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The Public Pension Black Hole
Sucked into the vortex of an undiscovered universe August 18th, 2016
Mike Newman
Beauty of pension
accounting
CalPERS has $412bn
unfunded liability or 3x
state tax revenue or
20% of GDP
Using 20yr yields as
appropriate market rate
“It’s not what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so!” – Mark Twain The beauty of pension accounting is that slight tweaks can make a large unfunded liability seemingly
disappear or at the very least shrink it to “she’ll be alright mate” levels. However if a pension fund
plays the game of understating its risks for long enough then eventually it catches up, especially if
performance is consistently poor. This is what we are starting to see in vivid colour among state and
local (S&L) governments in America. Reality is biting. Let’s jump right in.
California Dreaming
To put this in perspective the California Public Employee Retirement System (CalPERS) lost around
2% of its funds in 2015/16. The fund assumes an aggressive 7.5% return. Dr. Joe Nation of Stanford
Institute for Economic Policy Research thinks unfunded liabilities have surged to $150bn from $93bn
in the last two years. Furthermore suggesting the use of a more realistic 4% rate of return. CalPERS
has an unfunded liability of $412bn (or the equivalent of 3 years’ worth of state revenue). California
collects $138bn in taxes annually in a $2.3 trillion economy (around the size of Italy). With over-
inflated asset markets and increasingly negative returns on highly rated paper, the growth in
unfunded liabilities is even more concerning as any market correction (likely to be severe given such
blatant manipulation to date). If the correction is huge it will push the unfunded portion to even more
dizzying levels.
US Pension Tracker (USPT) defines its methodology to assess the true mark-to-market value of
unfunded liabilities versus actuarial assumptions.
“[We] reflect market pension debt using a discount rate equal to 20-year Treasury yields rounded to
the nearest one-quarter percentage point. The yield in 2014 was 3.00%. The use of this discount
rate here is intended, as most financial economists agree, to more closely represent market realities
and system liabilities.”
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20yr yields were 3% in
2014 now 1.7%
California unfunded
pension impact could
be as high as 18% of GDP
USPT assumes that public pension funds have a market based unfunded pension deficit of $4.833
trillion. The actuarial base (using a discount rate of 7.5%) of the pension deficit is approximately
$1.041 trillion. This assumes an unfunded portion of $3.8 trillion. Using the 2016 20-year US
Treasury bond yield of 1.71% the market based pension deficit explodes to over $8.8 trillion or a
$7.5 trillion unfunded portion equating to around $74,000 per American household. For California
alone this would push the pension debt per person above $135,000.
Source: Custom Products Research
The US Federal Reserve (Fed) reported in 2013 that the State of California had an official unfunded
pension liability status equivalent to 43% of state revenue. However, if marked-to-market with
realistic discount rates we estimate that it is equivalent to 300% of state revenue or 7x greater.
Going back to 2000, California had an unfunded liability less than 11% of tax collections. As a
percent of GDP it has grown from 2% to 9.7% based on official figures. If our estimate is correct,
the mark-to market reality is that California's unfunded state pension (i.e. for public servants only)
is around 18% of state GDP!
Source: US Pension Tracker
1
2
3
4
5
6
7
8
9
Fig.1: US 20 Year Treasury - Yield (%)
Now 1.71%
-30%
124%
297%
-50%
0%
50%
100%
150%
200%
250%
300%
350%
Mas
sach
use
tts
Co
lora
do
Rh
od
e Is
lan
d
Dis
tric
t o
f C
olu
mb
ia
No
rth
Dak
ota
Okl
aho
ma
Illin
ois
Min
nes
ota
Ore
gon
Oh
io
Ver
mo
nt
Ind
ian
a
Mai
ne
New
Yo
rk
No
rth
Car
olin
a
Wes
t V
irgi
nia
Haw
aii
Kan
sas
Sou
th C
aro
lina
Texa
s
Mar
ylan
d
Neb
rask
a
Mis
sou
ri
New
Jer
sey
Wis
con
sin
Uta
h
Wyo
min
g
Mis
siss
ipp
i
Ala
bam
a
Ken
tuck
y
Co
nn
ecti
cut
Ark
ansa
s
Del
awar
e
Ten
nes
see
New
Mex
ico
Mic
hig
an
Vir
gin
ia
Mo
nta
na
New
Ham
psh
ire
Geo
rgia
Iow
a
Nev
ada
Idah
o
Lou
isia
na
Pe
nn
sylv
ania
Ari
zon
a
Cal
ifo
rnia
Was
hin
gto
n
Flo
rid
a
Sou
th D
ako
ta
Ala
ska
Fig.2: 2008 vs 2014 Market Pension Debt/State Total General Tax Revenue growth rate (%)
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Impacts by state
The impact can be seen in Figs. 3-5. Gross pension debt marked-to-market at a 3% discount rate
works out at 9.6x California’s tax take and its impact on households has grown from $36,000 to
almost $78,000 between 2008 and 2014.
