Governments are so easily able to manipulate and hide their looming pension liabilities in the current reporting system that it’s tantamount to a crime, one finance expert said Thursday.
Stanford University Finance Professor Joshua Rauh said using past investment performance to plan for future investment returns was so dangerously optimistic, it would be a jailable offense if done in the private sector. Rauh, whose comments came at a Manhattan Institute for Policy Research event in New York City on reforming pensions, is also a senior fellow at Stanford's conservative-leaning Hoover Institution. Pointing to the oft-used 7.75 percent rate of return that many pension plans project, Rauh said that means governments are planning on every dollar invested doubling roughly every 10 years.
“In the private sector, with that kind of accounting…you’d be hauled off to jail,” he said. “But in government accounting, that’s the way it works.”
Corporate pension plans, by contrast, are required to incorporate market costs into their funding scheme. As a result, the projected rates of return are more conservative, usually falling in the 3 to 4 percent range.
Traditional public pension advocates believe that the 2008 market crash – and the chunk it took out of pension funds – will smooth out over the next decade and interest rates will return to historic norms. Therefore, an investment return assumption of 7 to 8 percent is completely reasonable.
"The problem with [the market rate] argument is there isn’t significant evidence other than the short term blip during the economic crisis that there’s been that shift," Chris Hoene, executive director at the California Budget Project, recently told Governing. "It’s a speculative argument coming out of a very deep recession."
But Rauh counters that the higher assumption carries more risk. “It’s that old adage that ‘past performance is no guarantee of future performance,’” Rauh said. “But these pensions are guaranteed – they have to be paid no matter what the assets.”
In that context, the event’s panelists painted a picture of pension liabilities crushing city budgets to the breaking point. Former Los Angeles Mayor Richard Riordan went the furthest, declaring, "In the coming years we will see city after city go bankrupt,” thanks to the burdensome legacy costs. Detroit, now in the second day of its bankruptcy eligibility trial, was often cited as an example: roughly $3.5 billion (nearly 20 percent) of the city's $18 billion in debt is from pension liabilities. (On the whole, 10 cities or counties have filed for bankruptcy since 2008 and three of those cases have been dismissed while Detroit’s eligibility is pending.)
Riordan went on to add that the federal government should offer a helping hand to cities – at a price. He advocated for a bailout fund that struggling cities and states could be eligible for as long as they stuck to “realistic accounting measures.” Requirements should also include moving new employees into a 401(k)-style plan instead of a guaranteed payment plan, he said.
“The president can’t stand there and watch his country go to waste and not do something about it,” Riordan said.
But those who want to keep public pensions unchanged labeled such comments as an attempt to undermine public pensions altogether. "Instead of using fear and blame to eliminate public pensions, the Manhattan Institute should focus on fiscally-responsible policies," said Jordan Marks, executive director of the National Public Pension Coalition.