“The New Normal” aka Ruin Nation

I have a phrase that I use to describe the current difficulties within state and local governments; I call it “The New Normal.”  The phrase is cribbed from PIMCO, but with me this phrase has a different meaning.  It starts with the difficulties that states and municipalities are having in meeting their budgets.  Much of this stems from pension and retiree healthcare promises.  Much of it stems from a loss of revenues from home sales, sales taxes, and lower income taxes.  In any case, it is a mess, and it is a mess that will get worse.

I suspect that lower sales and income taxes will persist for a little while.  Home prices and sales will be subdued for around 3-5 years.  The oversupply is that great.

But the difficulties from pensions and employee healthcare will last for decades.  States made generous promises that they did not fund.  Like profligate private corporations, the assumed that they could grow their way out of the promises that they had made.  But few considered the possibility that state or local tax revenues could shrink for a protracted period.  Also, few considered that the current cost of pension promises would eventually force its way into government funding.

So now state and local governments are faced with the perfect storm.  With pension and retiree healthcare costs rising, and tax revenues either falling, or not rising so rapidly, that squeezes out money from other public services.  As Roger Lowenstein wrote about in his book While America Aged, the NY Subway system got to the point where pension costs were equal to the cost of wages.  Thus for every employee working, there was another person or more being paid a pension.

That is the present of many American municipalities, and the future of most of the rest.  Few municipalities and states set their pension and healthcare assumptions in a conservative way.  Rather, they let those soft costs slip into the future, compounded with interest and survivorship, while they spent money in other areas that were more pressing.

The bill has come due in some municipalities, and will come due in far more before long.  Here’s that problem: if you engaged in this hopeless game of pushing pension and retiree healthcare costs into the future, it will not do to merely make cuts to meet the present shortfall.  You must get ahead of the curve and fund benefits, or, you can play a colossal game of chicken and say that you won’t pay benefits unless workers and retirees compromise and accept less.  Aside from states, I know that means chapter 9 of the bankruptcy code.  As for states, that could be a constitutional crisis, because states can’t go broke.  But would the Federal Government enforce it?  How?  What if a state decided to secede?  (Oh, wait.  We’ve been through that.  But does Obama have the guts of Lincoln?  No, but who does?)

I’ve seen many articles on this topic recently.  Here are a few:

  • The Union Pension Bailout — Multiemployer private plans are underfunded, and unions are making a grab for taxpayer funds.  Remember that the PBGC guarantees less of the benefits on multiemployer plans.
  • Public Pensions Headed for Disaster — Megan McArdle sounds a theme that I have been sounding for five years or more.   (I have one piece written in 1992, but it is not on the web.)
  • An excellent example of liberal accounting for pensions is California.  I would not want to be the next governor.  The choices will get harder over the next ten years, as retiree benefits overwhelm the budget, and all manner of services get cut, necessary or not.
  • This applies to teachers as well, and pity aspiring younger teachers who can’t get jobs, and middle-aged teachers that have trouble with larger class sizes.  Their agonies support retired teachers with generous pensions — generous because governments would not pay up with salaries in the past.
  • Now, cities can take on unions, but they are limited.  They can’t eliminate past promises, but they can reduce current promises.  Current employees can yell foul, but what can they really do?  Most governments are in this pickle, so bargaining power is not strong.
  • This article is three months old, but it is comprehensive.  It compares the troubles at GM to those of the states and municipalities, and concludes that many unthinkable things are happening today.  Who can tell what will happen?
  • This is not a time to raise risk in pension funding, but many are doing so.  And they accuse actuaries of driving through the rearview mirror?  The pension consultants are worse; the models of investment risk are not as stable as those of insurance risk.  It is rewarding in the short run to take more investment risk; the reward is often short-lived, but the risk has a much longer tail.  The funds that raise risk now will regret it.
  • Though it is long and somewhat wonky, this post by Keith Hennessey is worth reading.  He argues, as I would, that promises to fund pensions should not be watered down.  If you don’t want  larger future insolvencies of pension plans, oppose the efforts to extend payment terms.  It may mean more terminations of pension plans in the future, but that is better than extend and pretend.

A few notes:

  1. Discount rates change the timing of costs, but not the ultimate costs.  A low discount rate forces costs into the present.  A high rate pushes them out into the future.  (“We can earn more over the long haul, so we don’t need to fund as much today…”)
  2. The “New Normal” affects everything municipal.  Budgets will continue to be cut, and employees laid off.  Services will be cut, and morale will fall, but budgets will still rise, as funding for employee benefits expands because it was not properly prefunded.
  3. Learn to do without your local government’s optional services.  Aid that was not dreamed of 50 years ago will slowly be eliminated, and people will need to pay their own way for what they need.

That’s the “New Normal” as the Aleph Blog sees it.  State and municipal governments starve, as pension payments grow.