The Truth Behind the Public Pensions’ Funding Gap

Jack Rasmus

It’s not work­ers’ fault

State gov­er­nors across the nation, led by new­ly elect­ed right-wing Repub­li­cans (with sev­er­al Demo­c­ra­t­ic gov­er­nors in tow), are whip­ping up anti-union sen­ti­ment by declar­ing that pub­lic work­ers and their unions are the cause of state bud­get deficits. They argue that var­i­ous labor costs are dri­ving up their deficits, and that the lead cause of those labor costs is over­ly gen­er­ous increas­es pub­lic employ­ee pen­sion ben­e­fits.

But increas­es in pub­lic employ­ee pen­sion ben­e­fits are not the cause of the states’ bud­get crises. There are, indeed, seri­ous pen­sion fund­ing gaps in many states’ pub­lic pen­sion plans. But a close inves­ti­ga­tion of these gaps clear­ly shows that they do not exist because of states’ grant­i­ng pub­lic employ­ees exor­bi­tant pen­sion ben­e­fits.

The real rea­sons behind the pen­sion fund­ing gap are sev­er­al. First, the cur­rent job­less recov­ery’ since the 2007-09 reces­sion has reduced con­tri­bu­tions to pen­sion fund bal­ances. Cur­rent esti­mates are that it will take 84 – 96 months, or 7 to 8 years, for job cre­ation to recov­er to 2007 lev­els. That means a pro­ject­ed larg­er pen­sion gap.

But there’s an even greater rea­son why pen­sion funds have end­ed up short of income today. It’s the prac­tice of con­tri­bu­tion hol­i­days’; that is, pen­sion man­agers refus­ing to put the nec­es­sary con­tri­bu­tions into the funds — a prac­tice in the pub­lic sec­tor that has been going on since the mid-1990s and even before that in the pri­vate sector.

Con­tri­bu­tion hol­i­days in turn were made pos­si­ble by fund man­agers employ­ing fraud­u­lent actu­ar­i­al assump­tions about rates of return on fund invest­ments and, sec­ond­ly, by assum­ing they would hire large num­bers of younger work­ers when, in fact, that hir­ing nev­er occurred.

Both gim­micks allow a pen­sion fund to appear ade­quate­ly fund­ed when in fact it isn’t. They per­mit fund man­agers to main­tain that the pen­sion has more income and few­er lia­bil­i­ties than it in fact actu­al­ly has.

The result of con­tri­bu­tion hol­i­days and fraud­u­lent actu­ar­i­al assump­tions in the pri­vate sec­tor con­tributed sig­nif­i­cant­ly to the col­lapse of many pri­vate pen­sion funds since the 1980s and their replace­ment with 401k pen­sion con­tri­bu­tion plans. What’s start­ing in the pub­lic sec­tor today is mere­ly a repeat of what hap­pened already in the pri­vate sec­tor. The goal, once again, is to replace real defined ben­e­fit pen­sions of pub­lic work­ers with near­ly worth­less 401k plans. What CEOs have been doing in the pri­vate sec­tor for three decades, gov­er­nors are now attempt­ing to do as well.

In the 1980s, there were more than 100,000 defined ben­e­fit pen­sion plans in the pri­vate sec­tor. Today there are around 28,000. The rest were dis­solved or con­vert­ed to 401k plans or hybrid ver­sions called cash bal­ance plans.’ That is, they were in effect trans­formed into 401ks and thus pri­va­tized.’

The typ­i­cal con­ver­sion result­ed in a pay­off to employ­ees to trans­fer to a 401k that was bare­ly half what they would have received in total ben­e­fits from their pri­or defined ben­e­fit pen­sion. Today the aver­age bal­ance in a 401k is about $18,000. That’s all to fund an entire retire­ment peri­od! The gov­er­nors now want to do the same, to com­plete the shift to 401ks and pri­va­ti­za­tion of the pen­sions in the pub­lic sec­tor much like that already achieved in the pri­vate sector.

