The unfolding pension crisis in state and local pensions is, again, making the headlines.  The bear market of the past nine months has sent virtually all stock indices sharply lower.  It should come as no surprise that this has ravaged the asset values of state and local public pensions.

Writing for the Financial Times (“US public pension funds' returns slip 4%,” July 21, 2008), Deborah Brewster notes:

     "US public pension funds have had their worst returns in six years, losing an average of more than 4 per cent in the year  to June 30, that puts them under even greater pressure to meet their growing liabilities.

     "The average plan's funded status has declined by close to 5 per cent during the year, taking it well below 100 per cent to be only 96 per cent funded, according to BNY Mellon.

     "Until now funding had been improving, after five years of positive returns….

     "This year's loss is close to the loss of 4.8 per cent in 2001, which was the worst for pension funds in the 11 years from 1997."

With approximately 60% of all pension assets in equities, the funding status and fiscal health of the country’s pensions are directly tied to the performance of the stock market.  As we have been warning for the past several years, pension managers are simply not prepared for the possibility of a long-term bear market. 

Standard financial planning warns against the danger of taking large portfolio drawdowns when stocks are falling.  Doing so eats away at your capital and prevents you from fully enjoying the benefits of a rebound.  It can also cause your assets to become depleted much faster, thus causing you to run out of money in retirement. 

Pensions, unlike people, are presumed to have an infinite life, so they cannot “run out of money” in retirement, per se.  They can, however, become grossly underfunded when the value of their assets plunge during a multi-year bear market.   The assets shrink, but the liabilities remain.  Even worse, Brewster notes that “Even as pension fund returns shrink and liabilities widen, some state governments are giving their state employees higher pension benefits, further increasing the pressure on the funds and ensuring even greater liabilities.”

If an individual retiree sees his or her 401(k) destroyed by a long-term bear market, they may have family or friends to ask for help, but where does a city or state go when the money runs out? 

The answer, unfortunately, is to you, the taxpayer.

Government sponsored pension plans have limited choices to solve funding problems related to future retiree pension payments.

Raising taxes will usually require voter approval. With retirees being the largest voting bloc, expect this ballot issue to fail.

Reducing pension payments involves breaking the employment and social contract with retirees. It happens in the private sector when companies use bankruptcy court to reorganize. Pension liabilities are transferred to the PBGC where benefit adjustments are made. Governmental entities have no similar process to get out of the responsibility for the benefit reductions, except to file for bankruptcy. The latter is the path followed by the City of Vallejo, California.