zaterdag 15 juli 2017

Illinois "Budget Deal" Is Likely The Death Knell For The State's $130 Billion Underfunded Pensions

Last August, in a post that attempted to explain why public pensions are really about $8 trillion underfunded, as opposed to the $3-$5 trillion that you frequently see tossed around in the press, we described pensions in the following way: Defined Benefit Pension Plans are, in many cases, a ponzi scheme. Current assets are used to pay current claims in full in spite of insufficient funding to pay future liabilities, classic Ponzi. But unlike wall street and corporate ponzi schemes no one goes to jail here because the establishment is complicit. Everyone from government officials to union bosses are incentivized to maintain the status quo...public employees get to sleep better at night thinking they have a "retirement plan," public legislators get to be re-elected by union membership while pretending their states are solvent and union bosses get to keep their jobs while hiding the truth from employees. And while we weren't specifically writing about Illinois at the time, that state's recent "budget deal" perfectly mimics our point and illustrates precisely why America's underfunded pension ponzi schemes continue to grow at alarming rates, despite going largely unnoticed by soaring equity markets, and will ultimately be the catalyst for a major correction in the U.S.
# So, what are we talking about? As Bloomberg points out today, one of the ways that Illinois managed to "fix" its budget crisis, was by simply "kicking the can down the road" on their future pension funding requirements, pensions which are already only 35% funded as it is. So, how did they do it? Well, they simply decided to continue modeling future returns at a much higher rate than they'll ever be able to reasonably achieve. By leaving their discount rate at 7% they manage to reduce the present value of future liabilities and thus reduce current funding requirements. In short, tweak one simple number and, like magic, your whole funding crisis "disappears." That spending plan, pushed through by lawmakers eager to keep Illinois’s bond rating from being cut to junk, allows the state to sink deeper into the hole by giving it five years to phase in hundreds of millions of dollars in increased contributions to 80% of its retirement plans. Those extra payments stem from the funds’ decisions to roll back forecasts for what they expect to make on their investments, which means Illinois need to set aside more money to ensure it can cover pension checks due in the decades ahead.
“The phase-in of the actuarial assumption is another exercise in kicking the can down the road, but we’re not sure how far the can travels,” said Dave Urbanek, Illinois Teachers’ Retirement System, the state’s largest pension, which has $73 billion of unfunded liabilities. “You pay less now, pay more later.” After the stock market stumbled in 2015, Illinois’s four pension systems for teachers, state workers, judges and lawmakers all lowered their assumed investment rates of return, according to a March report from the Commission on Government Forecasting and Accountability. That, along with other accounting changes, added $9.67 billion to their unfunded liabilities, since they could no longer count on making as much on stocks, bonds and other holdings. The teachers and state employees systems dropped their rates of return to 7 percent, while the plans for judges and general assembly members cut their rates to 6.75 percent. All four had negative investment returns in the 2016 budget year, according to the commission. The state university retirement system was the only one with positive returns, eking out a gain of just 0.2 percent, the report showed.
Of course, as we recently pointed out, the silly fake math games only work so long as you have enough cash to prop up the ponzi scheme. Remember, Madoff's ponzi only came crumbling down when he could no longer raise enough money from new investors to fund withdraws from redeeming investors. Unfortunately, at least for Illinois pensioners who think they have a retirement waiting for them, Illinois' ponzi is about to run out of cash and meet the same fate as Madoff's ponzi. For those who missed, below is a post in which we explained why Illinois' pensions could run out of money in as little as 4 years. Chicago's pension funds, along with several other large public pensions around the country, are in serious trouble (we recently discussed the destruction awaiting our financial markets here: "Are Collapsing Pensions "About To Bring Hell To America"?"). The problem is that the pending doom surrounding these massive public pension obligations often get clouded over by complicated actuarial math with a plan's funded status heavily influenced by discount rates applied to future liability streams. Take Chicago's largest pension fund, the Municipal Employees Annuity and Benefit Fund of Chicago (MEABF), as an example. Most people focus on a funds 'net funded status', which for the MEABF is a paltry 20.3%. But the problem with focusing on 'funded status' is that it can be easily manipulated by pension administrators who get to simply pick the rate at which they discount future liabilities out of thin air...


So, rather than lend any credence to some made up pension math, we prefer to focus on actual pension cash flows which can't be manipulated quite so easily. And a quick look at MEABF's cash flows quickly reveals the ponzi-ish nature of the fund. In both 2015 and 2014, the fund didn't even come close to generating enough cash flow from investment returns and contributions to cover it's $800mm in annual benefit payments, which basically means they're slowing liquidating assets to pay out liabilities...



Of course, like all ponzi schemes, liquidating assets to pay current claims can only go on for so long before you simply run out of assets. So we decided to take a look at when Chicago's largest pension fund would likely run out of money. On the expense side, annual benefit payments are currently just over $800 million and are growing at a fairly consistent pace due to an increasing number of retirees and inflation adjustments guaranteed to workers. Assuming payouts continue to grow at the same pace observed over the past 15 years, the fund will be making annual cash payments to retirees of around $1.3 billion by 2023...


Investment returns, on the other hand, are much more volatile but have averaged 5.5% over the past 15 years. That said, the fund took big hits in 2002 (-9.3%) and 2008 (-27.1%) following the dotcom and housing bubble crashes. But, just to keep it simple, lets assume that today's market is not a massive fed-induced bubble and that the MEABF is able to produce consistent 5.5% (their 15-year average) returns every year in perpetuity. Even then, the fund will only generate roughly $500mm per year in income compared to benefit payments growing to $1.3 billion, see the problem?


Which, of course, means that the fund has likely just entered a period of perpetual cash outflows which will not stop until either (i) the city decides to cut back retiree payments or (ii) the fund runs out of money. And, putting it all together, even if Chicago's largest pension generates consistent positive returns for the foreseeable future, it will literally run out of cash in roughly 6 years...


And while we hate to be pessimistic, lets just take a look at what happens if, by some small chance, today's market gets exposed as a massive bubble and we have another big correction in 2018. Such a correction would force the fund to liquidate over $1.5 billion in assets in 2018 alone....


And the system would run out of cash completely within 4 years...


The risk associated with America's pension ponzi schemes have largely been overlooked by investors to date because so long as they can meet annual benefit payments then plan administrators can just continue to 'kick the can down the road' and pretend that nothing is wrong. Of course, that strategy ceases to work when the pensions actually run out of cash, which could happen sooner than you think and when it does, America's retirees will suddenly find themselves about $5 trillion poorer than they thought they were....

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