Pension Crisis Too Big for Markets to Ignore
We have heard about the California Public Employees’ Retirement System; the budget cliff facing San Francisco; six Los Angeles public safety officers who collected over $1 million apiece last year in pensions; and eight cities that could face bankruptcy when the next recession hits. Then there was the latest on the fiasco unfolding in Dallas, an update on Houston’s situation and features on states that have become the other usual suspects—Connecticut, Illinois and New Jersey.
Why haven’t the headlines presaged pension implosions? Call it the triumvirate of conspirators—the actuaries, accountants and their accomplices in office. Throw in the law of big numbers, and we have a disaster in the making. Unfunded pension obligations have risen to $1.9 trillion from $292 billion since 2007.
Pensions’ flight from safety has coincided with the drop in interest rates. Public pensions discount their liabilities using the rate of returns they assume their overall portfolio will generate. In fiscal 2016, the average return for public pensions was somewhere around 1.5%.
Too many cities would buckle under the weight of more realistic assumed rates of return if truth were required in public pension math. By some estimates, unfunded liabilities would triple to upwards of $6 trillion if the prevailing yields on Treasuries were used.
Just under half of pension assets are in the second-most overvalued stock market in history. Even as Fed officials fret about commercial real estate valuations, pensions have socked away 8% of their portfolios into this less-than-liquid asset class. Even further out on the risk and liquidity spectrum is the 10% that pensions have allocated to private equity and limited partnerships.
How many pensions are hedged in case of a correction? Will it be their bond, stock, real estate or private equity holdings that shield their portfolios? Or will it be none of the above?