Monday, June 25, 2012

New Public Pension Disclosures A Tempest in a Teapot

After five years of debate, the Government Accounting Standards Board came up with revised disclosure rules that will have the effect of showing some state plans with lower funding ratios than before.  Big deal! What's worse is that plan administrators know these new standards mean nothing.

The Wall Street Journal reports, "Many state pension managers downplay the impact of the new rules, arguing that the changes will merely affect how pension numbers are reported, and not the substance of the plans' conditions." 

In doing a lot of reading on related issues, I believe it all boils down to one, overarching issue: Promises.  State and local governments, abetted by unions, political machines, and special interests, have made promises to their employees which cannot be kept.  It costs them nothing to make these promises, but these actors capture significant benefits.  Moral hazard leads to unsustainable promises being made.

These promises made a Tammany Hall-like few bind all the citizens, the majority of whom, if presented with the data, would resoundingly reject the level and structure of public pension promises.  "Shareholder activists" (whatever this means) are busy crying for corporate transparency about public company political contributions.  There is absolutely no transparency and meaningful financial presentation of these liabilities in state, local and municipal reporting.  So the people on the hook for these promises have no idea what's going on.  How about transparency for a meaningful issue that affects every citizen? 

State courts, populated by political appointees, keep reform of public pension commitments off limits by forbidding changes to employee compensation once the employee is working. Many plans also have explicit  guarantees of the level of returns for plan assets. So, any changes to the system fall unfairly and inefficiently on new hires.  The most concise exposition of these issues I've found is by hedge fund manager Kent Osband, author of "Pandora's Risk," in an article entitled "Fatted Leviathan."  (his book is on my "Recommended" list on LinkedIn) 

As Osband writes, the fattening of public pensions is a relatively recent phenomenon: "In inflation-adjusted terms, private benefits per working hour have risen by nearly a dollar since 2000. The corresponding state- and local-employee benefits have risen by nearly three dollars." If it's that recent, it can be rolled back.

Gaming of the system by municipal employees is rampant. A local political website in New York, where I was visiting, showed real data for a municipal employee in law enforcement whose total compensation skyrocketed in the years leading up to his retirement by overtime rising to several multiples of his base pay, which was also growing because of COLA.  This made his retirement a lot more expensive to taxpayers, who will never know what went on. This kind of abuse is pervasive.

As municipalities in California, for example, have started to deal with their budget issues, they have done things like reduce their police forces by 25%.  Law enforcement typically takes a lion's share of a municipal budget.  The problem is that in a system driven by local property taxes, law enforcement and a safe community, collectively form the number one reason why property owners choose to live in a particular community, followed by schools.  This short-term fix doesn't deal with the problem that the public pension promises can't be kept, nor should they be. Fix the compensation and benefit systems, align them to the market, and let taxpayers choose ,with the right information, how they want to spend their money.

Niall Ferguson in a recent Reith Lecture has resurrected and expanded on Edmund Burke's notion of generational compacts that ensure continuity and stability of democratic systems.  He notes that our current public finances are going to place unprecedented burdens on young taxpayers, like your children and mine. Leaving aside what is "fair" and how we got here, there is a point that I take from Burke, recast by Ferguson.

Making these economically irrational and unwarranted promises to public employees and then making them irrevocable by judicial fiat puts future taxpayers down a rabbit hole.  Future taxpayers have had no input into these choices.  It is taxation without representation, which is tyranny.  Those state court decisions need to be struck down, but my lawyer friends will protest.  Without scaling back these outlandish, irrevocable promises and putting them into a rational, comparable economic framework, discussions about disclosure are like improving the the deck chair upholstery on the Titanic.

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