For previous editions of The Week in Public Finance column, click here.
401(k)s Aren’t Always Inferior?
New research by the Center for Retirement Research has found that people end up setting aside less of their salaries for retirement savings in 401(k)-style plans than they would for traditional pension plans. But there’s an interesting wrinkle here. When looking at returns on such investments, the report found that the annual change in pension wealth appears to have remained relatively steady. “In short, the data suggest that people are not accumulating less as the result of the shift from defined benefit to defined contribution plans,” the researchers wrote in the Sept. 22 report. “What has changed is not the amount of saving going on, but rather who is bearing the risk.”
The research looks at private-sector plans. In the early 1980s, many companies began switching to 401(k) plans so there is a plethora of data now available on the difference between the two types of plans. In the public sector, most conversions to 401(k)-style plans (and there are still relatively few) have just been in the past decade.
The conclusion of the report represents a blow to those who say that traditional, defined contribution plans offer less retirement security than traditional pensions. “We are going to have to change our story!” the authors wrote in their conclusion. Between 1984 and 2012, the annual change in pension wealth has increased by about 14 percent of wages and salaries, even as most plans have shifted to 401(k)s. Still, they noted, shifting the investment performance risk from the employer to the employee can hurt retirees’ savings. But the real effect of that “can be identified only by looking at data on individuals as opposed to those from our national accounts,” they concluded.
Down on Local Governments
Earlier this year, public finance credit rating upgrades finally outnumbered downgrades for the first time in more than five years. But now it looks like that good news of the first three months of the year may just be a blip on the radar. Public finance downgrades once again surpassed upgrades in the second quarter of 2015. Credit analyst Tom Kozlik noted recently that “these perpetual downgrades suggest to us that there is something more than just stress from the Great Recession ailing many public finance issuers.” The latest data showed 149 public finance sector downgrades from April through June -- a number Kozlik said “is disturbingly in-line with the average number of downgrades that occurred just after the Great Recession.”
Nearly three-quarters of those downgrades were in local governments and of those, many were concentrated in Michigan (14), New Jersey (8), Ohio (11) and Pennsylvania (10). The most local government downgrades occurred in Illinois (17).
The leading cause of fiscal stress is a structurally unbalanced budget as many local governments still have not adjusted to a fiscal reality, wrote Kozlik in his analysis for PNC Bank. That is that state government aid is lower, and the increase in local government expenditures is faster than the rise in revenues generated by the economic recovery. He singled out pension funding as a key component of government expenditures, noting that the cost to fund these long-term commitments will continue to crowd out other expenses -- namely taxpayer services. Kozlik believes “not enough pension reform occurred in the wake of the Great Recession.” And he questioned whether the funds, which on average have about 74 cents of every $1 they have promised to pay retirees, are healthy enough to withstand another downturn.
Don’t Understand P3s? You’re Not Alone.
Moody’s Investors Service has taken it upon itself to issue an FAQ this week about public-private partnerships (P3s). In its report, the rating agency predicted state and local governments will continue to expand P3 projects beyond transportation to include housing, higher education and water and sewer systems. Moody’s summarizes how P3s are executed in other parts of the world where they are much more prolific than in the U.S. where we have a tax-free municipal bond market that drives most infrastructure financing. China, for example, is seeking to actually replace its current public infrastructure financing with P3s. Latin America is also ramping up P3s with pipeline projects in Brazil and Mexico and sanitation, hospital and water treatment projects elsewhere. And in mature P3 markets like Canada and the United Kingdom, governments pick such projects based on whether such financing structures they would generate value for the money they cost.
Governments like P3s because they attract private investment in public infrastructure and they can share the risk of taking on the project with the private sector. This can -- but does not always -- lead to faster project delivery and lower total costs. Moody’s assigns credit ratings to P3s and most are in the investment-grade category, largely because of that risk sharing feature. Any P3 rating downgrades are usually driven by refinancing risk, tax-related risks and weakening credit quality among one of the parties. Lower-than-forecasted revenue performance is also a credit risk.