the state of unfunded state pension obligations

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the state of unfunded state pension obligations

Post by larryswedroe » Wed Aug 28, 2013 8:14 am

http://www.cbsnews.com/8301-505123_162- ... ligations/

Really ugly situation in many states, IMO there will be defaults, not question of if, it's only a question of what form (whether bond defaults or more likely default on the obligations themselves). Both investors and those who expect pension benefits should be aware.

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Re: the state of unfunded state pension obligations

Post by Jfet » Wed Aug 28, 2013 8:21 am

worms, can, open

*grab's popcorn*

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Re: the state of unfunded state pension obligations

Post by Grt2bOutdoors » Wed Aug 28, 2013 8:27 am

I can see it happening in my state. I think there are some substantial changes being made including the freezing of wages, layoff though attrition, and unfortunately revenue raising efforts. :( One of my neighbors retired at the ripe old age of 50 with a pension of 70% of final pay and free healthcare for life, is it any wonder they are going broke? They know the writing is on the wall, they're grabbing what the can, before the cuts come and even admitted as much.
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Re: the state of unfunded state pension obligations

Post by ofcmetz » Wed Aug 28, 2013 8:41 am

Thanks for the article again Larry. I realize you wrote it more from the point of the investor in bonds, but it's also important for those workers who plan on receiving the majority of their retirement benefits from one of the pensions. They need to realize that things aren't as rosy as they would like to believe.
What seems likely is that we could see employees being required to make greater contributions to their pensions. It's also possible that some pensioners will not receive the benefits they expected and are counting on. It might come in a direct cut in benefits or perhaps via a change in the COLA adjustments.
- Swedroe


I'm a member of LASERS here in Louisiana. According to the last annual statement, my pension is 55.9% funded assuming an annual return of 8%. It's been several years since the plan has given out a COLA. (In their defense they are promoting the 457B plan as a way for workers to keep up with inflation in retirement.) Newer employees have had their contribution rates raised higher and are needing to work longer to get the same benefits. The state froze the pay of employees for the last few years. I see all these changes as helping a little, but not addressing the real problem which is that the state never put in enough money.

An overwhelming majority of my coworkers are relying almost exclusively on their pension for all their retirement income as we don't participate in social security. A few put a token amount of say $50 to $100 per paycheck into the 403B or 457B, but even they are the minority. The retirement plan constantly sends emails telling everyone to ignore what they hear in the news about the plan and to trust that the plan is sound and will be fully funded by 2029. I already hear the grumbling from many private sector workers who talk about the lavish retirement benefits that have been promised. This is not going to end well.
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Re: the state of unfunded state pension obligations

Post by bottomfisher » Wed Aug 28, 2013 8:51 am

Additional comment on Louisianas pension liabilities. In recognizing our underfunded liabilities, legislation passed in 2012 to change the system for new state workers that would have shifted them from a traditional pension into a 401(k)-like, or "cash balance," retirement plan. While the plan was passed by a simple majority in both chambers, some lawmakers said the change required a two-thirds vote because it would result in an increase in cost to the state. The Louisiana Supreme Court struck down the controversial change made to the retirement system for new state workers, saying the legislation did not garner enough votes when it was originally passed in 2012. It appears that legislators recognize the issue and plan to go back to the drawing board and hopefully agree to some sort of compromise.

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Re: the state of unfunded state pension obligations

Post by YttriumNitrate » Wed Aug 28, 2013 8:58 am

When you factor in population growth rates, Illinois looks even worse. California will be able to counteract some of the pension obligations with its 10% population growth last decade. Illinois, having just a 3.3% increase, won't be so lucky.

http://www.census.gov/prod/cen2010/brie ... 0br-01.pdf

It's certainly a word of warning for any state employees and highlights their need for retirement savings in addition to their pensions.

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Re: the state of unfunded state pension obligations

Post by Grt2bOutdoors » Wed Aug 28, 2013 9:04 am

I'd like to ask a question: If someone works for 20 years, puts in 9% of their annual salary and receives a 9% contribution into the same account (a dollar for dollar match) invested in a typical 60/40 mix would that be enough to support a retirement income of 70% of ones highest 3 years of salary? It's easy to see the math doesn't compute, so why would folks be surprised if their "dream" didn't come true?

If the going recommendation is to do as Bobcat2 suggests in the recent thread "It's the income, stupid!" - then perhaps switching to liablity matching is the better mousetrap?
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Re: the state of unfunded state pension obligations

Post by Ged » Wed Aug 28, 2013 9:10 am

Here in NJ a lot of changes have been made to the pension system. COLA is a thing of the past. Participants are contributing a lot more.

Will it be enough? Hard see how. The state is still not contributing enough and the hole is getting bigger. The administration of the assets is being done in a less than sound manner (too much dependence on 'alternative investments') and the future return estimates are unrealistic.