Source: US Pension Tracker
0.42
9.59
16.95
0
2
4
6
8
10
12
14
16
18
Dis
tric
t o
f C
olu
mb
ia
Del
awar
e
No
rth
Dak
ota
Ind
ian
a
No
rth
Car
olin
a
New
Yo
rk
Ten
nes
see
Ver
mo
nt
Neb
rask
a
Mas
sach
use
tts
Min
nes
ota
Rh
od
e Is
lan
d
Mai
ne
Wes
t V
irgi
nia
Haw
aii
Was
hin
gto
n
Uta
h
Iow
a
Idah
o
Sou
th D
ako
ta
Ark
ansa
s
Texa
s
Wis
con
sin
Ala
ska
Geo
rgia
Co
nn
ecti
cut
New
Jer
sey
Vir
gin
ia
Kan
sas
Mar
ylan
d
New
Ham
psh
ire
New
Mex
ico
Okl
aho
ma
Mo
nta
na
Oh
io
Pe
nn
sylv
ania
Flo
rid
a
Wyo
min
g
Ken
tuck
y
Lou
isia
na
Ala
bam
a
Ari
zon
a
Mis
siss
ipp
i
Sou
th C
aro
lina
Ore
gon
Mis
sou
ri
Cal
ifo
rnia
Co
lora
do
Illin
ois
Mic
hig
an
Nev
ada
Fig.3: 2014 Total Market Pension Debt/State Total General Tax Revenues (x)
$58,253
$36,159
($11,608)
($20,000)
($10,000)
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
Ala
ska
Mas
sach
use
tts
Illin
ois
Co
nn
ecti
cut
Co
lora
do
New
Jer
sey
Cal
ifo
rnia
Haw
aii
Rh
od
e Is
lan
d
Oh
io
Wyo
min
g
New
Mex
ico
Ore
gon
Nev
ada
Mar
ylan
d
Min
nes
ota
Mis
siss
ipp
i
Lou
isia
na
Okl
aho
ma
Ken
tuck
y
Ala
bam
a
Sou
th C
aro
lina
Kan
sas
Mis
sou
ri
New
Yo
rk
Pe
nn
sylv
ania
Mic
hig
an
Mo
nta
na
Wis
con
sin
Uta
h
Vir
gin
ia
Ari
zon
a
Mai
ne
Wes
t V
irgi
nia
Texa
s
New
Ham
psh
ire
Geo
rgia
Del
awar
e
Ark
ansa
s
Ver
mo
nt
No
rth
Car
olin
a
Neb
rask
a
Idah
o
Iow
a
Ind
ian
a
No
rth
Dak
ota
Was
hin
gto
n
Flo
rid
a
Dis
tric
t o
f C
olu
mb
ia
Ten
nes
see
Sou
th D
ako
ta
Fig.4: 2008 Market Pension Debt/Household (US$) by state
$113,137
$77,700
$10,822
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
Ala
ska
Illin
ois
Cal
ifo
rnia
Co
nn
ecti
cut
Haw
aii
Mas
sach
use
tts
New
Jer
sey
New
Mex
ico
Nev
ada
Ore
gon
Oh
io
Wyo
min
g
Mar
ylan
d
Mis
siss
ipp
i
Co
lora
do
Pe
nn
sylv
ania
Ken
tuck
y
Lou
isia
na
Min
nes
ota
Mo
nta
na
Rh
od
e Is
lan
d
Mic
hig
an
Ala
bam
a
New
Yo
rk
Sou
th C
aro
lina
Vir
gin
ia
Mis
sou
ri
Kan
sas
Wis
con
sin
Ari
zon
a
Geo
rgia
Was
hin
gto
n
Texa
s
Uta
h
Ark
ansa
s
Del
awar
e
Flo
rid
a
Okl
aho
ma
New
Ham
psh
ire
No
rth
Dak
ota
Wes
t V
irgi
nia
Iow
a
Mai
ne
Idah
o
Neb
rask
a
Sou
th D
ako
ta
Ver
mo
nt
No
rth
Car
olin
a
Ind
ian
a
Ten
nes
see
Dis
tric
t o
f C
olu
mb
ia
Fig.5: 2014 Market Pension Debt/Household (US$) by state
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Risks for S&L
governments
Rewind to 2008
Bloated public
salaries
Crash hits
Vallejo missed its
obligations
Actuarial balance
Pressure mounts
It wasn’t just Vallejo
The risk of S&L governments going bust could become a reality yet no one is really thinking deeply
about the path out of it. It is a nightmare for Main Street who will likely have to wear it through higher
taxes and lower payouts.
Summary of a piece from the Pacific Research Institute, ‘Going broke one city at a time’
Rewind to 2008. The municipality of Vallejo, California filed for bankruptcy. It wasn't just the evil
