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Who’ll Pay for an Underwater Pension Mortgage?

Although some Internet sifting didn’t reveal their state-by-state list, leaving Rhode Island’s standing as an unknown, Rob Arnott and Lisa Meulbroek’s warning in the Wall Street Journal is worth consideration:

Most cities, counties and states have committed taxpayers to significant future unfunded spending. This mostly takes the form of pension and postretirement health-care obligations for public employees, a burden that averages $75,000 per household but exceeds $100,000 per household in some states. Many states protect public pensions in their constitutions, meaning they cannot be renegotiated. Future pension obligations simply must be paid, either through higher taxes or cuts to public services.

As I’ve noted repeatedly, government investment boards get away with unrealistic investment assumptions because their financial advisors and actuaries accept that the ability to increase taxes allows for higher risk, and Arnott and Meulbroek note that this power ultimately flows to one tax in particular:

State taxes are collected on four economic activities: consumption (sales tax), labor and investment (income tax) and real-estate ownership (property tax). The affluent can escape sales and income taxes by moving to a new state—but real estate stays behind. Property values must ultimately support the obligations that politicians have promised, even if those obligations aren’t properly funded, because real estate is the only source of state and local revenue that can’t pick up and move elsewhere. Whether or not unfunded obligations are paid with property taxes, it’s the property that backs the obligations in the end.

Thus, the authors say, the pension debt is like another mortgage on our homes.  (For Millennials with big education debt, it’s arguably a third mortgage.)

In some states, perhaps the resolution will weigh more in the direction of justice — hitting the honey pots of the politicians and labor unions that inflated this suffocating balloon.  In states like Rhode Island, though, we’d best come to grips with the reality that, more and more, we’re working for the benefit of the government, not the other way around.  What we owe on our government bill already far exceeds the value we derive, and that’s only going to get worse.

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Keep that 8% Investment Return in Context

News of Rhode Island’s 8% return on its pension fund is being spread far and wide. Here it is in Chief Investment Officer:

The $8.3 billion Employees Retirement System of Rhode Island returned 8.03% for the fiscal year ending June 30, ahead of its 7.0% annual target, and its benchmark, which returned 7.5% during the same period.

Read on, though, and you see how inadequate this really is:

The fund also outperformed a traditional 60% stock/40% bonds portfolio, which would have earned just 6.25%. The fund also reported three-, five-, and 10-year annualized returns of 6.3%, 7.2%, and 5.8%, respectively, compared to its benchmark’s three-, five-, and 10-year annualized returns of 6.0%, 7.0%, and 5.6%, respectively.

The only number in all of these comparisons  that matters is the 7.0% “annual target.”  Indeed, this phrase is misleadingly minimizing.  Everything depends on hitting that number — even, arguably, the solvency of state government.  One wouldn’t say that having enough household income to pay the mortgage is an “annual target.”

In that context, 7% is really the zero line, and an 8% return on investment is really only 1%.  Moreover, the zero line has to be hit every year for decades.  So, every year that falls short requires multiple years of higher returns.  Over the past decade, the average annual return has been 5.8%, which is really more like -1.2%.

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The Broad Story of Pensions

As is the publication’s wont, GoLocalProv’s coverage of the Diocese of Providence’s pension problems makes a play for a sense of scandal and therefore misses a bigger story in the lesson that it teaches:

The document is dated June 19, 2018, and marked “immediate action” and it calls for drastic cuts to beneficiaries of the fund. Also, to be considered at the meeting is the October 2017 recommendation document and the plan outlined is to be considered for action this week.

Another dire statement in the report says, “Even with the revised more realistic assumptions, if we make these changes, it will still take 30-35 years to fully fund the Plan.” …

The four primary reasons for the plan’s lack of stability have been conditions for years.  Catholic schools in Rhode Island have been closing for the last three decades, the 7.5 percent annual rate of return has not been considered achievable for the better part of a decade, and the major changes in mortality rates was achieved decades ago.

Note that the state of Rhode Island uses a 7.5% estimate for an annual rate of return, as well, and employees of the state have had the same changes in mortality rates.  The only difference is that state government can always raise taxes to pay its mammoth obligations.