My wife is tied into this pension system. Fortunately it's not a critical piece of our retirement income; we would be fine without it.

My main complaint about this is that not fixing it right the first time means that it's going to cost even more to fix long term.

Ultimately states need to dump defined benefit and go to defined contribution.

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Phineas J. Whoopee
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Re: the state of unfunded state pension obligations

Post by Phineas J. Whoopee » Wed Aug 28, 2013 9:17 am

I think it also would behoove all of us who are still in the labor market to be more skeptical than perhaps we might have been before about the potential for retroactive changes to compensation. One should consider how many of the benefits rely on somebody doing something years in the future, rather than this payday; even if that somebody appears rock solid today.

I agree that in many states and municipalities the situation will not end well.

PJW

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Re: the state of unfunded state pension obligations

Post by Grt2bOutdoors » Wed Aug 28, 2013 9:18 am

Ged wrote:Here in NJ a lot of changes have been made to the pension system. COLA is a thing of the past. Participants are contributing a lot more.

Will it be enough? Hard see how. The state is still not contributing enough and the hole is getting bigger. The administration of the assets is being done in a less than sound manner (too much dependence on 'alternative investments') and the future return estimates are unrealistic.

My wife is tied into this pension system. Fortunately it's not a critical piece of our retirement income; we would be fine without it.

My main complaint about this is that not fixing it right the first time means that it's going to cost even more to fix long term.

Ultimately states need to dump defined benefit and go to defined contribution.
What constitutes "alot more" in terms of contribution percentage increase year over year? I have friends who are in the same system, they aren't indicating the higher contributions are "alot more" that makes a noticeable impact on their after-tax paycheck.

I think the writing is on the wall - there is a solution but it's not palatable right now, so they offer to place a little more seasoning on the food in the hopes they can sell a mirage. Eventually the participants will see what they thought was a large shimmering blue lake in the midst of a large desert was nothing but a small pond unable to support more than just a few.
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Re: the state of unfunded state pension obligations

Post by Riprap » Wed Aug 28, 2013 9:23 am

What are the practical implications of this article for a Vanguard muni bond fund investor? For many, building an individual bond portfolio is not a realistic alternative.

For me, I have to have a certain amount of faith that Vanguard's research team does an adequate job of screening the bonds it holds. Other than that, the only option I see is to avoid tax-exempt funds altogether.

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Re: the state of unfunded state pension obligations

Post by Ged » Wed Aug 28, 2013 9:30 am

Grt2bOutdoors wrote: What constitutes "alot more" in terms of contribution percentage increase year over year? I have friends who are in the same system, they aren't indicating the higher contributions are "alot more" that makes a noticeable impact on their after-tax paycheck.
The reason your friends are not seeing a big difference is that it's being phased in slowly. Boiling frog approach. The end point will be 10% or 8.5% depending on job type.

For new employees they are also capping the max salary used for benefit calculations at the SS max.

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Re: the state of unfunded state pension obligations

Post by stat5 » Wed Aug 28, 2013 9:31 am

The retroactive benefit increases in CA didn't help.

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Re: the state of unfunded state pension obligations

Post by larryswedroe » Wed Aug 28, 2013 9:32 am

Few thoughts
Not much choice for typically retail investors, and at least a fund will be well diversified across issuers.
It's one of the real advantages of a separate account manager is to tailor the credit risks.

Larry

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Re: the state of unfunded state pension obligations

Post by Grt2bOutdoors » Wed Aug 28, 2013 9:36 am

Ged wrote:
Grt2bOutdoors wrote: What constitutes "alot more" in terms of contribution percentage increase year over year? I have friends who are in the same system, they aren't indicating the higher contributions are "alot more" that makes a noticeable impact on their after-tax paycheck.
The reason your friends are not seeing a big difference is that it's being phased in slowly. Boiling frog approach. The end point will be 10% or 8.5% depending on job type.

For new employees they are also capping the max salary used for benefit calculations at the SS max.
I hear state fire and police have already been contributing 9% of salary for the longest time. Using my previous example, I don't see how even with a dollar for dollar match they could possibly think that an 18% contribution level over 20 years would be able to generate 70% of highest 3 years for potentially 35 years of retirement. The numbers just don't compute or they'd have to have outlandish predictions on expected return.

They obviously did not use Brooks Hamilton's consulting service, he was quoted on Frontline saying a contribution percentage of 20-25% starting at age 25 and 40 years of contributions needed to replace 60% of final salary with social security. It really boggles (no pun intended) the mind.
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Re: the state of unfunded state pension obligations

Post by effillus » Wed Aug 28, 2013 9:45 am

I live in Illinois and am part of the State University Retirement System. Of course, Illinois is the poster child of the pension mess. It has the most underfunded pension system in the nation. Because of political gridlock, the state legislature and governor have been unable to come up with a plan to deal with the situation. However, a bipartisan legislative committee has been meeting over the past several weeks to come up with a compromise. Interestingly, they say that adjusting the pension COLA provision, with provides for a 3 percent cost of living increase each year, compounded, would take care of most of the problem. I don't remember the details of the adjustment, but this seems like a relatively doable solution. I know this would affect retirees, of which I hope to be one myself someday, but like I said, this seems doable. No need to bring the entire system down. It's not an impossible situation, it's a matter of political will.

