differ with their underlying methods and conclusions they use to arrive at that,” he said. “No one questions there has been some abuse (in pension systems) — and those abuses should be rectified — but federal oversight is not the answer.”

Brainard was critical of the federal government’s track record on worker retirement plans, citing current shortfalls in Social Security and bureaucratic regulations that forced many corporations to abandon defined benefits plans in favor of defined contributions plans like 401Ks, which he says provides workers a less stable retirement.

“And the solution is to take a reporting requirement to Washington?” he said. “The fact is there are core parts of puCapitol Hill insiders said the legislation is unlikely to be debated this year, but lawmakers hope the bill will set the stage for deliberations in the 112th Congress, adding that the bill may get a boost from a non-partisan Government Accountability Office study published earlier this year outlining the fiscal condition of state and local governments.

The report found state and local governments face a $10 trillion fiscal gap over the next several decades and steady erosion of government services absent policy changes.

Finance experts said the red ink has led to growing concerns among investors who have long regarded municipal bonds as nearly risk free investments.

“The people I talk to are moving away from them,” said Fred Sheehan, a former Director of Asset Allocation Services at John Hancock Financial Services in Boston. “Some of them have been investing in munis for 30 or 40 years.”

Sheehan said he sees investors shifting from general obligation bonds to revenue bonds, and the pace of the transition could quicken if distressed state and local governments fail to address rising debt.

“From what I’m seeing they are doing very little to help themselves,” Sheehan said. “It’s almost as if it’s a fight among 3rd grade boys. They can’t solve it themselves, an adult has to come in and break them apart.”

The fiscal challenges facing state and local governments has resulted in a growing from financial investment firms warning of a possible collapse in the $2.8 trillion municipal bond market, considered lifeline to state and local governments that have increasingly relied on debt to sustain government function in recent years.

Regardless of the outcome of the bill, a federal crackdown on state and local government accounting practices could be on the way.

In August, New Jersey was charged with securities fraud by the Securities and Exchange Commission for concealing from investors financial information about the funding status of two public pensions.

Brainard said he hopes to see abuses in states like New Jersey rectified, but he doesn’t believe they demonstrate a widespread problem. He said the fact that municipal bonds are still being purchased by investors shows the alleged crisis has been exaggerated.

“I think muni-bond investors are pretty smart people. They can read an annual finance report,” he said. “Bond rating agencies have known all along what New Jersey and other states were doing.”

Tracking Public Pension Plans

A new database offers the public a way to sift through public employee pension plan data at a time of rising national interest in government pension obligations.

Maintained by the Center for State and Local Government Excellence a nonprofit research group, and the Center for Retirement Research at Boston College, the site includes information covering some 85% of state and local pension assets and members.

For the 126 plans covered, the site pegs pension assets at nearly $2.7 trillion in 2009, compared to nearly $3.4 trillion in liabilities. That means plans were 78.9% funded that year — slightly lower than the preferred 80% funding rate. The prior year, plans were 84.3% funded.

The database includes actuarial assumptions, which have been a point of contention lately, for individual plans. On average, the plans assumed an 8% return. Corporate plans, meanwhile, tend to assume about 6%.

Kramer says state pension funds in $3T hole

Orin Kramer, chairman of New Jersey's State Investment Council, talks with Bloomberg's Mark Crumpton and Lori Rothman about the challenge of government pension shortfalls at the state and local level. Kramer says states can address shortfalls by raising taxes. Kramer is also general partner of the New York-based hedge fund Boston Provident Partners LP. (Source: Bloomberg)

US public pensions face $2T deficit

By Francesco Guerrera and Nicole Bullock in New York Published: January 4 2010 23:01 | Last updated: January 4 2010 23:01 The US public pension system faces a higher-than-expected shortfall of more than $2,000bn that will increase pressure on many states’ strained finances and crimp economic growth, according to the chairman of New Jersey’s pension fund.

The estimate by Orin Kramer will fuel investors’ concerns over the deteriorating financial health of US states after the recession. “State and local governments are correctly perceived to be in serious difficulty,” Mr Kramer told the Financial Times.

“If you factor in the reality of these unfunded promises, their deficits will rise exponentially.”