My understanding of the history, here, suggests that the problems for diocesan schools are wrapped up with changes in government.  (This would make for a worthwhile research project for any students in an appropriate field who have the time.)  During the same broad time period that the Church could no longer rely on religious brothers and sisters to run its classrooms, government employees unionized, and the unions began manipulating the electoral system to ensure that compensation — including pensions — would rocket beyond an amount that could conceivably be afforded without the bottomless well of taxpayer dollars. Private schools have to compete in this general job market.

Intentionally or not, public sector pensions were designed to hide the actual cost of the benefit.  The system looked affordable, and the diocese offered a variation.  Simultaneously, an explosion of regulations and mandates for schools, specifically, increased operating costs across the board.

So, yes, there’s a reckoning coming for this error, but it isn’t only for the diocese.

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Trading Water for a Fix

With his criticism of Democrat Governor Gina Raimondo for appointing Democrat Senate President Dominick Ruggerio’s son, Charles, to the Narragansett Bay Commission, Republican Mayor of Cranston Allan Fung has drawn attention back to the City of Providence’s perennial effort to turn its big water asset into a one-time payment, largely to infuse the city’s pension system with cash.

The immediate controversy is that Ruggerio, the younger, works in multiple roles as a lawyer for the city, but his appointment is most significant as a flash point to illustrate how government works, in Rhode Island.  The city has been after this for years.  In 2013, it took the form of an objectionable regional water authority.  Now, the strategy is to bring in the quasi-public Narragansett Bay Commission.

In every case, the goal appears to have been to come up with some excuse to saddle taxpayers and/or ratepayers with the additional burden of that one-time payment to the city.

Making matters worse is the general evidence that thinking about pension funds in this way is a mistake.  Just after the turn of the century, for example, the City of Woonsocket took on debt with the calculation that its investment returns would exceed the interest, and it could get its pension system on track.  That didn’t work out so well.

The Providence deal is different, of course, and would require a more thorough review prior to decisive pronouncements, but the impression one gets is that the primary difference is that the Woonsocket deal saddled the same people who owed the pension debt with the bond debt, while Providence is looking for somebody else to take on the new debt. Of course, Providence will also have offloaded an asset as a one-time part of the deal.

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The Reason for Pension Shortfalls in Providence

Taking up Providence pension woes, Dan McGowan and Walt Buteau highlight a recent study concluding the following:

Wainwright Investment Counsel LLC projects the beleaguered fund would have an additional $305 million today if city leaders made the correct yearly payments between 1996 and 2006 and again in 2010 and 2012, an amount that would bring the city’s current pension funding level close to 50%.

The firm calculated the amount that city leaders failed to contribute to the system – $111 million – and the monthly returns the actual money in the retirement fund saw between July 1996 and June 2016. Between 1998 and 2002, Wainwright estimates the city shorted the fund by $76.8 million.

Keep in mind that this means the rest of the shortfall was due to generous benefits hidden under faulty assumptions:

Providence is still solvent, but its pension system was just 25.8% funded as of June 30, 2017, with an unfunded liability that exceeds $1 billion.

So, skipped payments account for less than one-third of the missing money.  The other 700-some million dollars are a result of elected officials’ giving away too much in benefits and deceiving the public about the cost by gaming the actuaries’ calculations.  The key piece of that deception has been (and continues to be) the discount rate, or the rate of return expected on the investment.

Both elected officials and labor union leaders (who often helped elect the people with whom they’re negotiating) haven’t minded understating the cost of government employees.  Both union members and taxpayers should be furious, but taxpayers shouldn’t be held liable for promises that they had no realistic means of preventing.

And as the bill comes due, we can be sure that the exploding tax bills and collapsing services will push taxpayers — including those collecting government pensions — somewhere that they don’t have to pay for it.

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Backwards Ownership in Government Spending

Sometimes one must be reminded how backwards some sectors have become, particularly when government is involved.  Consider labor union claims that they own a particular employer’s jobs.  Most people would say that, while holding it, a job belongs to an employee and, in general, is under the authority of the employer who created it.  In the union mentality, the outside organization that somehow managed to secure employee approval — often sometime in the distant past — rises above both parties such that the job belongs to the union.