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Re: the state of unfunded state pension obligations

Post by MnD » Wed Aug 28, 2013 10:04 am

Colorado contributions are on a path by 2018 to 20.15% employer (taxpayer), 8% employee.
The benefit formula for new employees has been trimmed and the COLA formula has been altered for everyone (including retirees).

I don't know if 28.15% is "enough", but that's a pretty good chunk of change going in.
The road to 20.15% is a huge drag on school districts so a revenue measure for "education" is on the ballot for this fall.

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Re: the state of unfunded state pension obligations

Post by ps56k » Wed Aug 28, 2013 10:10 am

YttriumNitrate wrote:When you factor in population growth rates, Illinois looks even worse. California will be able to counteract some of the pension obligations with its 10% population growth last decade. Illinois, having just a 3.3% increase, won't be so lucky. http://www.census.gov/prod/cen2010/brie ... 0br-01.pdf
It's certainly a word of warning for any state employees and highlights their need for retirement savings in addition to their pensions.
YUP - wife is a teacher in Illinois - TRS - and it has not been funded since the 1970's, even though the teachers pay their share 100% of each payroll check. One proposal is to push the state's pension portion back to each individual school district, which in turn gets its funding from local property taxes.

Oh yeah - here's another kicker that most people don't know. The Illinois teachers can't get SS benefit payments, that is forfeited with Illinois TRS. In other words, if you came from industry, where you PAID into SS, you now LOSE any/all SS benefits as a TRS person.

total pension detailed in Illinois State Constitution = 18%
teacher contribution = 9% (100% of each payroll check)
school district contribution = 1% (100% of each payroll period)
Illinois State contribution = 8% ( NEVER ) - maybe the FOUR Illinois govs sent to prison had something to do with it.
Last edited by ps56k on Wed Aug 28, 2013 10:26 am, edited 5 times in total.

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Re: the state of unfunded state pension obligations

Post by Grt2bOutdoors » Wed Aug 28, 2013 10:14 am

ps56k wrote:
YttriumNitrate wrote:When you factor in population growth rates, Illinois looks even worse. California will be able to counteract some of the pension obligations with its 10% population growth last decade. Illinois, having just a 3.3% increase, won't be so lucky. http://www.census.gov/prod/cen2010/brie ... 0br-01.pdf
It's certainly a word of warning for any state employees and highlights their need for retirement savings in addition to their pensions.
YUP - wife is a teacher in Illinois - TRS - and it has not been funded since the 1970's, even though the teachers pay their share 100% of each payroll check. One proposal is to push the state's pension portion back to each individual school district, which in turn gets its funding from local property taxes.
I'm sure that proposal is going to go over real well. Look for that to be a non-starter at the local breakfast spot in town. They are doing that in NYS, if you think property taxes are high now, just look to Long Island to see what will come your way.
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Re: the state of unfunded state pension obligations

Post by Taboose » Wed Aug 28, 2013 10:22 am

My thanks to Larry for a reasoned article regarding this problem. Its also a pleasure to read cogent replies and discussion without the hysteria this usually brings. My spouse and I will be highly dependent on public pensions. Fortunately, one set will be from one of those states with a sub 20% ANPL to which Larry refers. My wife will also receive a pension from one of the many Texas state systems that recognized the problem several years ago and has taken steps to deal with it. I will get a pension from a municipality which adjusted their system approx 10 yrs ago and re-evaluates the contribution rates annually. Employees are at 13% and the city is at 20% with another slight increase this year.

We need to take care that we don't paint all states and other public entities with the same brush. Some are in good shape and some are a mess and have promised entirely too much and were never funded properly.

Regards

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Re: the state of unfunded state pension obligations

Post by ofcmetz » Wed Aug 28, 2013 10:30 am

Grt2bOutdoors wrote:I'd like to ask a question: If someone works for 20 years, puts in 9% of their annual salary and receives a 9% contribution into the same account (a dollar for dollar match) invested in a typical 60/40 mix would that be enough to support a retirement income of 70% of ones highest 3 years of salary? It's easy to see the math doesn't compute, so why would folks be surprised if their "dream" didn't come true?

