Gov. Cuomo and the state Legislature have agreed to let hard-pressed municipalities lower their annual pension contributions. But state officials and independent analysts note that many of the worst public-pension problems around the country began with similar short-term efforts to save money by short-changing retirement systems.
New Yorkers need look no further than New Jersey to understand how a pension system can spin out of control when government underfunds retirement costs. In Jersey, which has one of the worst-funded state retirement systems, even recent reforms haven’t done much to dig the state out of its hole. According to a new report, the pension system earned just a 2.52 percent investment return in fiscal 2012, and its funding hole grew larger by $5.5 billion.
Although New York’s system is better funded, its entire financial design is based, like Jersey’s, on aggressive and risky assumptions of future investment earnings, so that just a few wrong moves could quickly saddle Empire State taxpayers with the same kind of financial worries that Jersey will be grappling with for decades.
In Jersey’s case, the gimmicks started in 1992, when under the guise of “reform” the state passed legislation that allowed it to calculate pension assets in a way that made the system seem better funded than it was. That permitted the state to contribute $1.5 billion less to it over several years.
By 1997, state officials were already worried that the system’s debt was growing too big. That year, the state concocted a plan to borrow $2.7 billion and invest the money in financial markets for the pension system. Jersey’s investment managers, however, had to earn a 7.6 percent annual return just to equal the interest that the state would pay on the borrowed money. When financial markets took a deep dive after the dotcom stock bubble burst in early 2000, the pension borrowing backfired, costing the state money.
To hide growing problems, the state’s legislative leaders then started misleading taxpayers by describing the assets in the pension funds as if it were still 1999, before the stock meltdown. Jersey even carried out this fiction in financial documents issued from 2002 through 2004, for which the Securities and Exchange Commission eventually charged the state with fraud.
Saddled with deep debt, Jersey avoided paying billions of dollars in annual pension payments, until some experts began predicting in 2009 that the system would go bust in a few years. Finally, the state enacted reform in 2011 that rescinded unaffordable pension enhancements. But the state only slightly reduced its projections of future investment returns to 7.9 percent, from 8.25. To have cut the projections much more would have revealed a far higher level of pension debt and required that Jersey pour even more taxpayer money into the system.
That’s now Jersey’s problem, and potentially New York’s, too. Given Jersey’s high estimated rates of return dating back years, today the Dow Jones Industrial Average would have to be at about 26,000 for the system to be adequately funded.
It only gets worse. By 2020 (just eight years from now), Jersey’s investment managers would require market returns equivalent to the Dow at 43,000 to be adequately funded. By 2030, the system needs a Dow at 93,000, and by 2050, 430,000.
And if you are a Jersey taxpayer worried about the legacy you leave your grandchildren, consider this: Under current assumptions, Jersey’s pension system must achieve the equivalent of the Dow at 19 million by the year 2099.
New Yorkers must understand that even though their system is better funded than Jersey’s, the cost of sustaining it is rising because the system’s aggressive investment assumptions also require similar investment gains.
As Warren Buffett pointed out several years ago, pension-fund managers tend to tout their successes whenever they have a good quarter.But they need to maintain those gains over years to keep these systems solvent. Yet most private market analysts now predict we’re in the middle of an extended period of low interest rates and modest growth that make such heady returns unlikely.
Recognizing this, some states have switched to 401(k)-style retirement accounts for government workers, or to “hybrid” models that combine a modest defined-benefit plan with a 401(k) account. The reform is meant to end the unlimited liability that taxpayers face from unrealistic market projections.
In contrast, Gov. Cuomo’s proposal and gimmicks like it represent little more than an effort to bury the problem in the short term and hope that eventually the market will surge enough to ease the funding challenges for the next generation — when future leaders will have to deal with them in any case.
That’s exactly what Jersey banked on for years. Now the state’s taxpayers are left hoping for a Dow of 43,000 in the next several years, and practically unimaginable gains beyond that.