America, about 26 million people across America are relying on state and local pension plans to take care of them in their retirement years. That figure includes 15 million retired teachers, police officers, firefighters and other public sector workers, and another 11 million who are still working.
On the other side of the leger all the taxpayers— 330 million of us, give or take —who are on the hook to make sure they can get their check.
But, according to a new report, there may be bad news on the way — followed by even worse news.
The bad news is that these pension funds have already reported an accounting hole of $1.1 trillion, which works out to just over $9,000 for every household in the U.S. But that number is probably way, way too low.
The true figure may be over $6 trillion, which is about twice the entire value of all municipal bonds. It also works out at around $50,000 per U.S. household.
That’s all according to economics professors Oliver Giesecke and Joshua Rauh of Stanford University, who wrote a paper to be published in the Annual Review of Financial Economics. It’s based on a detailed study of 647 of the biggest state and local pension plans, covering about 90% of the total value of them all.
“As of fiscal year 2021, the latest year for which complete accounts are available for all cities and states, the total reported unfunded liabilities of these plans under governmental accounting standards is $1.076 trillion,” they wrote. “In contrast, we calculate that the market value of the unfunded liability is approximately $6.501 trillion.”
These pension funds have claimed to have $82.50 in assets for every $100 they owe, according to the study. But the real figure may be barely half that: 44 cents.
These new numbers don’t even factor in the risks that these pension funds fail to hit their lofty investment returns.
States with the lowest funding ratios include Hawaii, New Jersey, Connecticut, Kentucky and Illinois, they calculate.
Public sector funds are understating the value of future pension liabilities by using unrealistic “discount” or interest rates, the pair argue. As recently as 2021, funds were claiming an average discount rate of 6.76%. That allowed them to report that, for instance, each $1 they expected to have to pay out in 10 years’ time should only appear on the books today as a debt of 52 cents.
But these are contractual, risk-free, governmental debts, and should be valued like Treasury bonds, Giesecke and Rauh argue. Using the Treasury rates of 2021, that dollar due in 10 years should have been valued as a present-day debt of 75 cents instead.
After all, public sector workers aren’t just “hoping” for those pension payments, based on what happens in the markets. They are expecting them, regardless of what happens in the markets, because it’s in their contract. From the point of view of public sector workers, these pensions are risk-free. They’re just like owning a government bond.
These numbers have moved somewhat since 2021, and that may actually have helped the pension funds. Treasury rates have jumped. For instance, the yield — or interest rate — on 10-year Treasury bonds is now 4%. As recently as January it was just 1.6%.
On the other hand, markets have tanked. And with them, the value of pension funds’ investments.
“Complete data are not yet available for 2022,” Giesecke and Rauh report. “We predict that while the increase in bond yields during 2022 will have reduced the market value of liabilities through 2022, the decline in assets will have offset this improvement to some extent, and unfunded liabilities are likely to fall in the range of $5 — $6 trillion for fiscal year 2022.”
This isn’t just a technical accounting issue. These pension obligations must be paid when they come due, and in real money. If they can’t be, it will mean the mother of all financial and political crises.
How big is this problem?
“Unfunded public pension obligations represent the largest liability for state and local governments in the United States,” Giesecke and Rauh point out. To give you some perspective, a $6 trillion pension fund deficit is twice the value of all the money that state and local governments owe on their municipal bonds. It is about 170% of their total annual revenues. And it is 10 times the amount they took in last year from personal (non-corporate) taxes.
Bad news? Stay tuned.