If the going recommendation is to do as Bobcat2 suggests in the recent thread "It's the income, stupid!" - then perhaps switching to liablity matching is the better mousetrap?
In my case I put in 9.5%, the state currently puts in 30% of my salary, average is calculated for 5 years salary, and years needed for 82.5% retirement are 25. So that's something approaching 40% of my salary each year for 25 years. Problem is for about 30 years the state used the money they were going to put in for other things, and they have really only been putting in their portion since the late 80's or so. I'd love a more portable retirement where I could keep the 30% match and investment returns on my portion. Or maybe even if I could get paid 30% more and do my own saving. All I get if I leave the system and pull out is what I put in with no interest.
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Re: the state of unfunded state pension obligations

Post by reisner » Wed Aug 28, 2013 10:36 am

The issue is even more complicated by the various entities often covered by a state pension program. Moody's actually upgraded the state portion of CalPers--the real problems here coming from municipalities like San Diego, where a corrupt city council gave away the farm to retiring workers back in the late 1990s. Legal attempts to claw back this giveaway have so far failed. Even within the state portion variety (read, inequity) abounds. As a professor at SDSU I retired at 70% after 33 years of service, contributing all the while to my pension and health care. I met a parole officer who also retired at 70%, but after 23 years of service with no contribution to either pension or health benefits, and her final salary was much higher than mine and her years of pre-job training far fewer.

If state pensions begin to fail, will the cuts be across the board, or will legislatures and courts be up to addressing these inequities?

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Re: the state of unfunded state pension obligations

Post by thx1138 » Wed Aug 28, 2013 11:07 am

Thanks for the article on a growing issue.

As someone lucky enough to have learned financial planning early in life and able to save quite a bit I've always thought of pensions as an awful thing I want no part of. Both because of the mismanagement outlined here but also because they hinder mobility. Unfortunately most people aren't in my situation and defined contribution often works out poorly for them, so what is good for me isn't necessarily the best for everyone.

It sure looks like two different trains are going to wreck at about the same point. Underfunded defined benefit plans will collapse and any attempt to save them will be perceived as a luxury or graft because at about the same time people who failed to contribute to defined contribution plans will be coming up short as well.

Presently I don't have muni exposure but I suspect relatives do, some of it individual bonds I don't doubt. I'll need to manage that at some point and wonder what it will look like when the time comes.

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Re: the state of unfunded state pension obligations

Post by Jfet » Wed Aug 28, 2013 11:19 am

I agree with thx1138. Drastic increases in property taxes to fill the funding gaps will not go over well with people approaching or in retirement living off of defined contribution plans or SS...unless we get back to 4% real returns on treasuries or something. Expecting a 8% guaranteed return on pension fund in today's environment of 3% inflation is a 5% real return. I would do backflips for a guaranteed 5% real return in my 401K.

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Re: the state of unfunded state pension obligations

Post by larryswedroe » Wed Aug 28, 2013 1:13 pm

here's the problem called the death spiral, which hit Detroit
You raise tax rates and property taxes and wealthy people leave the state as do businesses, and then you have to raise them even more. The state is eventually left with high percentage of lower income people who need benefits and the state cannot provide. This is the problem for Illinois, and the longer they delay the worse it will get. It's already impacting California as wealthy people leave and so are businesses--even DFA left the state.

Larry

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Re: the state of unfunded state pension obligations

Post by Jfet » Wed Aug 28, 2013 1:25 pm

It is a problem with no good solution, which is why it makes interesting conversation.

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Re: the state of unfunded state pension obligations

Post by staythecourse » Wed Aug 28, 2013 1:35 pm

It will be interesting to see how things work out. The problem is NOT finding an intelligent way to deal with these issues. The problem is you are dealing with the HIGHEST levels of beuacracy and special interest that exist in the local/ state legislatures, i.e. politics and unions.

Good luck to see any appreciable advancement in many of these issues.

I see more delaying the inevitable in delaying benefits, increased contributions, pay into healthcare after retirement, etc... from the new hires. Will not be surprised the whole pension system start looking more like Ponzi scheme.

Good luck.
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Re: the state of unfunded state pension obligations

Post by ryuns » Wed Aug 28, 2013 1:44 pm

reisner wrote:The issue is even more complicated by the various entities often covered by a state pension program. Moody's actually upgraded the state portion of CalPers--the real problems here coming from municipalities like San Diego, where a corrupt city council gave away the farm to retiring workers back in the late 1990s. Legal attempts to claw back this giveaway have so far failed. Even within the state portion variety (read, inequity) abounds. As a professor at SDSU I retired at 70% after 33 years of service, contributing all the while to my pension and health care. I met a parole officer who also retired at 70%, but after 23 years of service with no contribution to either pension or health benefits, and her final salary was much higher than mine and her years of pre-job training far fewer.