Fund man­agers’ holidays

But beyond the reces­sion and weak job cre­ation, con­tri­bu­tion hol­i­days and actu­ar­i­al fraud, there are addi­tion­al caus­es of under-fund­ed pub­lic pensions.

The pen­sion fund­ing gap has also been mag­ni­fied sev­er­al fold since 2006 as a con­se­quence of pub­lic employ­ee pen­sion fund man­agers’ gam­bling on risky spec­u­la­tive invest­ments. Pri­or to 2006 and the pas­sage of the so-called Pen­sion Pro­tec­tion Act, pub­lic pen­sion fund man­agers weren’t allowed to part­ner with hedge funds and oth­er high-risk finan­cial insti­tu­tions in high-risk investments.

Since that leg­is­la­tion was passed, it has become a wide­spread and com­mon prac­tice. After the Pen­sion Act of 2006, pen­sion funds were per­mit­ted to make loans to hedge funds and pri­vate equi­ty firms, as well to plunge direct­ly them­selves into spec­u­lat­ing in sub­prime mort­gages and finan­cial deriv­a­tives of all kinds. The 2006 Pen­sion Act also per­mit­ted still fur­ther con­tri­bu­tion hol­i­days’.

The result has been that since 2006 all pen­sion funds have incurred great loss­es as a con­se­quence spec­u­la­tive invest­ing. These loss­es have added sig­nif­i­cant­ly to the pen­sion fund­ing gap in the pub­lic sec­tor. It is esti­mat­ed that pub­lic pen­sion funds lost around 25%-30% of their total asset val­ue in 2008 – 2010 as a result of their for­ay after 2006 into spec­u­la­tive invest­ing in risky assets like sub­primes, deriv­a­tives, for­eign exchange, and the like. 

Still, most pen­sion funds are con­sid­ered ade­quate­ly fund­ed and are thus AAA qual­i­ty if they are 85% fund­ed. A loss of 30% means a fund­ing drop to around 50% fund­ed, as is the case of some of the worst’ fund­ed state pen­sions like Illi­nois’ state pen­sion fund. But a fund­ing fall of 30% is, on aver­age, about the fund­ing gap attrib­ut­able to the recent reces­sion and spec­u­la­tive excess­es of fund managers.

Is Illi­nois’ worst case’ fund­ing gap there­fore sole­ly the cause of these non-employ­ee fac­tors? It appears so. If Illi­nois is typ­i­cal, then it may be that much of the cur­rent fund­ing gap is due to invest­ment loss­es — not due to pub­lic employ­ees pen­sion ben­e­fit hikes.

Still anoth­er pos­si­ble cause is esca­lat­ing health­care costs. It is a well known fact that fed­er­al tax law allows busi­ness­es to take mon­ey from their pen­sion funds to cov­er costs in their health ben­e­fit plans. While states don’t pay tax­es to the fed­er­al gov­ern­ment, could the same diver­sion of funds in the pub­lic sec­tor explain part of the pen­sion fund­ing gap? It would at least war­rant an inves­ti­ga­tion.

Local gov­ern­ment (city) employ­ees pen­sions were espe­cial­ly hard hit by invest­ments in over the counter deriv­a­tives’ inter­est rate swaps, which banks and oth­er finan­cial insti­tu­tions talked them into in the run-up to the 2007-08 finan­cial col­lapse. Their pen­sion fund­ing gap’ con­se­quent­ly grew even fur­ther as the pen­sion funds expe­ri­enced major invest­ment loss­es.

It is clear, there­fore, that the pen­sion fund­ing gap is not the con­se­quence of esca­lat­ing pen­sion ben­e­fits of the aver­age or even bot­tom 90% of the pub­lic employ­ee labor force — but is ulti­mate­ly caused by the banks, by bad invest­ments by pub­lic pen­sion funds man­agers, by fraud­u­lent account­ing prac­tices, by fund man­agers’ fail­ure to make appro­pri­ate con­tri­bu­tions to the plans, by reces­sions, by diver­sion of funds to cov­er ris­ing health costs, and by past Con­gress­es and pres­i­dents per­mit­ting pen­sion funds to gam­ble and spec­u­late with work­ers’ retire­ment incomes.

