Why Public Pension Funds are Headed for Disaster

You probably know that, a few years ago, Detroit declared bankruptcy. This isn’t just a one time event. Many municipalities and states are close to insolvency in the U.S. Thanks to declining tax revenues, these governments are facing a number of problems:

• Deteriorating infrastructure that looks as if it was built 40 years ago.
• Shrinking social programs due to a lack of funding.
• Increasing poverty and crime rates.
• Debts that will probably never be paid.

In this post, I’m going to focus on the 4th problem – municipal debts that are just way too big to be paid back.

These debts were piled on by cities, towns, and sometimes even states 10, 20, 30 years ago when the economy was great. By projecting their tax revenues into the future, these governments thought that they would be able to pay back their debts no problemo.

However, they assumed wrong. Below are a few of the debts that governments are drowning in and why they can never pay them back.

Over the past half a century, municipal governments have piling on a ton of pension promises. Why?

Sometimes, the politicians need to “encourage” voters to vote for them. What’s the easiest way to do that? Bribe them! Oh whoops, I’m not supposed to say that. What I mean is that politicians promise public employees a certain amount of pension money when they retire, thereby sealing their votes.

When the stock market is on a tear and the economy is good, such promises are easy to keep. Pension funds promise X amounts of money in the future because they project that they will make Y% investment returns in the future. Later on in this post I’ll cover why this is absolute BS.

Of the governments’ stated liabilities, only approximately 3/4 are currently funded. That means a full quarter of public pensions are unfunded liabilities. And of course, these are just the “stated” or “official” numbers. We know the governments tend to cover up the ugly truth. According to some estimates, more than half of the public pension liabilities are unfunded!

Let me repeat that. More than half. Where is the government going to make up for this shortfall? By taxing the hell out of Americans in this awful economy? Hell no!

What they’re going to do is up the ante on pension contributions for the current generation of workers (which they are already doing). Every year, existing public workers are asked forced to contribute more and more of their salary towards their public pension fund. Why?

Because these public pension funds are essentially just ponzi schemes.

The pension shortfall is so severe that in order to meet their current obligations (a.k.a. the baby boomers), they have to take money out of existing workers. In effect, this is just a transfer of wealth – money taken from 30, 40, and 50 something year olds is given to 60, 70, and 80 year olds. That is why this is the same as a ponzi scheme. They’re using in-flowing cash to pay off yesterday’s promise to retirees.

So in the end, who’s the mega-winner in this whole mess? The baby boomers. They’re living off of our money. Who’s going to be the loser? The current generation of workers. By the time we retire, the ponzi scheme will pop (as all ponzi schemes inevitably do) and there’ll be no more money left for us to retire on. (Ok, maybe I’m being a little extreme, but you get the idea. Things aren’t going to be pretty.)

Question: So how did we get into this mess in the first place?
Answer: The pension fund managers are incompetent.

Think of it this way: if pension fund managers actually were good investors, would they be making $100k a year managing some municipal government’s pension fund? Of course not! Jesus, they’d buy a one way ticket to Wall Street and hit the big jackpot with their own hedge funds! As a result, all the people who don’t have any decent money making capabilities end up being pension fund managers.

Note: *Very few people are willing to invest the public’s money and live a middle class life out of “civic duty”. Come on, this is America people. We’re all looking out for number one (the American Dream baby!).

As a result, over the past 50 years these pension fund managers have been having things easy. In the history of mankind never has there been such unprecedented economic growth. Any dodo and his grandma can make money in a mega-bull market: all you have to do is buy and hold!

The unfortunate reality is, in the future investing will be much, much harder. Over the past 50 years, America has had several huge advantages supporting its amazing economic (and stock market) growth. These advantages are unlikely to be repeated in the future.

Natural resource prices have been dirt cheap since WWII. When resource prices are cheap, the economy booms because the cost of producing everything is cheaper. But now that developing countries are consuming more and more resources, these prices will only increase in the long term. When raw material prices increase, economic growth is dampened. That’s what will happen in the future.

In the past 50 years, China was a no-factor. Europe’s never been any serious competition postwar. South America was still a backwater. In short, America has had it lucky these past 50 years. Virtually no competition from around the world! But with the recent emergence of developing countries, America will find that promoting American products around the world to be more difficult.

So in the future, economic growth will still exist, but not at the same pace we’ve experienced over the past 50 years. Things will definitely slow down. Times will get harder.

If these pension funds can barely keep themselves funded in good times, what’ll they do when the economy hits rough patches? What will happen if we experience 30 years of difficult markets?

The dodos running pension funds will drastically under-perform. If you barely survive during good times, you’d be lucky to stay alive when the going gets tough.

As a result, the current problems that pension funds are facing is just the tip of the iceberg. Wait another 10 years, and these public pension funds will really be in deep shit. (Sorry for the profanity.)

If I were on the public payroll, I would not stake my whole retirement on the ability of the state to meet its obligations. I thought this Great Recession was supposed to teach us that. Too many people worked their whole lives for a company only for the company to go bankrupt right before they retired. Instead of cruising on Easy Street, they’re still hauling ass just to make ends meet at home.

Lesson of the day: self-reliance. It’s the American Way. You cannot 100% rely on anyone except yourself.

Health Care Liabilities

A smaller factor that is putting immense pressure on pension funds is increasing health care liabilities. As health care costs skyrocket, governments are getting the short end of the stick. In addition, when governments first calculated their projected health care liabilities they forgot to take one thing into account: the increasing life expectancy.

As a result, many states have drastically underestimated their health care obligations and are now strapped for cash.

What do you think? Are public pension funds headed for disaster?