Taxpayers at peril without pension reform

 

Warren Buffett is a multi-billionaire investor who has made a few astute gambles in the market over time. He's bought into railroads, newspapers and insurance companies with a shrewd eye and strict financial discipline.

So now imagine Mr. Buffett, untold billions of dollars ago, sounding the alarm for pension funding problems in a memo he wrote to the chairman of the Washington Post Company.

That memo was written in 1975 - 39 years ago.

In his prescient observations, Buffett said, "As will become so expensively clear to citizens in future decades, there has been even greater electorate ignorance of governmental pension costs."

That day has come, rudely, to many taxpayers - from the ruins of Detroit Motor City to three communities in California that have declared bankruptcy and are attempting to rebuild their shattered economies on the backs of those very same taxpayers (and creditors) who have nothing left to show for their investments.

The city of Vallejo emerged from bankruptcy protection in 2011 without really addressing the main reason it had been forced into insolvency in the first place. If you guessed unsustainable pension benefits, you are obviously a lot smarter than those Vallejo city officials and their legal counsel.

City services - including police and fire response - were slashed, and crime soared. Government pensions, however, were left untouched. It's only been three years, but Vallejo is on the brink of declaring its second bankruptcy. Because it didn't fix the problem, it is looking at a structural deficit of $8.9 million - and rising.

Moody's Investor Service has seen enough and warned two other bankrupt California cities - San Bernardino and Stockton - to get serious about reining in unaffordable pensions or risk the fate of Vallejo.

"Vallejo substantially restructured its compensation structure, including significant cuts to retiree health care benefits, but by failing to address its pension liabilities, it remains vulnerable to increasing annual payments," Tom Aaron, a Moody's analyst, wrote in a new report.

The California Public Employees Retirement System apparently didn't read the Moody's report. It has announced three pension contribution rate hikes in the last two years - aimed at restoring the funding levels. Those contribution increases will raise pension costs for CalPERS member governments by more than 50% by the time they are fully implemented in 2020.

If there is another economic downturn, or recession, before then - watch out below.

To add insult to injury, the state Legislative Analyst's Office says that California State Teachers' Retirement System needs between $5.3 and $5.7 billion more annually by 2020 to pay down its more than $71 billion shortfall. That is more than California spends on the University of California and Cal State colleges, according to a Wall Street Journal analysis.

Meanwhile, 3,000 miles away in Michigan, the Detroit bankruptcy has garnered national headlines and attention as they present their plan to emerge from Chapter 11.

The problem is how Detroit plans to pay for past financial sins. City officials have proposed paying its general-obligation bondholders 20 cents on the dollar, and gone to court to invalidate an additional $1.4 billion in certificates of participation - used to help backfill the pension funds back in 2005.

Retiree pensions are scheduled to be cut between 4% and 34%. Unlike those investors and bondholders, these retirees can recoup their losses if their pension investments perform well. Unions get the best deal while banks and bondholders are left holding the bag.

It's not hard to diagnose the problem: Government workers and public unions were made promises (in the form of pensions) that are no longer financially possible, given the economy we live in. Adjustments must be negotiated and bargains must be struck in order to prevent municipalities from slashing services and burdening taxpayers with massive losses.

The problem is not going to solve itself. Stakeholders and parties with skin in the game must come to the table and negotiate to reduce pension obligations. Start by switching government employees to 401(k)-style defined contribution retirement plans, for example.

If pension reform - real, authentic reform - does not materialize soon taxpayers will be on the receiving end of slashed services and higher tax bills. There's only so much pain they should be asked to endure. It's not fair that unions are still making off with the money and leaving everybody else with the check.

 

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