What you need to know about state pension systems
Let's forget about unions and collective bargaining. Wisconsin Gov. Scott Walker says this is all about state pension funds. So let's take a look at them.
This paper (PDF) by Dean Baker is one of the clearest examinations of the pension funds, and what's happened to them, that I've seen. The big takeaway is this: "the main contributor to the current funding problem facing public pension funds was the collapse of the housing bubble and the subsequent downturn in the economy and the stock market." Before understanding what may or may not happen to state pension funds, and what can or cannot be done about it, you need to understand that.
Pension funds invest in various financial products. That means their projections assume some sort of rate of return on those investments. Before the crisis, their projections were perhaps a bit more optimistic than the data supported, but they weren't much more optimistic. The problem, as Baker says, is that we then had a financial crisis that was deeper and longer than anything we've experienced since World War II. "The managers of these funds obviously failed to recognize the housing bubble and the dangers it posed to the economy," Baker writes, "but this was true of the vast majority of economic and business analysts at the time."
This miscalculation, not union greed, is what has left state pension plans in apparent crisis. The conventional analysis right now is that pension plans are underfunded to the tune of about a trillion dollars (though there are good questions about how honestly state pension data are reported). If the stock market had simply performed as well as Treasury bonds in recent years, about $850 billion of that shortfall wouldn't exist. Much of the remaining gap is explained by states cutting back on contributions because they need to balance their wrecked budgets.
But Baker -- who did predict the housing crisis and so has some actual credibility on this subject -- thinks that some analysts have perhaps overlearned the lessons of the past few years. They're predicting rates of return going forward, he argues, that are much lower than what we should expect. He expects returns averaging around 7 percent from 2012 to 2022 -- not the 4 percent or so that some analysts are predicting.
In the final part of his paper, Baker warns that the dire talk of trillions in unfunded liabilities mainly confuses people. "The relevant context is the size of the projected shortfalls relative to the size of the state economies," he writes. Using data from the National Association of State Pension Fund Administrators -- which show a shortfall of about $650 billion over the next 30 years -- he calculates that the states are looking at funding gaps that range from 0.2 percent of their economies to 0.5 percent. Not nothing, but not an unmanageable crisis. The only way it becomes an unmanageable crisis is if the economy never recovers and thus the rates of return end up lower than we would expect and state economies end up smaller than we expect. But in that case, state pensions will be the least of our problems.
| March 1, 2011; 4:44 PM ET
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