Pension Tsunami Is About to Hit

01/26/2009 12:01 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

One day soon you may have to decide whose retirement comes first: yours or the fireman’s? Or the policeman’s? Or your child’s schoolteacher’s?

Your city and state have made generous pension promises to all those public servants—funded with your tax dollars. Only suddenly it turns out that those pensions aren’t very well-funded, after all!

While you’ve been worried about your shrinking 40l(k), our public servants have been smiling.  They know their defined-benefits pensions are guaranteed by your local taxing body.   

And while barely 20% of private-sector employees are eligible for defined-benefit pension plans, fully 90% of state and local workers get that coverage, according to the Federal Reserve Bank of Minneapolis.

But now, because of a combination of too-high estimates on investment returns, too-low annual contributions, and the current stock market losses, those pension funds are woefully underfunded!

Many funds’ 2008 market losses won’t be revealed for months. But the Center for Retirement Research at Boston College estimates that state pension plans have losses greater than $865 billion, a decline of nearly 40% in just the past year. 

The National Bureau of Economic Research says the value of pension promises already made by US state governments will grow to approximately $7.9 trillion in just 15 years. But the same report points out that states are unlikely to be able to keep those promises: “We conservatively predict a 50% chance of aggregate underfunding greater than $750 billion and a 25% chance of at least $1.75 trillion in underfunding.”

Put in current dollars, to bring those pension funds up to appropriate levels would cost almost $2 trillion. And while the Federal government can just “print” the money, the cities and states have no such option. That means we, the taxpayers, are facing hefty local tax hikes to pay for required pension plan contributions. Or we’ll face other cuts in state and municipal spending, for safety or education or Medicaid.

The Web site www.pensiontsunami.com has been tracking these issues as they arise around the country. California is the epicenter of the crisis for now—but this is certainly a national issue.

Could the cities and states simply default on their obligations when the time comes? At a recent Federal Reserve conference, attorney James Spiotto of Chapman and Cutler in Chicago noted:  “There are varying levels of protection, ranging from strict constitutional rights to general statutory provisions, that might allow for some renegotiation of benefit levels in light of adverse conditions.”  In other words, if the cities and states try to cut back on promised benefits, they will face a huge court battle. 

Spiotto notes that since 1937, more than 564 cities have filed for Chapter 9 bankruptcy reorganization, which allows a city to renegotiate its union contracts and potentially abrogate previous pension deals. And while the federal Pension Benefit Guarantee Corporation protects at least some amount of private pension (up to $51,750 in 2008), there is no similar agency to protect public pensions.

As pension-fund losses are disclosed and the extent of the underfunding is revealed, unrest will mount. Do you think those firemen, and policemen, and teachers are going to keep working—knowing that there is a question about their pension at the end of the line? And as a taxpayer, are you willing to make up the difference?

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