In the ongoing debt crisis taking place between Greece, Germany, and the EU’s financial Troika, Greek pensions remain squarely in the crosshairs for austerity cuts to allow acceptance of a new round of bailouts, and a saving of Greece’s insolvent financial system. But with the global economy in decline and even recession despite manipulated equity market highs, the Damocles Sword of underfunded pensions elsewhere threaten to keep central banks and central planners from doing what is necessary to rebuild sectors within the economy that have been stagnant since the 2008 credit crisis.
One country in particular, that of the United States, is a poster child for underfunded pensions that could matriculate a domino effect on the nation’s entire financial system should the Fed even attempt to stimulate growth through the raising of interest rates.
The cost to American cities for their cash-strapped pension funds is starting to look a lot worse, and it’s not because the stock-market rally may be losing steam.
Houston was warned by Moody’s Investors Service this month that it may be downgraded because of mounting retirement bills, the latest municipality put on notice as the company ignores bookkeeping gimmicks that let cities mask the size of their debt for years. The approach foreshadows accounting rules for even top-rated issuers that are poised to cause pension shortfalls to swell as new financial reports are released.
Cities that shortchanged pensions for years are under growing pressure to boost their contributions, even after windfalls from a stock market that’s tripled since early 2009. Janney Montgomery Scott has said growing retirement costs are “the largest cloud overhanging” the $3.6 trillion municipal-bond market, where investors are demanding higher yields from borrowers under the greatest strain.
That was on display this week for Chicago, whose credit rating was cut to junk by Moody’s in May because of a $20 billion pension shortfall. The city was forced to pay yields of almost 8 percent on taxable bonds maturing in 2042, about twice what some homeowners can get on a 30-year mortgage. – Bloomberg
And here is where it gets interesting, and in essence, critical for states and pensioners alike. Should the Fed begin to raise interest rates, the forecasted effect will be an assured decline in the stock market, leaving many pension funds who hold equities in even greater trouble as their pool of funds would shrink, and their rate of return would vastly decline since it has benefited immensely on the Fed driven bubble in equities over the past four years. And then complimentary to this, any raise in rates would cause bond rates to rise, meaning that it will cost cities and states much more to service those bonds, and require an even greater amount of revenue than they already bring in annually through taxes and fees.
States and municipalities have had to offer fiscally absurd benefits to skilled workers who in the past would have chosen to work in the private sector where their earnings are much greater than in civil service jobs. And when the markets were doing well, as between 2003 and 2007, they could get away with paying out much more than they were taking in since their return on investment made up for the lack of contributions by the states and employees. But as we saw in 2009, when the stock market lost over 40% of its value from a previous all-time high, much of that decline went straight onto balance sheets of mutual funds, pension plans, and individual retirement accounts, and provided a warning that has been little heeded on the fragile nature of promising too much in a volatile market structure.
States and municipalities in the U.S. are not the only ones to blame, as the devaluation of the dollar and in its purchasing power is a direct result of the Federal Reserve’s policies and inability to control inflation via increases in the money supply. Thus what was once a working and feasible system for employee retirement has turned into a boondoggle that neither states nor unions are willing to touch, and unless someone intervenes with hard lessons like those being attempted now for Greece, the result will be collapse and implosion, and many who trust and rely upon the government will be without a safety net in their golden years.
Kenneth Schortgen Jr is a writer for Secretsofthefed.com, Examiner.com, Roguemoney.net, and To the Death Media, and hosts the popular web blog, The Daily Economist. Ken can also be heard Wednesday afternoons giving an weekly economic report on the Angel Clark radio show.