One good side effect of the Detroit bankruptcy is that it has caused more attention gradually to be paid to the pension situation in other states and localities. Pensions (and, to some degree, health care benefits) are the place where politicians have taken on literally trillions of dollars of debt while never reporting the numbers to the voters and hiding the debt deeply off-balance-sheet. Will New York pay attention before it is too late?
The front page of today's New York Times contains a lengthy report on Chicago's pension troubles, headlined "Chicago Sees Pension Crisis Drawing Near."
The pension fund for retired Chicago teachers stands at risk of collapse. The city’s four funds for other retired city workers are short by $19.5 billion. At least one of the funds is in peril of running out of money in less than a decade.
An accompanying chart shows that Chicago's contributions to its various employee pension funds, about $600 million in the current year, are set to go to about $1.1 billion next year, $1.6 billion the following year, and then steady increases to about $2 billion by 2020. That's pretty steep! One consequence: Last month Moody's Investors Service downgraded Chicago's rating by an unexpected three notches.
Chicago's somewhat unique problem is the degree to which its politicians have simply avoided funding the pension promises they have made. The Times says that Chicago's pensions are only 36% funded by its own reports -- and remember, those reports use crazy-optimistic interest rate assumptions. As a rule of thumb, take whatever funding ratio they give you and cut it about in half. On real assumptions, Chicago's plans are maybe 20% funded. It's about time this started getting the attention it deserves.
In my estimation, Chicago has about a 50/50 chance of avoiding a Detroit-like death spiral. They are already at the point where the problem cannot be fixed by tax increases, because those would gradually accelerate the population shrinkage until there was no one left to pay the bill. Of course, this takes decades to play out.
And how about New York? The problem is not really any less than in Chicago, but is so far getting much less attention. There is one significant difference: under Mayor Bloomberg and state law, New York has made the pension contributions that the actuaries said to make. The result is that New York City's pensions are much better funded than Chicago's. But unfortunately, that is not saying a lot. As I reported here back in March, New York City has long used an 8% discount rate to value its pension obligations, and with that rate showed funding ratios averaging about 70% as recently as 2011. In 2012 the actuary did a recalculation at 7%, and the ratios dropped down to around 60%, and only 48.2% for the Fire Department fund. Try that at 5%. I estimated a funding ratio averaging about 40% and a funding gap of about $150 - $200 billion.
So how much is New York already paying per year for the pensions? It's $8 billion. To put that in perspective, we have about three times the population of Chicago, so even when they get to their $2 billion per year in 2020, they won't have caught up to us in per capita expense.
And our $8 billion is also set to soar further. Here's the way to think about it. You can estimate from the allowed retirement age how much pension expense will be relative to expense for active employees. People who have lived long enough to have a working career are going to have a life expectancy around 85. If they can retire at 65, you are going to have over 2 active employees per retiree (average 40 years working and 20 retired). But if you can retire at 45, you are going to reverse that, and have 2 retirees per active employee. That is the situation for New York police and fire. Teachers and transit workers can retire at 55, meaning about a 1 to 1 ratio (30 years working and 30 retired).
If you commit to paying as many retirees as active employees, or worse, twice as many, it doesn't really matter how well you have funded your pension obligations so far. Sorry, this is not sustainable. The stock market cannot possibly bail you out.
Mayor Bloomberg, to his credit, is on to this one. Yesterday he gave a substantial speech on the topic. Funny, I can't find any mention of it in the Times, but here at Bloomberg News we have a long report. (I guess it helps to have your own news service!) Headline: "NYC's Good Times May Sour Like Detroit's, Bloomberg Warns."
Pension benefits for city retirees have risen to $8 billion a year from $1.4 billion in 2002, when he first took office, Bloomberg said. Health insurance, free to most municipal workers, has almost doubled to $6.3 billion, he added.
Gains from a rising stock market won't increase pension assets enough to offset higher taxpayer costs, the mayor said.
"Just as the financial collapse had only a small impact on our pension bill, as the market improves, it will not solve the problem," he said. "The idea that our costs can be substantially reduced through increased market returns is a fantasy."
The article then goes through the positions of the various candidates for mayor on the pension issues. The summary: they refuse to say anything. The two leading Democratic candidates are Quinn and Thompson. Those two "have declined to discuss [union] contract issues." The two lesser candidates, de Blasio and Liu, have even said that they might allow retro-active pay increases. And how about the unions? "Michael Mulgrew, president of the 200,000-member United Federation of Teachers, rejected Bloomberg's
arguments and characterized the speech as self-serving." Not clear to me what is "self-serving" about this from Bloomberg's perspective. Maybe Mulgrew is expecting him to personally pay for the teachers' pensions?
Well, maybe when one of Chicago's funds runs out of money and stops paying the pensions this will finally become a big issue in New York.