Pensions: a suggestion made that Illinois borrow $107B and California short-term decisions with long-term consequences

The news making the rounds is a suggestion that was made for Illinois to borrow $107 billion to cover their underfunded pension. The St. Louis Post-Dispatch has a column on the matter. Essentially, the argument is that if you can borrow at 5 percent and earn 7 percent, the pension problems would disappear. This could work in a perfect world -- if there is never a market crash ever and if you ignore the fact that the CAPE ratio is rather high.

Also, it might work if politicians didn't like to raid funds. Here's a fun quote from the article:

Illinois issued $10 billion of pension bonds in 2003 and earned positive arbitrage on the money, but the pensions’ funding status continued to deteriorate. The Legislature used the new money as an excuse to cut its pension contributions.

Let's be honest, the time to make a bet like this is after a massive bear market, but at that point there would likely be other concerns that would prevent one from making such a large debt issuance.

And California makes short-term decisions to cut costs that later cause long-term pension problems. Per the OC Register:

First: In 2015, Gov. Jerry Brown got employees to contribute to their retiree health benefits fund.

Second: Then this cost to the employees was largely reversed in 2017. The LAO [Legislative Analyst's Office] said the pay increases offered in 2017 likely were “larger than they would be if the administration had not insisted on employee contributions to retiree health benefits.” And worse, the pay increases drive up pension costs.

Third: Note the quote about driving up pension costs.

Fourth: Labor contracts are usually two years, but Brown signed contracts that are five years in length.

So Gov. Jerry Brown spent much of his term trying to work through California's budget deficit. And now that he's nearly out the door, he signs an usually long labor contract that could tie the hands of the next governor. Not a nice thing to do when you're heading out the door.

The Sacramento Bee has an interesting article up on pension problems in the cities.

First: over the next 7 years, many California cities expect to see a 50% increase in pension spending.

Second: CalPERS now expects to average 7 percent earnings on its investments each year, down from its previous projection of 7.5 percent. 

So in a way, by lowering the average rate of return, CalPERS is forcing funding issues down to the city level. It is a nice conservative approach to things, but it causes issues at the city level. With the stock market gyrations, it'll be interesting to see what happens to the pension funding if 2018 doesn't see significant gains. If we see the stock market flat line for two years, I suspect those 50% increases in pension spending will be accelerated.