If state pensions begin to fail, will the cuts be across the board, or will legislatures and courts be up to addressing these inequities?
I was going to mention this with regard to the examples people mentioned earlier about the mathematical near-impossibility of the contribution + appreciation matching payouts. But the fact is that there is massive inequality to how payouts are calculated. Contributing 18% total for 20 years is unlikely to fund a thirty year retirement. However, contributing 18% for 30 years, to 60-80% of final three year salary for 15 years (retirement age of 62 or 65, life expectancy of 77) makes a little more sense. To your final question, I have no idea if they'll do anything about this. In California at least, some very reasonable but minimal changes have been adopted for new employees. It seems they wanted to avoid the third rail of affecting already-promised benefits, and they'll just cross their fingers for more high return years like this one.
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Re: the state of unfunded state pension obligations

Post by bobcat2 » Wed Aug 28, 2013 3:02 pm

Grt2bOutdoors wrote:I'd like to ask a question: If someone works for 20 years, puts in 9% of their annual salary and receives a 9% contribution into the same account (a dollar for dollar match) invested in a typical 60/40 mix would that be enough to support a retirement income of 70% of ones highest 3 years of salary? It's easy to see the math doesn't compute, so why would folks be surprised if their "dream" didn't come true?

If the going recommendation is to do as Bobcat2 suggests in the recent thread "It's the income, stupid!" - then perhaps switching to liablity matching is the better mousetrap?

Pension problems are not unique to state and local governments in the US. The Canadian province of New Brunswick has also had to deal with serious shortfalls in its pension obligations. New Brunswick’s new Shared Risk pension model is designed to respond to future shocks in an orderly and predictable way and to help head off trouble in advance.
New Brunswick’s Shared Risk program has three key elements: 1) a new design that splits plan benefits into highly secure “base” benefits and moderately secure “ancillary” benefits; 2) protocols that require pre-determined actions to change future benefits, contributions, and asset allocations in response to changes in the plan’s financial condition; and 3) a new risk management regulatory framework to keep these plans on track. The “base” and “ancillary” benefit design is based on the widely admired approach developed in The Netherlands. The new regulatory framework is largely based on Canada’s “stress test” methods for supervising banks and insurance companies.3 The key innovation is to combine these elements into a coherent pension program.

The Shared Risk plan guarantees base benefits, but only grants ancillary benefits if allowed by the plan’s financial condition. The funding program is then designed to ensure that both base and ancillary benefits will be paid with a high degree of likelihood. But the plan sponsor also specifies protocols for responding to changes in the plan’s financial condition: how to increase contributions, change asset allocations, and reduce benefits in response to funding deficits; and how to reduce contributions, change asset allocations, and restore benefits, including restoring previous benefit reductions, and grant ancillary benefits when the plan’s financial condition improves.
Link to article - http://crr.bc.edu/wp-content/uploads/2013/07/slp_33.pdf

Notice the similarity in this plan to the life-cycle approach to individual retirement planning where the household plans for both a safe floor level of retirement income as well as a higher aspirational level of retirement income that is not as secure as the floor income goal.

BobK
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Re: the state of unfunded state pension obligations

Post by technovelist » Wed Aug 28, 2013 3:09 pm

Riprap wrote:What are the practical implications of this article for a Vanguard muni bond fund investor? For many, building an individual bond portfolio is not a realistic alternative.

For me, I have to have a certain amount of faith that Vanguard's research team does an adequate job of screening the bonds it holds. Other than that, the only option I see is to avoid tax-exempt funds altogether.
I can't imagine owning municipal bonds in the current economic climate.
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Re: the state of unfunded state pension obligations

Post by Jfet » Wed Aug 28, 2013 3:22 pm

technovelist wrote: I can't imagine owning municipal bonds in the current economic climate.
+1

They just don't pay enough to offset the risk. I would rather take stock market risk right now than muni bond risk. Not only do you have low rates + interest rate risk, you also have default risk, perhaps on a scale we have not seen before.

Imagine having your retirement funds invested in muni bonds which default to pay for someone else's retirement. Not a pretty picture.

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Re: the state of unfunded state pension obligations

Post by freebeer » Wed Aug 28, 2013 3:45 pm

Jfet wrote:
technovelist wrote: I can't imagine owning municipal bonds in the current economic climate.
+1

They just don't pay enough to offset the risk. I would rather take stock market risk right now than muni bond risk. Not only do you have low rates + interest rate risk, you also have default risk, perhaps on a scale we have not seen before.

Imagine having your retirement funds invested in muni bonds which default to pay for someone else's retirement. Not a pretty picture.
Huh, I thought it was a general Bogleheads principle that risk gets priced in by the market. If there is research that indicates that this is not the case at the moment for muni bonds I'd love to see it. Personally I would suspect the opposite kind of price imbalance - that highly-publicized but isolated events like Detroit defaulting have caused prices to drop more than is called for, making muni bonds a particularly good investment right now, despite the evident risk of further such defaults. But then again my personal suspicion is not based on data anyone else doesn't have so I would expect that arbitrage has resulted in an equilibrium price that is fair, not being either good or bad.

