By Chuck Reed, RSI Chair

 

Analysis published this week by J.P. Morgan’s Chairman of Market and Investment Strategy Michael Cembalest demonstrates the growing risk to public employees and retirees as many municipal debts outweigh revenues.  

Following up on his 2016 tri-annual credit review of U.S. states, Cembalest has added the largest U.S. cities and counties to the mix in his latest review, The Arc and the Covenants 3.0. By calculating what local governments currently spend on bonds, pensions and obligations related to underfunded pensions and retiree health benefits (termed OPED) and what they would be spending over 30 years assuming a 6 percent rate of return, Cembalest has determined that U.S. cities and counties are substantially more debt-ridden than states and have some difficult choices ahead in order to meet their future obligations.

Using a calculation called “IPOD” (short for I=interest on bonds, P=pension payments, O=OPEB payments and D=defined contribution payments, all divided by municipality revenues), Cembalest looks at current IPOD ratios and, more importantly, full accrual IPOD ratios required to service all future obligations accrued to date. And the result is dismal. To meet the full accrual IPOD ratio, many municipalities will need to significantly increase taxes, cut services or increase public worker contributions.

For example, in my home state of California, to meet its future commitments, Oakland would have to increase taxes by 22 percent, or cut spending on services by 22 percent, or increase worker pension contributions by 462 percent. In Sacramento, policymakers would have to increase taxes by 19 percent, or cut spending by 18 percent, or raise workers’ contributions by 301 percent. And there’s municipalities in far worse shape, such as Houston, which would have to raise taxes by 26 percent, or cut services by 23 percent, or increase worker contributions by an outstanding 772 percent.

So, what happens if these governments choose to ignore the crisis, to maintain the status quo and do nothing? Municipalities may continue to rely on elevated investment returns, but that would require almost impossibly high annual returns for 30 years and it’s that short-sighted optimism that helped get our country into its current pension debt crisis.

According to Cembalest, at a more conservative and realistic return rate of 6 percent, municipalities would see their pension funding ratios decrease. For example, Houston’s current 23 percent funded ratio would fall to 15 percent; Cincinnati, Ohio’s would go from 60 percent funded to 49 percent funded; and Los Angeles County’s would drop from 87 percent to 79 percent—and that’s only if municipalities maintain their current contributions.

If contribution levels fall, the funding gaps will only widen, putting at risk the retirements of many public employees. As Cembalest noted, public sector workers “have earned the benefits they accrued and which were granted by state and local legislatures, and have the right to expect them to be paid.” I couldn’t concur more.

Unfortunately, the situation is dire for many municipalities around the country and this report only further reflects the tremendous debt burden faced by our country due to overpromising benefits and underfunding pension systems and the risk it places on public employees and taxpayers.

Moving forward, pension reform can no longer be prolonged by state and municipal policy leaders while liabilities accumulate. To maintain benefits for current retirees, ensure a fair retirement for future workers and deliver government services to taxpayers without significantly increasing revenues, the debt crisis needs to be addressed now.