How governments measure the value of pension assets

Covering Up the Pension Crisis

States and actuaries are trying to stifle debate about the growing shortfall in fund assets.

Plunging investment returns have sent debt soaring in state and local pension funds and prompted new financial concerns. Meanwhile, a debate has broken out about whether these pension funds are accurately measuring their obligations. Though the issues might seem arcane, the stakes are high for taxpayers who might have to bail out these funds and for public employees who rely on them for retirement.

On Aug. 1, the American Academy of Actuaries and the Society of Actuaries shut down a on pension financing when several members were about to publish a paper that found many state and local retirement systems calculate their obligations using overly optimistic future rates of return. The authors want states and municipalities to adopt new valuation standards that would make projecting the cost of future benefits more predictable.

The problem is that this change would also make many public pension funds seem far more indebted than they are under current standards. Such a change would produce more pressure on politicians to boost funding and cut benefits.

One of the task-force members, Edward Bartholomew, blasted the AAA and the SOA in an interview with the trade publication Pensions & Investments. This paper [is] being censored, he said. They didnt want it to get out. In a memo about the controversy, the AAA and SOA said they intended to block any attempt by task-force members to publish their work independently because that would be inappropriate.

The spat is part of a growing fight over how governments measure the value of pension assets. Private-sector retirement funds follow guidelines set by the Financial Accounting Standards Board. But states and municipalities follow voluntary rules from the Government Accounting Standards Board.

One crucial difference is that private pension systems must project the future growth of their assets using a conservative risk-free rate of return based on U.S. Treasurys, but public pension funds can adopt a higher rate. The difference, compounded over time, can account for enormous variations in pension asset calculations.

Government pension funds on average estimate they will earn 7.6% a year on their portfolios, according to a survey by the National Association of State Retirement Administrators. Using that number, the funds say they are currently about $1 trillion short of the money they will need to fund pension credits that workers have already earned. But if pension systems were required to use a riskless rate, currently below 3%, the shortfall would soar to more than $3 trillion.

Government officials have long argued that they should be allowed to employ the higher number because governments dont go out of business the way private companies do. That gives states and municipalities a much longer window to recover from bad investments.

The problem is that the arbitrary nature of the valuation standards allows elected officials to pressure pension systems to adopt overly optimistic assumptions, which can make offering new benefits to public workers seem more affordable and more attractive.

As Jeremy Gold, one author of the task-force paper, said in a September speech: Consistent lowballing of pension costs over the past two decades has made it easy for elected officials and union representatives to agree on very valuable benefits, for very much smaller current pay concessions.

But when pension funds fail to deliver on these lofty projectionsas many across the country have in the past decadepension debt soars. According to a July 2015 report by the Pew Charitable Trusts, since 2005 the unfunded liabilities reported by state pension systems have risen by nearly threefold from $339 billion to nearly $1 trillion thanks in part to investment shortfalls.

Some actuaries say theyve been reluctant to speak up about optimistic valuations because they could lose their jobs. When the Montana state pension system sought to hire new actuaries in 2009, it issued guidelines stating that any firm arguing that government pension funds should adopt more conservative valuation standards may be disqualified from further consideration. A May 2009 editorial in Pensions & Investments noted that there had been rumors for years of similar threats by other pension systems to prevent firms from expressing their reasoned positions on unsettled issues.

Yet as the government pension crisis widens, more voices like those on the task force are calling for reform. Meanwhile, firms working for government pension systems now face a different kind of pressurein the courts. In 2014 retirees of bankrupt Detroit sued Gabriel, Roeder, Smith & Co., the actuary for the citys pension, contending that the firms accounting helped the citys pension trustees cover up problems in the plans finances that resulted in benefit cuts to workers. The litigation is pending.

The public dispute over accounting standards is a signal to taxpayers, retirees and political reformers that fundamental flaws remain in how pensions measure their finances. The beginning of the end of this crisis wont arrive until more reasonable, less risky standards are in place.

Have You Checked Your Risk Level Lately?