bankers that caused financial markets to collapse resulting in tax revenues shrivelling. Sadly, the
city of Vallejo was living high on the hog. Bloated pensions and fat cat salaries for public servants
ruled by stubborn unions created a scenario where it could not bail water fast enough when the
crash hit.
The police captain was paid over US$300,000 while his lieutenants were on c.US$250,000. The
average fire fighter took home US$170,000. The police and firefighters pay and conditions sucked
up three-quarters of the budget much more than the 55-60% of most municipalities. That $80mn
budget suddenly faced a $17mn black hole.
The city was forced to fire 40% of its 260 police officers and told its residents to be judicious with
calling 911. Crime rates soared above the state average.
Vallejo did not sort its pension obligations to CalPERS during its bankruptcy negotiations which
ended up becoming its largest budget hole by a considerable margin. Even in 2011 when the city
came out of bankruptcy the pension time bomb ticked away. Moreover, the declaration of bankruptcy
prevented access to bond financing making budget gap filling even more complicated.
Fast forward to 2016, the anaemic (and slowing) economic growth around the world is putting stress
on pension funds ability to payout retirees and fund future pensions. Pension funds set "return
targets" which actuaries calculate to ensure the fund stays solvent. However, pension funds need
to be diversified with a mixture of cash, bonds and equities. With equities reaching more outlandish
valuations and bonds moving further into negative yield territory (capital appreciating at least)
pension fund returns are undershooting. When pension funds undershoot then the unfunded
liabilities keep growing. As more baby boomers retire the more outflows are putting more pressure
on the unfunded portions.
Vallejo was small fry but the risk of more cities declaring bankruptcy in coming years is something
that isn't even on investor, national government or central bank radar screens. We are fed more of
the same tripe that all is ok and they're in control.
San Bernardino, California also filed for bankruptcy after GFC carrying $140mn in unfunded pension
liabilities including $50mn in debt it had to raise to fill the pension hole. Yes! It was borrowing money
to plug a pension hole. Sort of like buying groceries on the credit card you can't pay off.
San Jose spends 20% of its $1bn budget on healthcare and pensions given the generous offer
following 30 years’ service in police or firefighting. They net 90% of final salary every year to see
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San Bernardino
San Jose
Detroit pension & healthcare obligations 4x revenue
out their retirement. Those sweet deals are now being contested in court giving people the option
of the same deal with much higher contributions or accept a higher retirement age with a lower
payment.
