‘D’ is for Downgrade

‘D’ is for Downgrade

Here’s a a dry news headline that buried in the back pages of business sections yesterday but deserves a closer look: according to debt-ratings service Moody’s, the 25 largest U.S. public pensions face about $2 trillion in unfunded liabilities. Translation: unless something changes, retiring U.S. public sector employees will not get the pensions they have been promised.

Public-sector-workers-007Of course, the situation regarding U.S. public sector pensions (and Canada and other countries have their own issues, if they are not as severe as yet) is already well known. Public sector unions for years fought for and got generous pensions. Contributions kept coming in from current employees. Returns on pension funds were decent. People retired and got their benefits – until everything changed.

What changed, and keeps changing, is that people came to the realization that revenues could not keep pace the amount of money that had to be paid out.

According to Moody’s, some of the shortfall can be blamed on actuaries who just tallied up the numbers wrong. Some can be blamed on pension fund managers, and on financial markets that have been challenging at best. And a lot has to do with the recession of 2008-09, which cut into contributions.

Mostly though, it is about the amount of money that employees kept getting paid, and the number of employees that are and will be retiring. The longer someone works for a public sector fund, the higher their salary will be, and the higher their pension will be. The more retiring employees there are – hello, baby boomers- the more pensions there are to pay out. Do the math – or just look at the math that Moody’s has done.

So what happens now? Well, in the short run, a bunch of local governments could get ‘downgraded’, which basically means they wear a giant ‘D’ and have to pay more when they borrow money (okay, its an imaginary ‘D’ but it might as well be real). You might recall that that happened to Chicago last year when it was revealed that the city had a giant unfunded pension liability.

In the long run, something has to change and the options are not pretty. Tax more? Increase the contributions of those still working? Cut the pensions of the retired? Find pension fund managers who can get better returns in tricky markets (and pay them accordingly for their skills, something else that is kind of tricky)? Slash public services?Go into public pensions and change the rules so that the next wave of retirees gets less? Which is the easiest and most ‘fair’ in an ‘unfair’ world? Places like the United Kingdom and Greece where things have really come to a head do not provide much of an example to follow.

Moody’s did not provide immediate solutions to the U.S. pension shortfalls, but there will be plenty of time for debate – and perhaps protest – over the next couple of decades when the shortfalls are revealed in real time.

 

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