Federal obligations and guarantees have ballooned since 2009. Taxpayers are on the hook for trillions.

If you asked most Americans how much loan risk theyve undertaken over the last decade, they would probably look puzzled. Few are in the lending business.

But how about the risk Americans have taken on collectively, through the lending and loan guarantees of the federal government? The exposure of taxpayers to delinquencies and defaults on federal loans and guarantees has ballooned since 2009. Add that to the soaring national debt and the excessive obligations of federal entitlement programs and you have what some might call an existential issue.

Stimulus programs have more than doubled the national debtwhile providing little stimulussince Barack Obama took office. The budgetary cost of servicing that debt will double over the next decade, even if the Federal Reserve manages to keep interest rates at current low levels. Its also widely understood that without serious reforms there is no way the government can fulfill the promises made to oldsters and the disabled by Social Security and other safety-net programs.

Less attention has been paid to the degree to which Washington has socialized lending risk. That too was part of the program when Mr. Obama was elected and progressives took full control of government in 2009-10. What they accomplished in two years of revolutionary zeal still affects the U.S. today, a mounting potential liability bigger than most taxpayers are aware of.

Yes, the student-loan fiasco has gotten a lot of attention. Since the 2010 federal takeover of lending to college students, loans outstanding have soared 64% to over $1.3 trillion. About one-fifth of these loans are in arrears and that is an understatement, as the Journal has reported, because it doesnt take account of forbearance and deferments.

But in the popular press, this is usually looked upon as a problem for the students, which of course it is. Those who are paying off big loans but whose degrees arent earning them big paychecks have to defer other wants, like homeownership or new cars. Yet if defaults become epidemic or the government broadens loan forgiveness, it will become a problem for taxpayers as well. More taxes or more borrowing will be needed to cover some very .

The student-loan fiasco and the failing Obamacare health-insurance takeover will have to be reformed to avoid very large taxpayer bailouts. But there are also the risks the progressives have loaded onto taxpayers on behalf of the powerful housing and banking lobbies. For all practical purposes, home-mortgage finance has been nationalized. Fannie Mae and Freddie Mac, the two onetime government-sponsored secondary finance giants went bust in 2008 when their toxic mortgage-backed securities played a central role in the 2008 market crash. George W. Bushs government extended them a $200 billion line of credit and put them in conservatorship, meaning effective government control.

Thats where they have remained under President Obama, except that whereas they once had implicit government backing, it is now explicit. With the aid of Moodys Analytics, the Economist magazine recently estimated that in another housing crisis the U.S. taxpayers exposure would run between $300 billion to $600 billion. Even without a crisis, the Economist estimates that the taxpayer subsidy for housing debt is $150 billion a year.

The Fed and other regulators insist that mortgage originators are more careful than they were in the days of liar loans a decade ago. They also assert that Americas banks are better capitalized than in 2008, thanks to stricter regulatory oversight. They seldom mention that one reason for the is that banks have loaded up on taxpayer-guaranteed securities.

According to the latest Federal Deposit Insurance Corp. bank condition statement, ownership of government securities (including state and local) by the 5,289 Federal Reserve member banks now represents 14% of their portfolios, almost double the share five years ago. The latest number far exceeds outstanding commercial and industrial loans and loans to individuals, (e.g., credit cards).

The Fed provides a big helping hand. Securities purchases under its quantitative easing program included a large volume of mortgage-backed securities along with Treasury bonds. Because the Feds portfolio is so huge, $4.4 trillion, its rollovers of maturing securities with new purchases help keep interest rates low on both Treasurys and mortgage-backed securities.

Some taxpayers might see some reason for concern about how all this might play out in the event of another market crisis. Apparently those worriers dont include Americas two leading presidential candidates. Hillary Clinton wants to make college free and plunge the country deeper into the socialized-risk pit her fellow Democrats created. As for Donald Trump, he boasts of being the king of debt.

Heres a question for their first debate, scheduled for Sept. 26: Please talk about the federal government and the hundreds of billions in lending risk it has exposed taxpayers to: Is it too big to fail?