Estimates of aggregate funding requirement of the US pension system have ranged between $400bn and $500bn, but Mr Kramer’s analysis concluded that public funds would need to find more than $2,000bn to meet future pension obligations.

A shortfall of that size could force state governments to take unpalatable decisions such as pouring more public money into their funds or reducing pension benefits. State and local governments have already cut spending to close budget deficits.

Mr Kramer, chairman of New Jersey’s investment council and also a senior partner at the hedge fund Boston Provident, warned that outdated accounting models and unrealistic expectations of future returns had led states to underestimate their pension requirements.

Public pension funds do not use mark-to-market accounting, relying instead on actuarial numbers that average out value of assets and liabilities over a number of years – a process known as “smoothing”. Mr Kramer’s analysis used the market value of the assets and liabilities of the top 25 public pension funds at the end of the year.

He also looked at market interest rates, which are used by corporate pension funds and are lower than the rate of return of about 8 per cent employed by public funds, to calculate future returns. Using the 8 per cent rate of return, the funding requirement of the US public pension system would still be about $1,000bn.

Mr Kramer, a power broker in the Democratic party, criticised the financial metrics used by public funds and argued that his assumptions were more realistic.

“The accounting treatment of public retirement plans is the political leper colony of government accounting. It is a no-go zone,” he said.

Pension funds’ requirements are expected to compound the pressure on local finances. Thirty-six of the 50 US states, including California and New York, have plunged into budget deficits since fiscal year 2010 began, which for most states was July 1 2009, according to the National Conference of State Legislatures.

Pew calculates $1T shortfall

States may be forced to reduce benefits, raise taxes or slash government services to address a $1 trillion funding shortfall in public sector retirement benefits, according to a new study that warns of even more debilitating costs if immediate action isn't taken.

The Pew Center on the States released a survey Thursday of state-administered pension plans, retiree health care and other post-employment benefits in all 50 states that blamed a decade's worth of policy decisions for leaving them shortchanged.

The result for some states will be "high annual costs that come with significant unfunded liabilities, lower bond ratings, less money available for services, higher taxes and the specter of worsening problems in the future," the study said.

The cost of the trillion-dollar shortfall, which will be paid over the coming decades, is about $8,800 for each American household. The study did not include many city, county and municipal pension plans, which are thought to have similar underfunding.

"We have a significant problem now, but it's a problem that can be solved by taking relatively modest steps," said Susan K. Urahn, the center's managing director. "If they don't do anything, if they wait, eventually they will have an unmanageable crisis on their hands."

As of 2008, states had $2.4 trillion to meet $3.4 trillion in promised pension, health care and other post-retirement benefits, according to the report.

The true gap may even be wider, because the study did not account for the full impact of investment losses in late 2008, during the stock market downturn, and because many plans employ multiyear smoothing techniques to lessen the effect of a single year's losses. But more recent stock market returns could help - on Wednesday, for example, Pennsylvania's $47 billion public school pension plan reported it had earned about 12 percent on investments in the 2009 calendar year.

9 considered to be facing serious concerns.

"Meanwhile, more and more baby boomers in state and local government are nearing retirement, and many will live longer than earlier generations - meaning that if states do not get a handle on the costs of post-employment benefits now, the problem likely will get far worse, with states facing debilitating costs," the study said.

The exploding financial burden could be a bitter pill for taxpayers, many of whom will not be collecting similar pensions or other benefits when they retire, said David Kline with the California Taxpayers' Association. About one in five private sector workers have traditional defined benefit pensions, compared with about 90 percent of public-sector employees - including some that do not get Social Security.

"Taxpayers in the future will be paying for people who worked decades before they may have even lived in the area or begun paying taxes, because the obligation for these benefits is just snowballing," Kline said.

The study graded states on how well they have managed employees' retirement benefits. Florida, Idaho, New York, North Carolina and Wisconsin began the current recession with fully funded pension systems, while eight states have left more than one-third of their pension liability unfunded.

Illinois was rated the most troubled pension system during the study period, with a 54 percent funding level and a total liability of more than $54 billion.

In Pennsylvania, a series of decisions by the Legislature and governor have shielded taxpayers from much of the pain for the past decade, but costs of less than $1 billion a year now is projected to climb to about $6 billion annually in the coming three years.