Take Detroit, Michigan. It declared bankruptcy around this time three years ago. Its pension and
healthcare obligations total north of US$10bn or 4x its annual budget. Accumulated deficits are 7x
larger than collections. Dr. Wayne Winegarden of George Mason University wrote that in 2011 half
of those occupying the city's 305,000 properties didn't pay tax. Almost 80,000 were unoccupied
meaning no revenue in the door. Over the three years post the GFC Detroit's population plunged
from 1.8mn to 700,000 putting even more pressure on the shrinking tax base.
The Federal Reserve has documented the current status (latest data is 2013) on unfunded public
pension liabilities at the state and local levels versus state GDP and annual tax revenues.
Source: US Federal Reserve
(60.00)
(40.00)
(20.00)
-
20.00
40.00
60.00
80.00
Ore
gon
20
00
Co
nn
ecti
cut
200
0
Rh
od
e Is
lan
d 2
000
New
Jer
sey
200
0
Illin
ois
20
00
Wes
t V
irgi
nia
200
0
Lou
isia
na
200
0
Mas
sach
use
tts
2000
Co
lora
do
200
0
Okl
aho
ma
2000
Mis
sou
ri 2
000
New
Ham
psh
ire
200
0
Mai
ne
200
0
Geo
rgia
200
0
Haw
aii 2
000
Kan
sas
200
0
Ind
ian
a 20
00
Ala
ska
2000
Ken
tuck
y 20
00
Mo
nta
na
200
0
Nev
ada
200
0
Ver
mo
nt
200
0
Ala
bam
a 20
00
Sou
th C
aro
lina
200
0
New
Yo
rk 2
000
New
Mex
ico
200
0
Mar
ylan
d 2
000
Wyo
min
g 20
00
Mis
siss
ipp
i 200
0
Un
ited
Sta
tes
2000
Sou
th D
ako
ta 2
000
Oh
io 2
000
Flo
rid
a 2
000
Uta
h 2
000
Cal
ifo
rnia
200
0
Min
nes
ota
200
0
Neb
rask
a 2
000
No
rth
Dak
ota
200
0
Ark
ansa
s 20
00
Mic
hig
an 2
000
Was
hin
gto
n 2
000
Idah
o 2
000
Ari
zon
a 2
000
Vir
gin
ia 2
000
Pe
nn
sylv
ania
200
0
Ten
nes
see
200
0
Del
awar
e 2
000
Texa
s 20
00
No
rth
Car
olin
a 2
000
Iow
a 20
00
Dis
tric
t o
f C
olu
mb
ia 2
000
Wis
con
sin
200
0
Fig. 6: Public Pension shortfall status as % of state revenue - 2000
Shortfall
(140.00)
(120.00)
(100.00)
(80.00)
(60.00)
(40.00)
(20.00)
-
20.00
40.00
Illin
ois
20
13
Co
nn
ecti
cut
201
3
Ken
tuck
y 20
13
New
Jer
sey
201
3
Mas
sach
use
tts
2013
Ala
ska
2013
Lou
isia
na
201
3
Pe
nn
sylv
ania
201
3
Rh
od
e Is
lan
d 2
013
New
Mex
ico
201
3
Haw
aii 2
013
Nev
ada
201
3
Co
lora
do
201
3
Mis
siss
ipp
i 201
3
Oh
io 2
013
Sou
th C
aro
lina
201
3
Mis
sou
ri 2
013
Geo
rgia
201
3
Sou
th D
ako
ta 2
013
Mic
hig
an 2
013
Mar
ylan
d 2
013
Ari
zon
a 2
013
Cal
ifo
rnia
201
3
Un
ited
Sta
tes
2013
New
Ham
psh
ire
201
3
Ala
bam
a 20
13
Ver
mo
nt
201
3
Mo
nta
na
201
3
Min
nes
ota
201
3
Kan
sas
201
3
Vir
gin
ia 2
013
Okl
aho
ma
2013
New
Yo
rk 2
013
Wes
t V
irgi
nia
201
3
Mai
ne
201
3
Wyo
min
g 20
13
No
rth
Dak
ota
201
3
Ark
ansa
s 20
13
Ore
gon
20
13
Neb
rask
a 2
013
Flo
rid
a 2
013
Uta
h 2
013
Was
hin
gto
n 2
013
Ind
ian
a 20
13
Idah
o 2
013
No
rth
Car
olin
a 2
013
Iow
a 20
13
Texa
s 20
13
Del
awar
e 2
013
Ten
nes
see
201
3
Dis
tric
t o
f C
olu
mb
ia 2
013
Wis
con
sin
201
3
Fig 7: Public Pension shortfall status as % of state revenue - 2013
Only West Virginia & Oregon saw an improvement vs 2000
Shortfall
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Hard action
needed
Figs. 6-7 show the extent of the growing pension shortfalls. In order for states and local
municipalities to overcome such gaps, they must reorganise the terms. It could be a simple task of
telling retiree John Smith that his $75,000 annuity promised decades ago is now $25,000 as the
alternative could be even worse if the terms are not accepted. I doubt many Americans will accept
that hands down, leading to class actions and even more turmoil.
