Friday, April 06, 2018

COTW: Pension Problem Gets Worse

State and local governments are deep in the red due to pension liabilities. In fact, derivative financing (credit rate swaps) of generous pension obligations was a key factor of the Detroit bankruptcy. Total unfunded liabilities in state and local pensions have roughly quintupled in the last decade according to John Mauldin writing at Market This chart shows the growth in pension debt:

Few governments have their pension programs fully funded--approximately 15%. Most rely on debt financing of one form or another. Kentucky for example has unfunded pension liabilities of $40 billion or more. Consequently, the costs of funding is extremely sensitive to changes in the discount rate. The chart shows that when the Fed took the discount rate to near zero to recover from the "Great Recession" of 2008, the cost of funding future pension payments went drastically up. Some pension programs were overly generous, declaring returns in excess of 6-7%.

The graph shows almost $2 trillion in liabilities if the expected rate of return is 7% (about average for pension funds). If that is recalculated at a more realistic 4%, then future unfunded liabilities up to $4 trillion. If there is another recession or even a depression and the stock market collapses by a historically average 40%, then future pension liabilities hit an unsustainable $7-8 trillion, or more than 3 times the tax revenue collected today by states and municipalities. The result: multiple bankruptcies on the scale of Detroit. Tell that to the police, firemen, and teachers banking on their retirement funds.