An article published today by the Manhattan Institute highlights a significant challenge with U.S. public pensions, a challenge that the Retirement Security Initiative is all too familiar with: the almost complete reliance of public pensions on a thriving bull market.
The vast majority of public pension systems are houses of cards built on risky holdings like stocks, hedge funds and real estate. Unbalance just one piece of the structure and the houses collapse. We can see this very scenario already playing out across the country as many state and local governments face service cuts and tax increases due to tremendous pension debt. As it is, public pension systems already carry trillions of dollars in unfunded liabilities. Major market downturns continue to add hundreds of billions of dollars more.
Just picture what would happen if we are suddenly faced with a bear market. A state pension that is expecting an 8 percent return will instead be faced with a 20 percent loss. It would take 56 percent investment returns the following year to close this new 28 percent hole. Since such returns never happen, taxpayers are forced to shovel in even more money to fill the hole.
Today’s pension crisis is due to policy decisions made years ago by legislative bodies that created unsustainable systems. Couple that with several years of a bull market, which lulled those in-charge into thinking they could increase benefits based on unrealistic and risky market expectations. These policymakers did so knowing that taxpayers would be left picking up the shortfall when the bottom fell out.
If pension systems were set up with less risk (as they once were), more sharing of that risk and lower return expectations, then the real cost of retirement benefits would be more apparent to everyone. The price of benefits, like those offered today in most plans, would be so high that public employees would likely never have asked for them, preferring instead to receive higher wages or other benefits, and we wouldn't find ourselves in this current predicament. So while the market downturn isn’t to blame, it is exposing our pension systems for what they are.
While today’s policymakers didn’t create the mess they find themselves in, it is most certainly incumbent upon them to turn the tide and make the systems sustainable. While it’s easy to kick the can down the road for another day, if policymakers don’t get control of the public pension crisis now the ramifications could be dire.