Source: US Federal Reserve
(30.00)
(25.00)
(20.00)
(15.00)
(10.00)
(5.00)
-
5.00
10.00
15.00
20.00
Ore
gon
20
00
Rh
od
e Is
lan
d 2
000
Wes
t V
irgi
nia
200
0
Co
nn
ecti
cut
200
0
Lou
isia
na
200
0
New
Jer
sey
200
0
Illin
ois
20
00
Mas
sach
use
tts
2000
Okl
aho
ma
2000
Co
lora
do
200
0
Mai
ne
200
0
Mis
sou
ri 2
000
New
Ham
psh
ire
200
0
Haw
aii 2
000
Geo
rgia
200
0
Kan
sas
200
0
Ala
ska
2000
Ind
ian
a 20
00
Ken
tuck
y 20
00
Mo
nta
na
200
0
Nev
ada
200
0
Ver
mo
nt
200
0
Sou
th C
aro
lina
200
0
Ala
bam
a 20
00
Mar
ylan
d 2
000
New
Yo
rk 2
000
New
Mex
ico
200
0
Un
ited
Sta
tes
2000
Mis
siss
ipp
i 200
0
Sou
th D
ako
ta 2
000
Wyo
min
g 20
00
Oh
io 2
000
Flo
rid
a 2
000
Uta
h 2
000
Cal
ifo
rnia
200
0
Min
nes
ota
200
0
Neb
rask
a 2
000
Ark
ansa
s 20
00
No
rth
Dak
ota
200
0
Mic
hig
an 2
000
Vir
gin
ia 2
000
Ari
zon
a 2
000
Was
hin
gto
n 2
000
Del
awar
e 2
000
Idah
o 2
000
Ten
nes
see
200
0
Pe
nn
sylv
ania
200
0
Dis
tric
t o
f C
olu
mb
ia 2
000
Texa
s 20
00
No
rth
Car
olin
a 2
000
Iow
a 20
00
Wis
con
sin
200
0
Fig.8: Unfunded public pension status as a % of state GDP (2000)
Shortfall
(30.00)
(25.00)
(20.00)
(15.00)
(10.00)
(5.00)
-
5.00
10.00
Illin
ois
20
13
Ala
ska
2013
Ken
tuck
y 20
13
Co
nn
ecti
cut
201
3
New
Jer
sey
201
3
Mis
siss
ipp
i 201
3
New
Mex
ico
201
3
Mas
sach
use
tts
2013
Rh
od
e Is
lan
d 2
013
Pe
nn
sylv
ania
201
3
Haw
aii 2
013
Oh
io 2
013
Lou
isia
na
201
3
Sou
th C
aro
lina
201
3
Nev
ada
201
3
Co
lora
do
201
3
Mis
sou
ri 2
013
Mic
hig
an 2
013
Cal
ifo
rnia
201
3
Ari
zon
a 2
013
Ver
mo
nt
201
3
Geo
rgia
201
3
Sou
th D
ako
ta 2
013
Mar
ylan
d 2
013
Un
ited
Sta
tes
2013
Mo
nta
na
201
3
Ala
bam
a 20
13
New
Ham
psh
ire
201
3
Min
nes
ota
201
3
Kan
sas
201
3
Wes
t V
irgi
nia
201
3
Okl
aho
ma
2013
New
Yo
rk 2
013
Mai
ne
201
3
Vir
gin
ia 2
013
Wyo
min
g 20
13
Ark
ansa
s 20
13
Ore
gon
20
13
No
rth
Dak
ota
201
3
Neb
rask
a 2
013
Flo
rid
a 2
013
Uta
h 2
013
Was
hin
gto
n 2
013
Idah
o 2
013
Ind
ian
a 20
13
No
rth
Car
olin
a 2
013
Iow
a 20
13
Ten
nes
see
201
3
Del
awar
e 2
013
Texa
s 20
13
Dis
tric
t o
f C
olu
mb
ia 2
013
Wis
con
sin
201
3
Fig.9: Unfunded public pension status as % of state GDP (2013)
Shortfall
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State of Illinois the
worst
Fed figures
Unfunded Liabilities are 100% of tax
collection
Count on yourself
The State of Illinois is the worst in the Fed study, Fig.9. The unfunded pension liability is around
24% of state GDP. In 2000 the unfunded gap to state revenue was 30% and in 2013 was 124% in
2013, Figs 6-7. Alaska is at 20% of GDP up from 0.27%.