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Re: the state of unfunded state pension obligations

Post by Riprap » Wed Aug 28, 2013 3:47 pm

Jfet wrote:I would rather take stock market risk right now than muni bond risk.
Just to be clear, would it be safe to say that your advice for a mostly taxable investor is to dump fixed income for stocks? To heck with an investment plan? :confused

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Re: the state of unfunded state pension obligations

Post by technovelist » Wed Aug 28, 2013 3:53 pm

freebeer wrote:
Jfet wrote:
technovelist wrote: I can't imagine owning municipal bonds in the current economic climate.
+1

They just don't pay enough to offset the risk. I would rather take stock market risk right now than muni bond risk. Not only do you have low rates + interest rate risk, you also have default risk, perhaps on a scale we have not seen before.

Imagine having your retirement funds invested in muni bonds which default to pay for someone else's retirement. Not a pretty picture.
Huh, I thought it was a general Bogleheads principle that risk gets priced in by the market. If there is research that indicates that this is not the case at the moment for muni bonds I'd love to see it. Personally I would suspect the opposite kind of price imbalance - that highly-publicized but isolated events like Detroit defaulting have caused prices to drop more than is called for, making muni bonds a particularly good investment right now, despite the evident risk of further such defaults. But then again my personal suspicion is not based on data anyone else doesn't have so I would expect that arbitrage has resulted in an equilibrium price that is fair, not being either good or bad.
That may be true in general, but clearly is not always true. For example, were MBS risks priced in before the housing crash? No, they were considered safe. Why? Because it was an article of faith among those investing in those securities that "real estate always goes up". There were some people who realized this was incorrect, and made a fortune by betting against that belief.

So an exception to the general rule is that if a specific belief is strongly enough held among those investing in a particular type of asset, the market may not recognize the potential consequences if that belief turned out to be incorrect.
In theory, theory and practice are identical. In practice, they often differ.

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Re: the state of unfunded state pension obligations

Post by Jfet » Wed Aug 28, 2013 3:57 pm

Riprap wrote:
Jfet wrote:I would rather take stock market risk right now than muni bond risk.
Just to be clear, would it be safe to say that your advice for a mostly taxable investor is to dump fixed income for stocks? To heck with an investment plan? :confused
No.

I would rather have 70% stocks 30% short/medium term US treasury bonds to give me X% real return than to have 60% stocks 40% muni bonds to get the same return. Or whatever the numbers work out to be. Probably close to those numbers.

The market prices out of the money call and put options correctly too...doesn't mean I want to buy them.

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Re: the state of unfunded state pension obligations

Post by donall » Wed Aug 28, 2013 4:00 pm

ps56k wrote:
YttriumNitrate wrote:When you factor in population growth rates, Illinois looks even worse. California will be able to counteract some of the pension obligations with its 10% population growth last decade. Illinois, having just a 3.3% increase, won't be so lucky. http://www.census.gov/prod/cen2010/brie ... 0br-01.pdf
It's certainly a word of warning for any state employees and highlights their need for retirement savings in addition to their pensions.
YUP - wife is a teacher in Illinois - TRS - and it has not been funded since the 1970's, even though the teachers pay their share 100% of each payroll check. One proposal is to push the state's pension portion back to each individual school district, which in turn gets its funding from local property taxes.

Oh yeah - here's another kicker that most people don't know. The Illinois teachers can't get SS benefit payments, that is forfeited with Illinois TRS. In other words, if you came from industry, where you PAID into SS, you now LOSE any/all SS benefits as a TRS person.

total pension detailed in Illinois State Constitution = 18%
teacher contribution = 9% (100% of each payroll check)
school district contribution = 1% (100% of each payroll period)
Illinois State contribution = 8% ( NEVER ) - maybe the FOUR Illinois govs sent to prison had something to do with it.
Yup, Illinois is kooky. Illinois has public pension systems funded from 85% to 40%. State hasn't paid their total pension contribution on the underfunded pension systems more than 3 times in three decades. Kinda like using a credit card for decades and wondering why the bill is sooo large. In fact EVERYONE is nutty. Even the business community is making the state budget worse by calling the rating agencies to downgrade Illinois bond ratings. See this article on the actions of the Civic Committee of the Commercial Club.
http://voices.suntimes.com/early-and-of ... r-motives/
The funny part was, that the downgraded Illinois bonds, who people cautioned would never sell, were oversold 3X. Then there is the majority leader who would not call up a vote on a pension bill that had plenty of support and votes to pass. Ect. Etc. What a train wreck!

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Re: the state of unfunded state pension obligations

Post by abuss368 » Wed Aug 28, 2013 4:01 pm

A very unfortunate situation indeed that has yet to be addressed.