The report said policy makers have exacerbated the problem by expanding benefits, relying on overly optimistic assumptions about investment returns and failing to sufficient fund the programs.

"Even though the actuaries tell the states what they should be doing, the states feel free to ignore that," said Olivia Mitchell, director of the Pension Research Council at the University of Pennsylvania's Wharton School. "So putting some teeth behind the requirements is really the problem."

Pew calculated a $587 billion national cost for current and future retiree health care and other nonpension retirement benefits, with only about 5 percent of that amount funded as of 2008. The cost of health care and the number of retirees are both on the rise, adding to the pressure on states.

The study found that 15 states made some legislative changes to their state-run systems last year, 12 did so in 2008 and 11 in 2007. About a third of states had formal efforts to study potential reforms under way last year.

"Pension plans work when they are allowed to work, and part of that dynamic is that sometimes adjustments have to be made," said Keith Brainard, research director with the National Association of State Retirement Administrators. "It's important not to take away decent retirement benefits for some of the few people that have them."

Pew said states should consider changes that have proven to be effective and politically viable. Among them: setting minimum contribution levels that are actuarially sound, sharing some of the investment risk with employees, cutting benefits, increasing the minimum retirement age, making employees pay more into the system and providing more robust oversight and investment rules.

Mitchell said many states have constitutional prohibitions against lowering employee pension benefits, but health care programs can more easily be altered.

State and local plans take on increasing risk

A variety of stakeholders, such as boards of trustees and external consultants and managers, are involved in guiding plan investments. Plan officials generally expressed a commitment to policies or principles cited by many experts as key to sound governance, such as enhancing the knowledge and skills of plan fiduciaries and increasing organizational transparency.

State and local plans reported gradually changing their asset portfolios over many years by increasing their allocations in higher risk investments partly in pursuit of higher returns but also for diversification following well-accepted techniques of portfolio management given their long investment horizon.

Indeed, currently about two thirds of public pension funds are invested in such higher risk assets. Plan officials stated they are focused on the long term and generally reported they had not made any major changes to their investment strategies in response to the market downturn, in which they lost nearly a quarter of their asset value from June to December 2008.

Despite these losses, plans have reported having sufficient assets to cover years of benefit payments. Still, according to our survey, an estimated 60 percent of large and medium plans anticipate changes to their investment strategies in response to the current economic environment.

Plans have devised various approaches to attempt to address governance, investment, and funding challenges. These include pooling assets to pursue lower fees and higher quality managers, consolidating the governance structures of multiple plans to improve accountability and transparency, and issuing pension obligation bonds to overcome funding shortfalls.

While some of these approaches predate the market downturn, their impact on plan health remains to be seen. Still, efforts at increasing disclosure may be helping plan stakeholders understand the considerable challenges they face.

New Jersey settles SEC fraud claims over $26B in bonds

New Jersey settled claims that it misled investors in $26 billion of municipal bonds by masking underfunding of its two biggest pension plans, in the first Securities and Exchange Commission case to target a state.

Documents for 79 bond offerings from 2001 to 2007 “created the false impression” that the Teachers’ Pension and Annuity Fund and the Public Employees’ Retirement System were adequately funded, hiding that the state couldn’t make contributions without raising taxes or cutting services, the SEC said in a statement today.

“This is an area of concern,” Elaine Greenberg, head of the SEC’s municipal securities and public pension fund unit, said today in a telephone interview. “We hope to alert other states and municipalities of their disclosure obligations under the federal securities laws as it pertains specifically to their pension fund liabilities.”

The suit marks the first time the SEC has sued a state for violating federal securities laws and marks an early salvo in the agency’s plan to crack down on fraudulent practices in the $2.8 trillion municipal bond market.

Pension obligation bonds allow financial markets speculation

"...States and cities have also used muni debt to play dangerous games in the stock and bond markets. A particularly potent weapon in the politicians' debt arsenal is the so-called pension-obligation bond, the municipal equivalent of borrowing money on your credit card to make contributions to your IRA. Oakland issued the first pension-obligation bonds, which were tax-free, in 1985, and invested the proceeds in taxable securities, which paid the city a higher interest rate than it had to pay on the bonds. Oakland then banked the difference in its pension fund for city workers. The move proved too slick for Washington, however, which eliminated pension-obligation bonds' tax-free status in the Tax Reform Act of 1986.

