The Week in Public Finance: Contradictory Pension Reports, Brewing Pension Battles and Recession Worries

A roundup of money (and other) news governments can use.
by | February 12, 2016

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Contradictory Pension Reports

Two groups published studies this week looking at whether traditional pensions or 401(k) plans are better for teachers and came up with … exactly opposite conclusions.The University of California at Berkeley looked at the state’s teacher pension system (CalSTRS) and found that for the “vast majority” of California teachers (six out of seven), a defined-benefit pension provides more secure retirement income than a 401(k)-style plan.

The study also concluded that pensions reduce teacher turnover, “which is better for students, reduces costly and time-consuming training, and increases teacher effectiveness.” It portrayed 401(k) and cash balance plans as bad for teachers because they place more risk on the retiree as their final benefit is not defined. Such plans also decrease the incentive for early and mid-career teachers to stay on the job, the report said.

Separately, TeacherPensions.org ran an analysis of teacher pensions in Illinois. It found that traditional pensions are not a good deal for teachers because they disproportionately favor those who stick around for 30 or 35 years, “at the expense of everyone else. The state plan assumes, and depends upon, the fact that the majority of teachers will not stay long enough to collect full benefits.” The report recommends considering other retirement plan options, such as the 401(k)-type plan offered to full-time staff at Illinois’ state universities.

Maybe this seeming contradiction isn't that great a surprise. Consider the sources. It's worth pointing out that TeacherPensions.org produces lots of reports that spell out the shortcomings of traditional pensions, while the Berkeley study was funded by CalSTRS.

Still, one lesson worth thinking about is that no two pension plans are alike. A key difference between the plans in Illinois and California is the so-called withdrawal penalty, which occurs when a teacher quits and opts out of the retirement system before reaching retirement age.

All states let teachers withdraw at least the automatic contributions taken from their paychecks, sometimes with interest -- as is the case with California teachers. But Illinois has one of the most punitive withdrawal policies of any public retirement plan in the country. Illinois teachers who withdraw early don’t even get all their own contributions back in full. The state charges withdrawal tax, meaning they only get 89 cents back for each dollar taken out of their paychecks. No wonder the TeacherPensions.org authors conclude these pensions are a bad deal for most teachers.

Brewing Pension Battle in Puerto Rico

As Puerto Rico hurdles toward financial insolvency, a big barrier to finding a solution lies in its pension debt. The island territory has about $70 billion in debt, but that total leaps to more than $110 billion when pension liabilities are included. Puerto Rico has released a proposal to restructure its debt, but it doesn’t include cuts to pensions. That’s a big problem for bondholders who are looking at an average loss of half their investment under the island’s restructuring plan.

This week, Thomas Moers Mayer, an attorney who represents mutual funds that collectively hold about $10 billion in Puerto Rico debt, warned that bondholders will not soon forget how the government is treating them.

“Puerto Rico has needed [bondholder] investment in the past and it will need it in the future,” Mayer said at an American Enterprise Institute event in Washington, D.C. He added that anything mirroring the Chapter 9 bankruptcy results seen in Detroit and Stockton -- where pensioners fared far better than bondholders -- “could impede access to capital markets” in the future.

Recession Worries

This week did not produce rosy news for the national economy. On Wednesday and Thursday, Federal Reserve Chair Janet Yellen testified before Congress on the state of the economy. Her tone was decidedly more cautious than it was in December, when the Fed raised short-term interest rates for the first time in a decade.

Notably, she said the board had not ruled out so-called negative interest rates, which some European governments are experimenting with as a way to stimulate growth. And she gave no indication of whether the Fed would step up U.S. rates again in March as part of its broader goal of raising interest rates more than 1 percentage point by next year.

What Yellen did say, with carefully chosen wording, was that financial conditions in the United States “have recently become less supportive of growth.” One big reason is falling equity prices. Another is that the strengthening dollar, while making things cheaper for American consumers,  has hurt U.S. exports. “These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market,” said Yellen.

Still, she predicted that employment gains and faster wage growth “should support the growth of real incomes and therefore consumer spending, and global economic growth should pick up over time.”

Contemplating a possible slowdown, even as many feel the Great Recession is still lingering, is sobering. But Guy LeBas, an analyst for the Janney Montgomery Scott firm, offered this gentle reminder this week in his municipal market outlook: The Great Recession was especially severe and it followed an unusually long period of expansion.

That’s “blinded us to a surprising reality,” LeBas wrote. “Most economic downturns in the U.S. are relatively short-lived and not especially severe. While extreme contractions do occur, they’re the exception, not the rule.”