Similarly, Democrat Governor Gina Raimondo’s old investment firm, Point Judith Capital, in a real sense appears to own the money the state unwisely invested with the company, as Kathy Gregg reports in the Providence Journal:

Point Judith Capital, the private equity firm co-founded by Gov. Gina Raimondo before she entered politics, has advised the state it intends to hold on to an under-performing Rhode Island pension-system investment for one more year, under the terms of a 2006 agreement. …

Over the span of the investment, the pension fund paid the firm $1,011,891, according to Magaziner spokesman Evan England.

The way the state treasury accounts for investments, England reported: Point Judith earned the pension fund 0.6 percent on average each year, and a total of $297,466.

So, the state has hired this company to earn money on a sizable investment, and instead, Point Judith has collected more from the state than it has provided in investment returns.  Yet, it is up to the company to decide whether the state can have its money back in order to find a contractor who can actually perform as expected.

Maybe it makes one an investment-world yokel to say so, but something just seems wrong about that. This sort of option may be very common, but why would the state accept it?

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Selling Assets as a “Once and for All” Pension Fix Is a Bad Idea

Reporting on WPRI, Dan McGowan and Walt Buteau explain that Democrat Mayor of Providence Jorge Elorza is looking to sale of the city’s water supply as a means of filling the giant chasm of Providence employees’ pension fund:

Elorza, who is planning to run for re-election next year, said he’s seeking a “once and for all” solution to the city’s pension challenges.

 

As a general proposition, selling the water supply might or might not be a good idea, but this reason is horrible.  Just look to Woonsocket, which sold pension obligation bonds to fill its fund to 100% in 2003, but by 2011 was down to 57.7% funded.  The latest numbers on the Web site of the state Division of Municipal Finance put Woonsocket’s funding at 49.1%.

Unless a municipality fixes its underlying problems — such as overly generous employee packages and a more-realistic estimate for investment returns — every scheme will be a temporary fix.  In this case, Providence will have one fewer asset to help with unforeseen challenges in the future.

Even more, Elorza explicitly claims that another entity could run the system better because Providence is “so heavily regulated by the Public Utilities Commission.”  If that’s the problem, fix the PUC, and if Elorza thinks the PUC is little more than an expensive restriction, he should advocate for its abolishment. Otherwise, he’s just condemning those who drink and pay for Providence water to unnecessary expense (if the PUC is an excess) or unhealthy drinking water (if its regulations are actually needed).

By all means, if the city is having trouble running its water system, sell it off, but only if the new system is a better system of itself.  If a private company is willing to buy the water, it’s because there’s profit to be made (at least for employees), which indicates a problem with city management.  And if the money for the assets ultimately comes from the state, the whole thing will have been a one-time scam whose benefits for the city will rapidly disappear.

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A Side Benefit of Giving Away Retirement Bonuses

Katherine Gregg notes, in a Providence Journal article, an interesting side effect of Democrat Governor Gina Raimondo’s plan to pay off long-time state employees to retire.  Gregg notes that the administration is assuming that 426 state workers will retire under the program, receiving $8.94 million in “retirement-incentive payments” and another $4.57 million in pay for unused time off from their years of employment.

[The plan] will also, coincidentally, turn state government into a hiring factory in the six months leading up to the 2018 elections.

So, heading into a statewide election for legislators and the governor, 426 union members will be happily flush with cash and another estimated 252 will have received seats on the state payroll gravy train.  That’s a nice little bonus effect of retirement incentives.

Of course, we shouldn’t accept the governor’s estimates.  Pushing employees into an underfunded pension plan may result in some near-term savings, but in the long term, it’s a terrible idea.  Taxpayer dollars go toward these pensions, and with people living longer and longer and government employees’ pay on ratcheting scales, we’ll only end up paying multiple people at a time for each job.

These sorts of buyouts are a bad idea when the idea is just to save money, and the impulse exposes a much more problematic fact of government.  Think about it:  If these employees are so far from worth what they’re being paid that we’ll give them bonuses up to $40,000 to get rid of them, why are we paying them so much in the first place?  If that’s not an indication that we need huge, systematic reform, then nothing is.

