America About 26 million people across America rely on state and local pension plans to provide for them in their retirement years. That number includes 15 million retired teachers, police officers, firefighters and other public sector workers, and another 11 million who are still working.
On the other side of the lever are all the taxpayers — 330 million of us, give or take — who are on the hook to make sure they get their check.
But bad news could be on the way – followed by even worse news, according to a new report.
The bad news is that these pension funds have already reported an accounting deficit of $1.1 trillion, which is just over $9,000 for every household in the US. But that number is probably way, way too low.
The true number could be over $6 trillion, which is about twice the total value of all municipal bonds. It also works at around $50,000 per US household.
That’s all according to Stanford University economics professors Oliver Giesecke and Joshua Rauh, who wrote an article to be published in the Annual Review of Financial Economics. It is based on a detailed study of 647 of the largest state and local pension plans, covering about 90% of the total value of all.
“As of fiscal 2021, the most recent year for which full accounts are available for all cities and states, these plans’ reported unfunded liabilities under state GAAP total $1.076 trillion,” they wrote. “In contrast, we calculate that the market value of the unfunded liability is approximately $6.501 trillion.”
According to the study, these pension funds claimed they had $82.50 in assets for every $100 they owed. But the real number is maybe half that: 44 cents.
These new numbers don’t even account for the risks of these pension funds not achieving their high investment returns.
States with the lowest funding ratios are Hawaii, New Jersey, Connecticut, Kentucky and Illinois, they calculate.
Public sector funds are underestimating the value of future pension obligations by using unrealistic “discounts” or interest rates, the two argue. As recently as 2021, funds were claiming an average discount rate of 6.76%. This has allowed them to report, for example, that every dollar they expect to have to pay out 10 years from now should only show up as 52 cents in debt on the books today.
But this is contractual, risk-free government debt and should be valued like government bonds, argue Giesecke and Rauh. Using 2021 Treasury interest rates, that dollar due 10 years should have been valued as today’s debt of 75 cents instead.
After all, public sector workers aren’t just “hoping” for those pension payments, depending on what’s happening in the markets. They expect them no matter what happens in the markets because it’s in their contract. From the point of view of employees in the public sector, these pensions are risk-free. They are like owning a government bond.
Those numbers have shifted a bit since 2021, and that may actually have helped pension funds. Treasury interest rates have skyrocketed. For example, the yield — or interest rate — on 10-year government bonds is now 4%. In January it was only 1.6%.
On the other hand, the markets have collapsed. And with it the value of the pension fund investments.
“There is still no complete data for 2022,” report Giesecke and Rauh. “We expect that while the increase in bond yields during 2022 will have reduced the market value of liabilities by 2022, the decline in assets will have offset this improvement to some extent and unfunded liabilities are likely to remain in the $5 to $6 trillion range for fiscal 2022.”
This is not just a technical accounting problem. These pension obligations must be paid when due and in real money. If they can’t be, that means the mother of all financial and political crises.
How big is this problem?
“Unfunded public pension obligations represent the largest liability for state and local governments in the United States,” Giesecke and Rauh point out. To give you perspective, a $6 trillion pension fund deficit is double all the money that state and local governments owe on their municipal bonds. That’s about 170% of their total annual sales. And it’s 10 times the amount they took in from personal (non-corporate) taxes last year.
Bad news? Stay tuned.