The day I graduated with my Masters’ Degree, I remember my parents beaming proudly and Dad giving me some quintissentially fatherly advice. It came straight from the psyche of a first-generation American parent who grew up in poverty but worked hard and eventually made good on his life. While clapping me on my shoulder, he said, “Go out there, kiddo, get a good job, and make sure it comes with a nice pension!”
In his day, pensions (of the defined benefits sort) were an employment staple and source of pride for a wide swath of American employees. For better or worse, however, pensions gradually started disappearing during my early adulthood. As the economy became financialized, people started living longer, and cheaper labor from faraway places came within easy reach, the idea of paying American workers to live comfortably for decades after they stopped being productive became seen as being an unnecessary a drag on business and the economy.
I never got the opportunity to act on Dad’s advice. Times were changing in the science research industry like everywhere else, and the great job with the pension never materialized for me. I used to feel very frustrated about that. However, given what’s happening in the pension system today, I now think that I may have dodged a bullet. For most American pensioners, there is no longer any guarantee that the “benefits” that they worked, sacrificed for, and planned on for support during their “golden years”, will be there for them when they’re needed. Our pension system (combined public and private) is currently approximately in the neighborhood of $5 trillion in debt, and the vast majority of pension plans are significantly less than completely funded. This, in itself, might not constitute a crisis, but the road to making up the deficits and creating the future cash flow necessary to guarantee delivery of all promised benefits is very steep, very rocky, and very difficult to navigate. The good news is that both the pension funds and the government are finally becoming focused upon finding solutions. The bad news is that the situation may be beyond hope of a resolution that will please everyone and be a net positive for our economy. Below, I examine seven possible solutions to our current pension crisis and the likely consequences of each for the wider society (including you and me).
How did this happen?
In a nutshell, most pensions were fully or even more than fully funded prior to 2001. Funding was a relatively easy and sure-fire process when all the pension managers had to do was collect the historically average (about 7%) rates of interest on safe, risk-free investments such as U.S. Treasury bonds and bank savings accounts. (Remember when savings accounts actually paid measurable interest?) Helping to keep the pensions afloat was the fact that the major wave of boomer retirements hadn’t started in earnest. When the tech bubble burst and the economy crashed in 2001, however, the Federal Reserve dropped Treasury interest rates to 50-year lows in an effort to re-stimulate the economy. Of course, as Treasury rates dropped, so, too, did interest rates on savings accounts, corporate and municipal bonds, and all manner of investments including traditionally “safe” vehicles. Pensions were bound by legal obligations to protect their clients’ interests by keeping their clients’ funds invested in the safest groups of assets, so, as the income streams from those assets rapidly dried to a trickle, the pensions got hammered. And there weren’t many options for recourse. When the Fed later dropped interest rates even further to historic lows to save the economy from the fallout of the crash in 2008, pension funds got hammered again. How do you make money on investments when investments are paying next to nothing in interest?
While it’s true that many pensions still have a portion of their funds invested in 30-year Treasury bonds paying a respectable 7, 6 or 5%, the last of these bonds will reach maturity between now and about 2029 – not long after the Congressional Budget Office predicts that the Social Security Trust Funds will be all used up (!) The pension funds will then be forced to cash in bonds paying decent cash flows for new bonds that pay almost nothing, or even less than nothing. They’ll effectively be hammered for a third time. In the meantime, they’ve been forced to abandon their obligations to invest safely. In a desperate bid to scrounge up yield wherever they can find it, pension funds have broadened the mix of their holdings to include foreign government bonds, corporate bonds, real estate, stocks and other more risky investments. Sadly, for all of their effort and the chances they’re taking with their clients’ money, what they’re finding is that this potentially toxic mix of assets is still paying far less than what the funds require to keep solvent. By some estimates, the pensions currently still making all or nearly all of their payouts will be unable to meet their fiscal obligations within the next ten to twenty years, assuming we have no recessions or catastrophies such as war between now and then. By other calculations, many pensions, including large multi-employer pension plans, could become unable to pay their obligations as soon as 2025. With the sheer number of Boomers retiring and expecting to live primarily on their pension benefits, this is a national nightmare in the making.
So What Is The Government Doing About This?
Whenever something goes massively wrong in the economy or society, we generally look to the government for solutions, which is rather silly because it’s generally the government that created the problem in the first place. In true predatory fashion, however, government is usually only too happy to oblige the wishes of the public in this regard. After all, that’s the easiest route by which government can take over our lives. Predictably, the behavior of the pubic and the public’s “servants” in the pension debacle is proving to be no exception.