Thank you for posting.
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Re: the state of unfunded state pension obligations

Post by Kevin M » Wed Aug 28, 2013 4:03 pm

So some of you don't think these risks are already priced into these bonds? I tend to agree that interest-rate risk is pretty lopsided now, which is why I have more fixed income in CDs than in bonds, but especially for those with higher marginal tax rates, muni bond fund yields are relatively attractive. TBM SEC yield is only 2.08%, while CA Int-Term TE is 2.62%, CA LT TE is 3.72%, IT TE (national) is 2.61%, and LT TE is 3.61%. So even before taxes, the yields on the TE funds are quite a bit higher than TBM.

If you don't want to take risk with fixed income, you should stick with short-term treasuries or FDIC-insured products with minimal interest-rate risk (if you have the choice, which you may not in a 401k/403b). For the retail investor, savings accounts and directly purchased CDs with maturities up to five years provide higher yields than comparable treasuries, with same credit risk (none) and less interest-rate risk (much less for the longer maturities).

If you are going to take risk in your fixed income, who is to say where to draw the line? A California investor with a combined marginal tax rate of 50% is getting paid a huge premium to invest in the CA LT TE fund instead of something like TBM in a taxable account.

It is interesting to note that Vanguard rates its TE funds as high quality--right along with TBM and treasury funds.

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Re: the state of unfunded state pension obligations

Post by staythecourse » Wed Aug 28, 2013 4:10 pm

technovelist wrote:I can't imagine owning municipal bonds in the current economic climate.
Comments like this is why I active management will ALWAYS exist. Folks, even on bogleheads, support active management in both security selection AND market timing at the same time. Of course, only for obvious situations. :D

The only reason to change your asset allocation is if your willingness, ability, or need to take risk changes. I don't think muni yield or current default risk (perceived or real) fall into that category.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: the state of unfunded state pension obligations

Post by Ged » Wed Aug 28, 2013 4:13 pm

Using my previous example, I don't see how even with a dollar for dollar match they could possibly think that an 18% contribution level over 20 years would be able to generate 70% of highest 3 years for potentially 35 years of retirement. The numbers just don't compute or they'd have to have outlandish predictions on expected return.

They obviously did not use Brooks Hamilton's consulting service, he was quoted on Frontline saying a contribution percentage of 20-25% starting at age 25 and 40 years of contributions needed to replace 60% of final salary with social security. It really boggles (no pun intended) the mind.
That sounds a bit excessive. I've done better than that with a 15% contribution level over my career.
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Re: the state of unfunded state pension obligations

Post by Jfet » Wed Aug 28, 2013 4:17 pm

Maybe it is priced in but maybe it isn't. What if Meredith Whitney was just early on her prediction just like Rick claims to be early on his prediction of $500 gold.

Muni bonds could get hit by a double whammy. There are governments issuing muni bonds to pay for obligations because they don't have enough tax revenue. What happens if we get a rapid rise in interest rates, causing muni bond interest rates to spike, which puts the bond market out of reach of these governments already on the edge? Feedback loop? Interest rate spike = muni default = higher interest rates = more default...

But yeah, it will never happen...

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Re: the state of unfunded state pension obligations

Post by Shaudius » Wed Aug 28, 2013 4:33 pm

It seems to me, and the article seems to confirm, that the problems with munis are in the long term, and perhaps the intermediate term, but not the short term, with perhaps notable exceptions. That being said it would therefore make sense to not hold individual munis(at least not ones with long maturities) and instead hold a muni fund which you can more easily divest than the bonds themselves(at least I would think that would be the case), so you can make munis part of your balanced profile with the understanding that at some point in the future it might not make sense to hold them as part of your holdings.

I know this kind of goes against the idea of not trying to time the market, but at the same time, AA should be reevaluated over time, and I think this is just one of those things, in the same way that your bond holdings should likely increase as you age, so too should your muni holdings as they become more a risky investment in the future.

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Re: the state of unfunded state pension obligations

Post by larryswedroe » Wed Aug 28, 2013 5:42 pm

Shaudius
I agree though markets can always force the issue sooner via the pricing mechanism--driving costs up. And that will or could happen with longer term bonds.

So I would look at it differently, since the issue is longer term in most cases I would not necessarily sell bonds that I would no longer buy today, if the maturities are relatively short term.

Larry

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Re: the state of unfunded state pension obligations

Post by Artsdoctor » Wed Aug 28, 2013 6:26 pm

larryswedroe wrote:Few thoughts
Not much choice for typically retail investors, and at least a fund will be well diversified across issuers.
It's one of the real advantages of a separate account manager is to tailor the credit risks.

Larry
Larry,

Excellent article, and timely.

