Pensions face bankruptcy in the future

2016-4-10. US faces disastrous $3.4 trillion pension funding hole. Collective deficit of retirement plans is three times larger than official figures. Financial Times.

The US public pension system has developed a $3.4 trillion funding hole that will pile pressure on cities and states to cut spending or raise taxes to avoid Detroit-style bankruptcies. The Stanford study found that the states of Illinois, Arizona, Ohio and Nevada, and the cities of Chicago, Dallas, Houston and El Paso have the largest pension holes compared with their own revenues.

Devin Nunes, a US Republican congressman, said: “It has been clear for years that many cities and states are critically underfunding their pension programs and hiding the fiscal holes with accounting tricks. When these pension funds go insolvent, they will create problems so disastrous that the fund officials assume the federal government will have to bail them out.”

Large pension shortfalls have already played a role in driving several US cities, including Detroit in Michigan and San Bernardino in California, to file for bankruptcy. The fear is other cities will soon become insolvent due to the size of their pension deficits.

Joshua Rauh, a senior fellow at the Hoover Institution, a think-tank, and professor of finance at the Stanford Graduate School of Business, who carried out the study, said: “The pension problems are threatening to consume state and local budgets in the absence of some major changes. It is quite likely that over a five to 10-year horizon we are going to see more bankruptcies of cities where the unfunded pension liabilities will play a large role.”

In order to deal with the large funding shortfall, many cities and states will have to increase their contributions to their pension funds, either by raising taxes or cutting spending on vital services.

Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania, told FTfm last month that US public pension plans face “grave difficulties. I do believe that US cities and towns will continue to suffer, and there will be additional bankruptcies following the examples of Detroit,” she said.

Currently, states and local governments contribute 7.3% of revenues to public pension plans, but this would need to increase to an average of 17.5% of revenues to stop any further rises in the funding gap, the research said.

Several cities and states, including California, Illinois, New Jersey, Chicago and Austin, would need to put at least 20% of their revenues into their pension plans to prevent a rise in their deficits, while Nevada would have to contribute almost 40%.

Mr Rauh’s study claims the “true extent” of funding problems in US public pension system has been obscured because plans calculate both their costs and liabilities on the assumption they will achieve returns of between 7 and 8% a year. This rate is “wildly optimistic and unlikely to be achieved. A more realistic return rate, based on US Treasury bond yields, is around 2 to 3% a year.

 

Melin, M. April 10, 2014. Bridgewater Founder Says 85 Percent Of Pensions will Go Bankrupt. $3 trillion in assets against $10 trillion in liabilities

Dalio’s mathematical skills are on display as he shocks observers saying US pension funds don’t have the wherewithal to pay out benefits in coming years.  What was stunning was not Dalio believing the pension math was turning negative, as Detroit and Chicago examples are in front of our eyes.  What was stunning is that he said it in such plain talk and so bluntly in public.

According to a USA Today report, Dalio does the math – and its doesn’t add up, says the man who studies mathematical probability tables for a living.  Bridgewater deduces that 85% of public pension funds will go bankrupt in three decades, and they are projected to achieve 4% returns on their assets, or worse.

After conducting his quantitative version of a stress test, Dalio likely threw a little discretionary analysis into his thesis.  The economic environment will not always be positive, if history is any guide. Odds are that economic environments will shift, and with a taper undoing the needle in the stock market’s arms, he considered a variety of realities. Public pensions have obligations exceeding $10 trillion, yet only $3 trillion in assets to cover the coming expenses.  That is simple math.  Bridgewater, then, notes an investment return of nearly 9% a year is required to meet those onerous obligations.  They won’t get 9% in bonds – that could be a drain on assets if the coming rise in interest rates reduces the asset value of bonds.  Public pensions are looking at a 20% shortfall, Bridgewater claimed in the USA Today report.

 

 

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