On a gross country level, the US Fed reports that aggregated S&L unfunded pension amount of
$1.35 trillion in 2013 from $94.8bn in 2000. As a percentage of GDP it has climbed from 0.9% of
GDP to 8.19% over that same period. If the FT is right in assuming a $3.4tn (we think $3.8tn by their
reckoning) pension funding gap today then the impact should be 2.5x higher or 20% of US GDP.
Putting unfunded liabilities as a percentage of state tax collections under that scenario and we would
effectively see 100% of state budgets across America be required to close the gap. Of course the
entire gap doesn't require immediate action (because all retirees aren't happening at once) to get it
to zero. However getting it to a point where it could safely cover future liabilities on realistic returns
over the long run would still require significant injections. Such injections would crimp S&L services
causing retrenchment of staff, public services and so on.
Source: US Pension Tracker
Perhaps more alarming is that with asset prices so artificially inflated we must question the mark-
to-market pension assumptions should equity and bond markets collapse, leaving even larger
unfunded liabilities with the ensuing economic impacts crushing tax collection creating an even more
vicious circle. As Caroline Burnham said on American Beauty, "You cannot count on anyone but
yourself!"
-1
0
1
2
3
4
5
Sou
th D
ako
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Dis
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ia
Ten
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Was
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Ind
ian
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rgia
Ver
mo
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Mas
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Ore
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Oh
io
Mis
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Haw
aii
Rh
od
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Mex
ico
Mo
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Mar
ylan
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Vir
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ia
Ala
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Kan
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Ham
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ire
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Jer
sey
Ala
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Ari
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Ken
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ada
Illin
ois
Mic
hig
an
Fig. 10: Actuarial (assumes 7.5% return) Pension Debt/State Total General Tax Revenues 2014 vs 2008 (x)
2008 Actuarial Pension Debt/State Total General Fund Revenues 2014 Actuarial Pension Debt/State Total General Fund Revenues
Page 8
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Bring in the B-52s.
Helicopters
too small
This going to hurt
Summary
This study is a mere snapshot of the state of public pensions in the US. Once again we have a
festering problem that is turning gangrenous yet not enough attention is being focused on solutions.
The over reliance on authorities to get us out of this economic mess is concerning. Perhaps there
is a wish that helicopter money (as B-52 might be more appropriate) will somehow kick off inflation
and cut back into these unfunded liabilities. However, we should be careful what we wish for. The
risk of duration on the negative yielding debt would wipe out large portions of pension assets making
the journey highly challenging not to mention any hyper-inflation risks would reduce the purchasing
power of any retirees who got paid their promised distributions. Quite simply there is no easy way
out of this and whatever solution is found will involve pain. For all the kicking and screaming in the
world, the problem has festered over the past decade and many administrators have chosen not to
do anything serious about it. Brace yourselves.
.
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P a g e | 9 [email protected]
Tokyo 14/F Win Aoyama 942 2-2-15 Minamiaoyama Minato-ku, Tokyo Japan 107-0062
Office Locations
Tokyo Michael Newman
+81-80-4446-8200 [email protected]
Contacts
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