Although I would trust YOU and your team to be thoughtful in selecting individual munis, I don't believe the majority of SAMs would protect their clients in the same way. A client would need a huge amalgam of individual bonds to defray the risk of some default as the pension issue snowballs, and the ratings agencies may not be as helpful as you'd like to think. There comes a point for most investment agencies where research will just consume more resources than are available. For the majority of investors, a well-run bond fund will be the best option for a large number of reasons.

It seems unimaginable that an entire state would default on its GO debt although anything is possible. This has to be considered the last option in a long line of many.

The more significant risk, at least for the next several years, is with the pensioners themselves. This is awful and I don't see a way out of that. You're already starting to see that.

Artsdoctor
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Re: the state of unfunded state pension obligations

Post by Shaudius » Wed Aug 28, 2013 10:29 pm

larryswedroe wrote:Shaudius

So I would look at it differently, since the issue is longer term in most cases I would not necessarily sell bonds that I would no longer buy today, if the maturities are relatively short term.

Larry
Which is an excellent point, I was more looking at it from a perspective of someone entering the muni market today versus someone who already has a muni position and is wondering what to do with it.

Obviously if you're holding individual bonds they should be analyzed on a case by case basis as to their individual risk when that risk is likely to rise and your overall risk tolerance, but not simply divested because they will probably be riskier in the future especially if they are maturing before this whole thing is likely to blow up. If you're holding a fund, it doesn't really make sense to divest simply because of some distant event that could have an adverse effect on your position at some point in the future because your bond fund position is likely very easy to divest at some point in the future.

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Re: the state of unfunded state pension obligations

Post by nedsaid » Wed Aug 28, 2013 11:02 pm

Denial ain't a river in Egypt. But there is a lot of it around. It is a difficult issue for politicians to take on because the state employee unions (particularly the teachers unions) are powerful. These employee unions spend a lot of money in our state elections.

Our state is taking steps to address this problem and our public employee retirement system is about 80% funded. So we are in better shape than many states. But more needs to be done. The rising plan premiums really have put a crimp in the budgets of school districts, counties, and cities.

All participants in public pensions should be aware of these problems and plan accordingly.
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Re: the state of unfunded state pension obligations

Post by Professor Emeritus » Wed Aug 28, 2013 11:06 pm

staythecourse wrote:It will be interesting to see how things work out. The problem is NOT finding an intelligent way to deal with these issues. The problem is you are dealing with the HIGHEST levels of beuacracy and special interest that exist in the local/ state legislatures, i.e. politics and unions.

Good luck to see any appreciable advancement in many of these issues.

I see more delaying the inevitable in delaying benefits, increased contributions, pay into healthcare after retirement, etc... from the new hires. Will not be surprised the whole pension system start looking more like Ponzi scheme.

Good luck.
I'm sorry but you have veered into the political nonsense sphere. State employee pensions are not in any way shape or form a Ponzi scheme That is just cheap political rhetoric
Think of each pension as a obligation which is issued on a monthly basis to each employee. They are no different from any other obligation. States issue both callable bonds, where they can change the terms by paying off the bonds and non callable bonds where they are required to keep making the payment as specified in the bond.In my case The state issued obligations which were callable and the did call them in effect back in the 1980s. They made us pay more for the future benefits. In return, in effect the obligations to pensioners were put in the same category as state Bonds. (FWIW Health insurance is not guaranteed the same way ). New hires were put in a less desirable pension system. In 2000 they found that they could not hire people with the lousy pension so they enhanced it.

The intelligent way to deal with my pension is to pay it, just like paying off the state bonds.

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Re: the state of unfunded state pension obligations

Post by Professor Emeritus » Wed Aug 28, 2013 11:08 pm

nedsaid wrote:iAll participants in public pensions should be aware of these problems and plan accordingly.
My plan is that I'm ready to sue anyone who says they don't have to pay the obligation, just like the bondholders would

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Re: the state of unfunded state pension obligations

Post by clevername » Thu Aug 29, 2013 12:03 am

In a June 2013 report, Moody's analyzed the pension data for the 50 individual states.
Does anybody actually care what Moody's thinks anymore?

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Re: the state of unfunded state pension obligations

Post by larryswedroe » Thu Aug 29, 2013 7:55 am

shadius
I don't think that is right because the longer bonds could get hit in price more than ST bonds as investors see what we see--the risks are longer term. So if I had a muni fund I would prefer it to be ST and also very high quality.

clevername
IMO you are making a major mistake here, one that many make. There was/is big conflict with ratings agencies on Asset Backed Securities of all kinds--the higher the ratings the more that could be originated and the more fees they could collect for rating them. There is not that issue with munis. A school district is not going to build another school because they got a higher rating than they should have. A city is not going to build another sewer district either. Ratings agencies actually have an outstanding record when it comes to ratings on munis--with the default losses lining up really well with ratings. That's why you should care and not taint them because of the problems in ABS, this is truly a different ball game

Larry

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