That point highlights the only time that buyouts might be reasonable in principle, which is when doing so is part of a system-wide fix.  But nothing is being fixed, in this case.  The governor’s just looking for a short-term budget trick that comes with some political benefit.

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Cranston’s Disability Pension Funny Factory

This is hilarious… but unfortunately not so hilarious that Rhode Islanders won’t accept it or step up their laughter into a demand for change.  In Cranston, 69% of retired firefighters and 77% of retired police officers in the state municipal pension system have disability pensions, which are meant to provide the additional benefit of a two-thirds-of-salary, tax-free pension in compensation for some disabling injury on the job.

Of course, when the large majority of your employees receive enhanced benefits, they’re no longer “enhanced.”  They’re just the norm.

The funny part comes with Cranston union boss Paul Valletta’s explanation:

What could explain the difference [from other municipalities’ disability percentages]? There are no easy answers, although Cranston fire union chief Paul Valletta suggests that “bad luck” plays a role.

Valetta, readers might recall, was a visible presence in the successful push this legislative session to add “illness,” not just “injury,” to the language allowing a disability pension.  Everybody from the union activists to the Democrat Governor Gina Raimondo, when she courageously let the expansion become law without her signature, has insisted this is a mere correction to an oversight in the law.

That’s laughable.  To see why, consider that the law includes mental incapacity, as well as physical.  Allowing disability pensions for mental illness is clearly something broader than for mental injury.

The task of successful comedy writers — think Seinfeld — is to put characters in zany circumstances that seem like they really could happen.  It isn’t funny if it isn’t at least reasonably plausible with just a mild quirk of the character to make the difference.

The task of successful negotiation con artists is to make their special deals seem plausibly reasonable, with just the minor supernatural intervention of “bad luck” to explain what would otherwise be outrageous.  Bad luck, indeed… for Rhode Islanders.

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Campaigning on Your Dime; Dud of a Press Conference

In case anybody missed it, I’d like to highlight the following item from this week’s Political Scene in the Providence Journal:

Gov. Gina Raimondo has a new $61,751 staffer: RISD grad Jon Gourlay. His newly created job title: “Creative Manager — Governor’s Communications Office.” His actual role: producing web videos for Governor Raimondo, who is expected to run for reelection next year.

To some extent, her spokesman, Mike Raia, has a point when he says, “The way people get their information has changed, and elected leaders need to generate creative content to break through on social media and other digital and curated platforms.”  The content of the videos will be the decisive tell, though.

If Rhode Islanders get short instructional videos about interacting with government or more-catchy-than-usual public service announcements, the governor’s office will have an argument.  However, if we get more self-promotional trash like this, then the “21st century constituency” stuff will have proven to be just spin.

I know which way I’d bet, especially given what appears to have been a dud of a press conference from the governor, yesterday.  Is Raimondo so thoroughly without political chips that she’s got nothing but words to salvage a budget containing her single biggest emphasis of the past year?  She just doesn’t seem to get how to govern or use leverage and communications to bring about real action, so why would her new employee’s videos be dedicated to that purpose?*

* Before she actually became governor, Raimondo’s success with pension reform would have seemed to suggest otherwise, based on the “Truth in Numbers” campaign.  As time goes on, though, that issue is looking more like a one-hit-wonder achievement, perhaps founded more on the promise that her mild reform would make the mammoth problem of pension funding go away.  The clock is ticking toward the date at which the fallacy will be proven.

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Expanded Disability Pensions Will Be Boon for Investigative Journalists

The bright side, if the bills that Ted Nesi summarizes for WPRI were to pass into law, would be a boom in gotcha-journalism stories about questionable disability pensions:

The first bill, sponsored by Providence Rep. Joe Almeida, would allow an “injury or illness” sustained on duty – rather than just an “injury,” the current wording – to be cause for the granting of a tax-free accidental disability pension to a police officer or firefighter. It would also increase how long officers have to file a disability claim from 18 months after the incident to 36 months. …

The second bill, sponsored by North Kingstown Democrat Robert Craven, would mandate that any firefighter who suffers from hypertension, stroke or heart disease will be “presumed to have suffered an in-the-line-of-duty disability” and therefore be eligible for a disability pension, unless there was evidence of the condition in his or her entrance exam.

