POLICY

States Made Risky Bets with Pensions Before Coronavirus. Now They Want a Bailout.

 
 
 

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Charles Fain Lehman - APRIL 23, 2020 5:00 AM

Staring down the coronavirus's effect on their budgets, states like New Jersey and Illinois are calling on federal leaders to backstop public pensions as part of future coronavirus relief.

Democratic leaders in those states are pushing the federal government for billions in funding to shore up underfunded public pensions. Democrats in Congress have made bailouts for state and local governments a major priority for the next round of coronavirus stimulus, even allowing a major small business loan program to run dry as Republicans refused to package a renewal with more cash for states.

But the pension shortfalls are not just a product of the bear market, experts tell the Washington Free Beacon. Some states now seeking bailouts are in part covering for more than a decade of economic mismanagement, having chased increasingly risky investments to fund generous benefits at low up-front costs. Bailouts would allow states to dodge hard questions about the viability of excessively generous public pensions.

Illinois state senate president Don Harmon (D.) over the weekend sent a letter to the state's congressional delegation asking for $10 billion for the state's chronically underfunded public pension system. On Tuesday, New Jersey state senate president Stephen Sweeney (D.) expanded on Illinois's request, asking for $500 billion in federal loans to buckling state pensions across the nation. The National Governors Association has called for $500 billion for fiscal relief generally, some of which would undoubtedly go to state pensions.

Andrew Biggs, a pension expert at the American Enterprise Institute, told the Washington Free Beacon that a bailout for Illinois could break the dam of federal funding: "If Illinois got money, then everybody's going to ask for it, because all of these pensions have some level of funding problems. I think this is the feeler to see what happens."

The requests for a pension bailout follow crippling losses thanks to the coronavirus-driven downturn. Credit rating agency Moody's estimates that state and territory pensions have lost about 21 percent of their value, close to $1 trillion. By comparison, 401(k)s have lost about 11 percent on average since the market went south.

Advocates of a bailout argue that states are the front line for the fight against the coronavirus. State spending has risen just as standard sources of revenue—sales taxes, income taxes, etc.—are either delayed or drying up altogether.

But data reveal that state pensions have been a ticking financial time bomb for years, chronically underfunded and ill-prepared for a recession. As of 2017, analysis from the Pew Charitable Trusts finds there was a $1 trillion gap between state pensions' assets and liabilities. Some states, including New Jersey and Illinois, held as little as one dollar for every three of outstanding liability.

States pension funds last took a beating during the Great Recession, with every state feeling at least some heat. But states responded differently—the eight best-funded states had rebounded 95 percent by 2017, while the 20 worst-funded states saw funding drop from 76 percent in 2007 to 56 percent in 2017.

"The general narrative of pensions over the past 10 years is that we're back on track, we're doing okay, our rate of return assumptions are alright, we're making our contributions," Biggs said. "Now they get hammered again, and there's been kind of willful ignorance among a lot of them about what's involved in really running one of these things."

Josh McGee, a research assistant professor at the University of Arkansas and the former chairman of the Texas State Pension Review Board, told the Free Beacon that this growth in shortfalls comes down to a number of factors. Liabilities have grown—they're now 30 to 40 percent of GDP, he said, up from 10 percent in 1990. Meanwhile, interest rates have fallen, making it harder for states to get the returns on investment they want. States largely failed to capitalize on the market expansion between 2009 and 2020—"Essentially plans have just been treading water and have not closed the gap [between liabilities and assets] since 2008."

Facing these yawning gaps, many states have chosen to move their pension funds out of safe assets and into riskier ones, like stocks and real estate. This, McGee explained, helps keep annual contributions to pension funds low.

"If they were to derisk, their advisers would say they would have a lower assumed return on assets, which would mean they would have to discount at a lower rate, which would mean they'd have to put more money in today, and state budgets have been relatively strapped, so they're hesitant to do that," McGee said. "So they chase riskier and riskier returns, so they can keep their budget contributions lower today."

All of that risk, however, came back to spite public pensions when the current recession hit—they were much more exposed to the downturn than comparatively risk-averse 401(k)s. That's part of what concerns McGee about a federal bailout: Loans issued to state pension funds would move some of that risk on to the federal balance sheet. Should the federal government take on that risk? "I don't know," he said.

Biggs, who sits on the federal board overseeing Puerto Rico's bankruptcy, cautioned that allowing state pensions to fail would be "an incredibly messy, awful thing," especially as the immediate servicing of obligations could push a state like Illinois into bankruptcy. Both he and McGee said they could get behind federal support for pension funds, but only if there were safeguards in place: some reduction in or freeze on benefit increases, restrictions on the risk level of assets bought with federal funds, and requirements for additional reporting.

Whether national politicians, especially Democrats still eager to push funds to states, will impose such restrictions is another question. A bailout with no strings attached, McGee said, would be a bad look in the eyes of states—including corona-battered New York—that did practice fiscal discipline prior to the start of the current crisis.

"If the federal government bails out the less responsible states, states like New Jersey and Illinois whose legislatures and governor have been pretty militant about underfunding pensions, then I think it sends a bad message," he said.