But that didn't end their use. During the early 1990s, governments started playing a risky arbitrage game in which they issued bonds and then invested the money in the stock market, hoping that the market would outperform the bonds. For a while, the strategy worked: the market was rebounding from the 1989–90 recession, and returns were good. But over the long term, it proved impossible for the stock market to keep up with the returns that the pension bonds were offering. As the Center for State and Local Government Excellence noted in a report earlier this year, most pension bonds issued since 1992 have been money losers for states and cities.

Take New Jersey, whose fall into fiscal chaos has been accelerated by pension bonds. During the mid-1990s, the pension system for state and local employees needed shoring up because the previous governor had overvalued the system's assets. Governor Christine Todd Whitman took the easy way out, deciding to finance the state's payments into the system by taking the proceeds from a pension-bond sale and investing them in the stock market. The market was near its peak; since then, of course, it has endured a decade of essentially zero growth. So Jersey's returns were dismal: the state now has so little cash that it has been skipping its payments into the pension system. Now, to add insult to injury, it must start paying back the bonds that it issued. Some actuaries say that the state's pension system will either go bankrupt in the next several years—testing the limits of guaranteed public-employee pensions—or need a federal bailout. "These pension funds are often run for a political rate of return to keep the pension benefits high and put off the costs," says Rick Dreyfuss, an actuary and a fellow at the Commonwealth Foundation in Harrisburg, Pennsylvania. "It's a recipe for disaster."

Or look at Oregon. Seven years ago, officials there began to push for a change in the state's constitution to let its pension funds issue bonds, saying that it would save millions of dollars. The Statesman Journal in Salem called the idea "a no-brainer," while the Oregonian claimed that it constituted "state government acting prudently, like a business." The measure passed, and Oregon municipalities loaded up with billions in pension debt, which they invested in the market—often using risky investment strategies in an attempt to beat what the bonds paid out in interest. That approach proved ruinous during the financial crisis. In 2008, Oregon pension funds lost 27 percent of their value, the largest decline in the state's history. Oregon taxpayers are now staring at a $1.2 billion hike in the state's contributions to the pension system. "That could force school districts, cities and counties to lay off workers or cut services as they struggle to pay higher pension contributions," the Oregonian noted, conveniently omitting its earlier support for the bonds.

Pension obligation bonds put Denver deeper in debt

In the spring of 2008, the Denver public school system needed to plug a $400 million hole in its pension fund. Bankers at JPMorgan Chase offered what seemed to be a perfect solution.

The bankers said that the school system could raise $750 million in an exotic transaction that would eliminate the pension gap and save tens of millions of dollars annually in debt costs — money that could be plowed back into Denver’s classrooms, starved in recent years for funds.

To members of the Denver Board of Education, it sounded ideal. It was complex, involving several different financial institutions and transactions. But Michael F. Bennet, now a United States senator from Colorado who was superintendent of the school system at the time, and Thomas Boasberg, then the system’s chief operating officer, persuaded the seven-person board of the deal’s advantages, according to interviews with its members.

Rather than issue a plain-vanilla bond with a fixed interest rate, Denver followed its bankers’ suggestions and issued so-called pension certificates with a derivative attached; the debt carried a lower rate but it could also fluctuate if economic conditions changed.

The Denver schools essentially made the same choice some homeowners make: opting for a variable-rate mortgage that offered lower monthly payments, with the risk that they could rise, instead of a conventional, fixed-rate mortgage that offered larger, but unchanging, monthly payments.

The Denver school board unanimously approved the JPMorgan deal and it closed in April 2008, just weeks after a major investment bank, Bear Stearns, failed. In short order, the transaction went awry because of stress in the credit markets, problems with the bond insurer and plummeting interest rates.

Since it struck the deal, the school system has paid $115 million in interest and other fees, at least $25 million more than it originally anticipated.

To avoid mounting expenses, the Denver schools are looking to renegotiate the deal. But to unwind it all, the schools would have to pay the banks $81 million in termination fees, or about 19 percent of its $420 million payroll.


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