As of August, 2019, with little media fanfare, the U.S House of Representatives passed the Rehabilitation for Multiemployer Pensions Act (H.R. 397). Support for the Act was bipartisan but heavily lopsided with mostly Democratic support. At the same time, the Senate reintroduced comparable legislation that was first introduced in 2017. So far, the Senate bill has only Democratic support. These bills would fund a pension bailout via creation of low-interest U. S. Treasury loans made especially for purchase by troubled pensions to cover their outstanding expenses. A special new department within the United States Treasury would be created just to handle this loan program. Supportive Democrats pointed out that the loans would allow pensions to cover their obligatory payments for many years to come. Some Republicans pointed out that the loans would only kick the can down the road and do nothing to fix the structural problems that got pensions into their predicament in the first place. What, apparently, nobody pointed out (or what the media may have kept quiet) is that such a bailout would require an increase in pension funding to the tune of – you guessed it – approximately $5 trillion or more.
If congress does create a loan program to bail out the pensions and the pensions take it, the question then becomes, how will the pensions get the money in the future to pay off those loans? Where will all the monies to repay the loans, plus pay the interest, plus fund investments for generate more cash to meet future needs, come from? Finding all that money is a lot to ask for in an environment consisting, on the one hand, of very low – possibly negative – interest rates on safe investments, and, on the other hand, of high risk investments which are also spinning off low yields. Throw in possible malfesance by the largest global banks which stand accused of cheating the pension funds of yield on domestic and foreign government bonds, and every which way the pension funds turn, there seems to be something standing in between them and the profit they require to cover their current and future obligations.
Seven possible outcomes
The bottom line is that there are, as I see it, only a limited number of possible methods of “solving” the pension crisis, and none of them are good. Here are the seven different possibilities that I see:
- Pension funds may use the proposed Treasury loans, if they come to pass, to pay pension benefits in full for a while, then take out even more loans to continue payment after the first ones are used up. The eventual effect of paying off loans with more loans will be an unavoidable, catastrophic pension default when investment income drops too low to cover more than the repayment of multiple rounds of principal plus interest. Not only will the pension recipients then be finally, fully out of luck, but should Congress then choose to forgive all the loans, taxpayers and the pensioners themselves will be collectively be on the hook for repayment. According to Olivia Mitchell, Director of both the Pension Research Council and the Boettner Center on Pensions and Retirement Research, if we assume a figure of $5 trillion (collective public and private) pension shortfall and divide that by the roughly 158 million workers in America’s current labor force, that works out to a current deficit of $32,000 per worker. Now here’s the question for us: how many of us can afford to simply lose $32,000 from our savings? An how many American workers can continue to pay $32,000 (or more as pension adjustments for inflation climb) from our salaries and savings every future year that pensions continue to operate in the red?
2. An alternative to taking loans to continue paying out full pension benefits, would be for the pension funds to simply cut benefit payments. This is already happening in some states including New York, Ohio, Pennsylvania and Oregon. Theoretically, states experiencing shortfalls could use the difference between what is owed and what is being paid out, to slowly decrease their debt to zero. Such a move would allow pensions to continue to exist and at least partially fulfill their obligations while fundamentally retooling for today’s economic realities. Of course, benefit cuts are extremely unpopular with current pension holders and are likely to damage the credibility of the organizations (unions, businesses or government entities) that promised their workers lifetime income beyond retirement. It’s therefore an option that most pension funds don’t want to engage in unless more politically palatable options simply don’t exist.
It’s worth asking here how much of America’s internal migration is being driven by retirees fleeing from high-cost, reduced-pension states to lower cost of living locales? It’s not unreasonable to suppose that underfunded and failing pensions may be helping to drive the recent business and population booms, and their accompanying inflation, in formerly stable and “sleepy” places which never expected significant outside growth. The surprising reality is that residents of many small cities and towns that used to be socially stable, lower-cost and very livable, are now facing rising prices, taxes and crime as an indirect cost imposed by failing pension funds from elsewhere.
3. A third alternative to solving the national pension crisis would be to rob Peter to pay Paul. In at least one state, for example, lottery proceeds are being partially re-directed to shore up pension deficits. This not only cheats lottery winners and programs that are supposed to benefit from the lottery, but sets a very bad precedent. Environmental programs? Road and bridge repair? Public school modernization? Local parks? Police and fire coverage? Will we kiss these lottery-funded programs all goodbye to pay the pensioners their due?
4. States could simply raise taxes across the board and use the resulting revenue to fill the gap. Alternatively, states could shift existing revenues from currently funded programs and use them to shore up pension payments. According to a study by J. P. Morgan Bank, though, even if pensions could assume a (rather optimistic by today’s standards) a steady 6% return on investments, half of states would still need to devote 10% of their total current tax revenue to make pensions whole! Is this a real option for YOUR state?