There­fore a detailed inves­ti­ga­tion state by state should be under­tak­en to deter­mine exact­ly how much these pre­ced­ing non-employ­ee caus­es have been respon­si­ble for each state’s pen­sion fund­ing gap.

Yet state gov­er­nors, led by Repub­li­cans, are instead dri­ving ahead and plac­ing the blame on pub­lic employ­ees and mak­ing them pay for the gap in pen­sions with their wages, jobs, and health­care ben­e­fits. Their goal is con­vert­ing state defined ben­e­fit pen­sion plans to 401k plans and so-called cash bal­ance plans’ that are a pre­lim­i­nary to 401ks.

This con­ver­sion will lead in the pub­lic sec­tor, as it did in the pri­vate before, to elim­i­nat­ing at least half of what pub­lic employ­ees would have received in pen­sion ben­e­fits. It will lead to the destruc­tion of retire­ment secu­ri­ty among work­ers in the pub­lic sec­tor, just as it had pre­vi­ous­ly among work­ers in the pri­vate.

Why should pub­lic work­ers’ pen­sion ben­e­fits be reduced to resolve the fund­ing gap when they aren’t the fun­da­men­tal cause of it in the first place? Why not make those who cre­at­ed the pen­sion fund­ing gap pay — the hedge funds, banks, insur­ance com­pa­nies, and oth­er finan­cial insti­tu­tions that were respon­si­ble for the mas­sive invest­ment loss­es and the pen­sion fund man­agers who neg­li­gent­ly risked work­ers’ pen­sions? Or the politi­cians who let them?

Mak­ing the real per­pe­tra­tors pay for the fund­ing gap will take time, crit­ics say, and the fund­ing gap is now. True. But why not, in the short run, tem­porar­i­ly sta­bi­lize pub­lic employ­ee pen­sions (and thus a good part of states’ bud­get deficits) by sim­ply mak­ing the Fed­er­al Reserve pro­vide direct loans to the pen­sion funds at the same cost of 0.25% that the Fed has pro­vid­ed loans to oth­er finan­cial insti­tu­tions the past two years? After all, pen­sion funds are also finan­cial insti­tu­tions. And Fed loans won’t add a cent to the fed­er­al or state bud­get deficits as an added plus.

It should not be for­got­ten that the same Fed­er­al Reserve pro­vid­ed $9 tril­lion to banks dur­ing the recent cri­sis — of which $1 tril­lion was loaned to for­eign non-US banks! If the Fed can loan $1 tril­lion to for­eign bankers and their wealthy bond­hold­ers and investors, why can’t it do so to pro­tect the retire­ment of mil­lions of U.S. work­ers in the pub­lic sec­tor — who are the vic­tims, not the crim­i­nals respon­si­ble for the pub­lic pen­sions cri­sis.

Jack Ras­mus is the author of EPIC RECES­SION: PRE­LUDE TO GLOB­AL DEPRES­SION, Plu­to Press, May 2010, and the forth­com­ing OBAMA’s ECON­O­MY: RECOV­ERY FOR THE FEW, Plu­to Press, 2011. His web­site is: www​.kyk​lospro​duc​tions​.com

Jack Ras­mus, pro­fes­sor of eco­nom­ics and polit­i­cal econ­o­my at San­ta Clara Uni­ver­si­ty and St. Marys Col­lege, is author of Epic Reces­sion: Pre­lude to Glob­al Depres­sion, and The War at Home: The Cor­po­rate Offen­sive From Ronald Rea­gan to George W. Bush. His forth­com­ing book (2011) is Obama’s Econ­o­my: Why Recov­ery Failed. What’s Next? Ras­mus has pub­lished numer­ous arti­cles in Z mag­a­zine, Cri­tique, Amand­la, Against the Cur­rent, the Dis­patch­er and oth­er periodicals.
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