The beauty of pension accounting is that slight tweaks can make a large unfunded liability seemingly disappear. However if a pension fund plays the game of understating its risks for long enough then eventually it catches up with them. The risk of state and local (S&L)governments going bust is becoming a reality. I wrote on the S&L bankruptcies to date in the US last week. It is a nightmare for Main Street.
The US Federal Reserve has an interesting set of data on state and local pensions tucked away in its vaults. The unfunded pension liabilities as a % of GDP are truly worrying. As I pointed out with CalPERS, the generous return profile it states but isn’t achieving means its unfunded proportion is much higher in reality.
The Fed reported in 2013 that the State of California had an unfunded pension liability status equivalent to 43% of state revenue. However if marked-to-market with realistic discount rates we estimate that it is equivalent to 300% of state revenue or 7x as great. Going back to 2000, California had an unfunded liability less than 11% of tax collections. As a percent of GDP it has grown from 2% to 9.7%. If our estimate is correct, the mark-to market reality is that California’s unfunded state pension (i.e. for public servants only) is around 18% of state GDP!
The State of Illinois is even worse. The unfunded pension liability is around 24% of state GDP. In 2000 the unfunded gap to state revenue was 30% and in 2013 was 126% in 2013. Alaska is at 20% of GDP up from 0.27%.
On a gross country level, the US Fed reports that aggregated S&L unfunded pension amount of $1.35 trillion in 2013 from $94.8bn in 2000. As a percentage of GDP it has climbed from 0.9% of GDP to 8.19% over that same period. If the FT is right in assuming a $3.4tn pension funding gap today then the impact should be 2.5x higher or 20% of US GDP.
Putting unfunded liabilities as a % of state tax collections under that scenario and we would effectively see 100% of state budgets across America be required to close the gap. Of course the entire gap doesn’t require immediate action (because all retirees aren’t happening at once) to get it to zero but getting it to a point where it could safely cover future liabilities on realistic returns over the long run would still require significant injections. Such injections would crimp S&L services causing retrenchment of staff, public services and so on.
Perhaps more alarming is that with asset prices so artificially inflated we must question the mark-to-market pension assumptions should equity and bond markets collapse, leaving even larger unfunded liabilities with the ensuing economic impacts crushing tax collection creating an even more vicious circle. As Caroline Burnham said on American Beauty, “You cannot count on anyone but yourself!”