When first published, Nesi’s story noted that the bills had been posted for votes, implying passage, but after his story went live, they were removed:

“They were posted prematurely,” House spokesman Larry Berman said in an email. “Both bills were on a preliminary list for possible posting and then were posted in error. Those two bills are still being reviewed.”

Even if it ends there, this episode is a good reminder that special interests (ultimately funded with taxpayer dollars) are constantly working the system to expand benefits for government union members at the public expense.  They work to elect friendly officials to local office for generous contracts, and they work to elect friendly legislators to write generous benefits into the law.

Something dramatic and structural has to happen to change this, because our system has no countervailing forces short of bankruptcy that will withstand the year after year after year push.  The embarrassment of hidden camera stories about retirees abusing their benefits will only go so far in restraining ever-more-unsustainable benefits from being bestowed.

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Mild Nod to Pension Reality Shows the Scam

You have to laugh (lest you cry) at the gimmicks of state government financing.  Rhode Island General Treasurer Seth Magaziner is preparing to lead the state Retirement Board in reducing the pension fund’s discount rate (that is, the assumed investment return) from 7.5% to 7.0%.  For the record:

The pension’s investments lost 0.27 percent in fiscal 2015-2016 and have gained 5.75 percent over the prior five fiscal years and 4.8 percent over 10 years.

Our investment assumption should be no more than 4.5%, because this assumption is supposed to be what we can reasonably guarantee the investments will yield.  Unfortunately, the pension fund’s assumptions aren’t really meant to help the state plan accurately; they’re meant to hide the real cost of benefits that politicians have promised to unionized employees.  As I’ve gotten Tiverton’s investment advisors to admit, the high investment assumption actually has built into it the willingness of elected officials to increase taxes down the road to cover shortfalls.

Notice, for example, that the treasurer’s plan delays increased payments for a year.  That’s a political concession, not a financial one.  Again, making the pension system work in the way that has been sold to taxpayers and employees is not the primary goal.  Helping politicians get away with bad management and crony deals is.

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The Measure of Debt in Rhode Island

The debt study put out today by the state treasurer’s office merits a more detailed look than I’ve been able to do today.  For the quick summary, see Ted Nesi’s article on WPRI:

The $10.5 billion in total public debt – excluding pensions – breaks down as $1.9 billion for Rhode Island state government, $6.6 billion for quasi-public state agencies such as Rhode Island Housing and Commerce RI, and nearly $2.05 billion for municipalities and local special districts. With pensions, the combined total rises to $17 billion, Magaziner’s office said. …

… The study suggests a community’s debt and pension liabilities should be less than 6.3% of its total assessed property value; in Providence that ratio is 17.8%, and in Woonsocket it’s 20.3%. Central Falls, Pawtucket, Johnston, West Warwick and Cranston are also above the target.

One question Rhode Islanders should consider is whether assessed property value really ought to be the measure.  Assets are certainly important to the question of debt, but mainly from the perspective of the lender, not the borrower.  For your mortgage, banks want to know your property value and other assets because they’re looking at the likelihood that you’ll be able to liquidate and pay them back if things go wrong.  That’s not really possible for a state (even “a state for sale,” as Rhode Island has been called).

From the perspective of the borrower, income is more important, because it relates to the ability to pay off the loan.  In that regard, we can look at the matter in two ways.  Rhode Islanders’ personal income (including investments) is about $44.5 billion, which means that even using the treasurer’s unrealistically sunny estimate of pension debt, government debt is about 40% the size of our income.  And of course, personal debt would come into play when thinking about personal income.

The second way to look at the public debt would be public revenue, and Rhode Island’s state and local tax revenue totals around $6 billion.  So our government owes about three years’ worth of revenue.

Each man woman and child in the state owes $17,000, around $68,000 for a family of four.  Whatever arbitrary benchmarks politicians may pick, that’s too high.

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