Honesty on Pension Debt: It's Now or Never
"You never want a serious crisis to go to waste," said then-White House Chief of Staff Rahm Emanuel, who is now the mayor of Chicago, in 2008. Puerto Rico's current financial situation is just such a crisis, but congressional Republicans' legislation on the issue may put parochial political concerns above the national interest. The current draft would fail to ensure that all state and local governments — not just Puerto Rico's — accurately disclose the unfunded pension debts they have accumulated.
Governments don't go bankrupt for one reason alone. But every financially troubled government in recent years has had a poorly managed pension plan in the background. Detroit's public-employee pensions were essentially looted via bonus benefit payments. The city borrowed to fill the gap, then defaulted on the borrowing. Similarly, the bankrupt California cities of Stockton and San Bernardino granted massive, retroactive pension-benefit increases during the stock-market bubble of the late 1990s.
Emanuel's Chicago is itself in the midst of a pension crisis. Despite layoffs, unpaid furloughs, and budget cuts, Chicago's public schools recently instructed principals to stop spending money to help fund a large pension contribution due June 30. Just last week, the Illinois Supreme Court overturned a Hail Mary Chicago law to reduce pension benefits and raise employee contributions.
As for Puerto Rico, its government-employee plans are practically broke, through a combination of insufficient contributions, excessive investment risk, and sweetheart deals for participants. Indeed, one of the plans' main "assets" today is low-interest loans made to public employees to take overseas vacations.
No federal bankruptcy law applies to Puerto Rico, so Congress and the Obama administration must construct a rescue plan on the fly. Reform-minded members of Congress, including Senate Finance Committee Chairman Orin Hatch, R.-Utah, want any legislation to require all state and local governments to accurately disclose their pension liabilities. But draft legislation from House Republicans would require this of Puerto Rico alone.
This omission is more worrying given the reason: not Democratic opposition, but pressure from state-level Republican lawmakers not to enact stricter pension disclosures.
Under current public-pension accounting rules, established by the Governmental Accounting Standards Board, a plan that takes more risk may assume a higher investment return — and then use that higher assumed return to "discount" its liabilities. This accounting trick immediately reduces governments' contributions, before that riskier portfolio has paid even a penny of higher returns.
It's a gimmick that works only under public pensions' unique accounting rules, and it explains public plans' massive shift in recent years toward risky alternative investments such as hedge funds and private equity, a shift that the Society of Actuaries declares "goes against basic risk management principles."
Almost every other pension system in the world operates instead under "fair market" valuation rules, which, the Congressional Budget Office has stated, "provide a more complete and transparent measure of the costs of pension obligations." To institute these rules, Hatch would draw on the terms of the Public Employee Pension Transparency Act, authored by Rep. Devin Nunes, R.-Calif.
Hatch would only force disclosure, not set funding standards. But the mere disclosure of accurate liability figures would allow municipal bond markets to reward governments that responsibly fund their pensions and punish those that skip contributions. It would also reveal the true size of the pension crisis as a whole: Instead of being underfunded by merely $1 trillion, state and local plans would be shown to face a funding gap of $3 trillion or more.
This is no time to look to parochial interests. Last year, nearly 60 percent of state and local governments failed to make their full pension contributions. With trillions of dollars in public-pension liabilities residing off the ledger books, and increasingly risky investments used to fund those liabilities, failing to address public-pension disclosure would be a huge lost opportunity.
Andrew G. Biggs is a resident scholar at the American Enterprise Institute. From 2008-2009 he was principal deputy commissioner of the Social Security Administration, and in 2013-2014 he served as co-vice chair of the Society of Actuaries Blue Ribbon Panel on Public Pension Funding.