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You say tomato…
More bad news for Puerto Rico. On Feb. 6, a U.S. District Court judge rejected a law that would have allowed some of the territory’s public corporations to restructure their debt in a bankruptcy-like process. (Like states, the territory can’t file for Chapter 9 bankruptcy.) The law would have allowed Puerto Rico to unilaterally eliminate or greatly reduce the rights of its creditors. Interestingly, the reactions to the development by Moody’s Investors Service and Standard & Poor’s show the different approach these agencies are taking to the issue.
Earlier this week, Moody’s said the law’s rejection did not affect its current rating of B2. After the governor signed the law, Moody’s downgraded the territory in July 2014, saying that the law had negative implications for Puerto Rico’s credit standing because it marked the “end of the central government’s willingness to take steps to ensure payment on the debt of public corporations.” And as the island’s credit pressures have only worsened since then, and such pressures can still lead to bondholder losses, Moody’s said, the law’s repeal doesn’t change its view.
For Standard & Poor’s, the development was enough to warrant a change – but its decision was based on the government’s ability to restructure its debt, not on bondholders. S&P on Feb. 12 issued a three-notch downgrade to Puerto Rico, bringing its rating in line with the Moody’s rating. But S&P reasoned that the territory's "current economic and financial trajectory [makes it] now more susceptible to adverse financial, economic, and market conditions that could ultimately impair the commonwealth's ability to fund services and its debt commitments.”
Improving the mood
Moody’s had some news of its own to announce this week. For the first time since 2008, the agency’s credit rating upgrades outpaced downgrades. (At S&P, upgrades have long outpaced downgrades.) At Moody's the final three months of 2014 saw 91 public finance upgrades on $16.8 billion of debt, compared with 87 downgrades affecting $7.6 billion of debt. Health care, housing, states, and infrastructure all saw upgrades outpace downgrades, the agency said.
The year as a whole still had more public finance downgrades (564) than upgrades (360). Still, Moody’s said the gap between downgrades and upgrades narrowed for the second consecutive year, and the percentage of downgrades decreased in three of four quarters last year. Moody’s attributed its growing share of upgrades to continued economic and financial stabilization across most public finance sectors and expects the trend to continue in 2015.
The elusive pension cure-all
A new study by the National Institute on Retirement Security provided a good reminder that the 401(k)-style retirement plans that some governments have established for new employees are not a cure-all for the unfunded pension liabilities those governments have. Governments that close off their pension plans to new employees will still have huge liabilities for the employees under the old plan, a situation made worse when there’s a market downturn and they have to pay out more money from the fund in benefits than their dwindling employee members are putting in.
Even if plans are fully funded when they’re closed, things can turn sour. Michigan closed its defined benefit plan to new hires back in 1997. The plan was actually overfunded at the time – it had slightly more money in it than it needed to pay all the benefits it had promised to those employees. But by 2012, the plan’s funded status had dropped to about 60 percent while retirement security for defined contribution plan participants had decreased, the NIRS report said.
The report found similar losses in West Virginia and Alaska. Two very important factors are at play. For one, the 2008 stock market crash wiped out nearly a third of most plans’ assets. Michigan’s assets still have not recovered from the recession. That’s partly due to another other factor: Michigan had not been putting in its full contribution to during those years. The state is now trying to fix the problem and in 2013 put in 99 percent of the recommended contribution.
Still, the report correctly noted that there is less retirement security for those in a 401(k)-style plan. Of course, that’s the financial benefit for governments – they pay a set benefit now and thus eliminate the risk that they will have to pay more later. The risk is transferred over to the employee.
In Washington, hybrid plans potentially offer a balance. A paper by the University of Washington’s Center for Education Data & Research on the state's teacher pension system indicated that the state’s financial exposure is significantly lower under a hybrid plan becuase its per-teacher pension liability is approximately half as large as under its traditional plan. And, when given a choice, at least six in 10 teachers (statistics vary by year) choose the hybrid plan.