5. Pension funds may also attempt to close their funding gaps by investing ever greater portions of their assets into ever more risky investments. Accepting more risk of loss is the only way to potentially acquire more gain in the absence of risk-free yields. The net effect of so many institutions all simultaneously taking increasingly desperate chances to chase yield, is the raising of the risk that some or all of them may fail, while tanking the stock, bond, and housing markets at the same time, In essence, this cure may be worse than the disease.
6. Yet another way to get a handle on the problem, and one that’s being tried in a few places, is to employ a simultaneous cut in pension payouts to beneficiaries with mandatory increases in pension contributions and retirement age for current workers. This strategy seems a bit more fair in that it requires everyone to sacrifice and feel some pain together, but because it’s painful, it’s not likely to be embraced by anybody.
7. A last, and very sneaky, desperate measure that unions, in particular, could take to boost their current cash flow, would be to expand into areas where union presence is currently sparse. New members might be recruited with relative ease in virgin territory if unions sow dissatisfaction with current employment norms and a promise of a “better deal” for workers (Hey! Something for nothing!) This would constitute a type of Ponzi scheme in which the dues of new members could be used to pay the pensions of more senior members, Such an arrangement would allow unions to fulfill their obligations – for a while – and delay the problem of how to pay current workers then THEIR pensions are owed for years, or possibly for decades. In the meantime, the odds of the pension funds being able to make the money needed to pay then current workers’ pensions are likely to be dropping as the growing Federal debt mandates that interest rates be kept artificially depressed lest the cost of paying the debt and its compounding interest, explode beyond all capacity to service. What will happen to current and future union workers, and to the economies of the union-heavy states, if the money being paid out into pensions by younger workers is continually being drained away to shore up the pensions of retirees now living elsewhere?
Don’t look to the Pension Benefit Guarantee Corporation for salvation
The Federally chartered Pension Benefit Guarantee Corporation (PBGC) was created to insure America’s pension funds against crises, much as the FDIC was created to insure bank deposits against bank insolvencies. Unfortunately, and ironically, the PBGC is racing towards insolvency, itself. According to the 2018 PBGC annual report, the agency has so far taken over 58 failed single-employer pensions and paid out over $150 million in financial assistance to 81 different multiemployer pension sponsors. The PBGC is now, like the pension funds it’s covering, going further and further out on the limb of risk to generate the yield income it needs to backstop troubled pensions. With no safe sources of yield available to fully support the guarantor of pension safety, how much more safety will the PBGC be able to offer the pension funds, and by extension, the pensioners who depend upon those funds?
The final act
Although Congress has finally decided to get serious about “fixing” the pension crisis, there is a strong case to be made that the structural problems are too deep, complex, numerous and entwined to allow for any palatable solutions. At the root of the issue, and the subject for another blog, is how the skyrocketing Federal debt is keeping a lid on interest rates, and how this, in turn, is preventing the pension funds from obtaining the risk-free interest yield they require to remain solvent. The debt is also creating so much financial drag that it’s also putting a damper on how much the real economy can grow through honest expansion of manufacturing and other high-paying jobs. The bottom line is that, even if Congress DOES choose to bail out pensions by creating a separate class of low-interest Treasury bonds for pension funds to purchase, YOU, as a taxpayer, are going to be affected even if you have no pension.
While Uncle Sam is unlikely to ask you to your face for money to bail out failing pensions, he and the pension fund managers will use stealth tricks (review 1-7, above) to part you from your money so they can funnel it to the pension funds without you ever knowing that they were doing it, or why. You will experience higher taxes, inflation, fewer but more costly municipal services, a degraded environment, an increasingly crowded or an emptying out and decaying municipality, a higher retirement age, or a cut in your retirement benefits – or some combination of the above – as an indirect, but very real, result of our current pension crisis. In other words, the pension problem is now a problem for all of us. And don’t count on Congress or anybody else to be able to ‘fix’ it. We’re probably just going to have to live with it until the last recipients of the glorious “defined benefit” pensions goes of to meet their maker. In the meantime, the best we can probably do is understand, and individually plan for, the consequences of our failing pension system. It’s not going to be fair for anybody except those old enough to have been able to collect their benefits in full before compensatory measures started being put in place, but as Mom used to say, “sometimes life just isn’t fair”. But understanding how and at what levels the pension crisis is contributing to other problems we’re faced with, at least gives us a fighting chance to figure out how to constructively come to grips with them on an individual level. Or perhaps we could eventually collectively reverse the problem at a national level if we could get ourselves socially and politically organized to do so, but good luck with that. I’m not going to hold my breath.
If you’d like more detail about the topic of the pension crisis, you may wish to link to a paper I recently wrote about it. Just click on the ‘download’ button below. I created the article specifically to explore the effects of union pensions and pension deficits on the cost and future quality of life in Idaho, but the data and principles are about pension funds in general and their effects on our entire country. This blog was a condensed excerpt from that article.
Economics Watchdog 