Sunday, August 28, 2016

Feeling the Pinch(ion)

While it gets a fair amount of press, the financial woes of the nations pensions do not seem to get as much attention as they should from the government and the Fed.  Let me qualify that.  The pension issue is not getting enough attention other than from those politicians that are in jurisdictions that can no longer ignore these obligations and kick them down the road.  Illinois and Chicago in particular are nice poster children for the problems that are gradually being visited upon more jurisdictions.  There are a host of reasons for the issue with the principal one being politicians knowingly not funding pensions and using the tax money for more immediate needs.  After all, if you are in office four, six or eight years, why take the pain yourself when you can hoist it upon some politician down the road. 

Another reason for the underfunding is that pensions regularly rely on getting unworldly returns on their investments.  Expectations of 7%, 8% and higher are common.  Guess what happens when those expectations are not met or are lowered?  Well, the Governor of Illinois just found out:

http://www.zerohedge.com/news/2016-08-27/illinois-taxes-rise-500-million-after-teachers-pension-fund-cuts-returns-assumption-

Just a reduction in expected return from 7.5% to 7.0% has given him a whopping half a billion dollar shortfall that taxpayers of Illinois now need to make up next year.  Let's clarify that; it is one that the remaining taxpayers will have to make up next year.  You see, it seems Illinois and Chicago are losing some taxpayers.  Last year Chicago lost more than any other metropolitan area in the U.S.

http://www.chicagotribune.com/news/local/breaking/ct-chicago-population-record-loss-met-20160324-story.html

And as Illinois as a state is losing them left and right - at a rate of 1 resident every 10 minutes.

https://www.illinoispolicy.org/press-releases/illinois-losing-residents-at-a-rate-of-1-person-every-10-minutes-new-report-from-il-policy-institute/

Which means there are going to be fewer folks to pay that bill, which means the incentive for more to leave just increased, and so forth and so on.  For more details on the woes of Chicago and Illinois, I recommend Mish Shedlock who lives there and follows it closely.

https://mishtalk.com/

But Illinois is not alone.  With an aging population of baby boomers, this is a common issue throughout the U.S.  It is also one that low interest rates are not helping in the least.  Pensions have no safe alternatives for a decent return (thank you Fed) and are forced to take unnecessary risks with their investments.  These risks over the past 8 years have not been too painful as the markets, at least in the U.S., have continued to grow.  But what happens when the inevitable happens and the markets finally revert?  Those 8% or 7% return rates go up in smoke.  Indeed, a 40% or more correction as many (like Buffett, Ichan, Soros, Gross, Rogers) are now predicting would wipe out these expected returns for many years.  As John Hussman, Ph. D. notes, this overdue reversion to mean likely will lead to an overall return over the next decade of 0%. 

http://www.hussman.net/wmc/wmc160815.htm

Last I checked, that is a tad below the lowered 7% expectation for Illinois.  Let's see, if half a percent means half a billion in increased taxes then another 7% reduction means . . . time to move.

But where do I go, how will I live?  The U.S. as a whole has roughly a nice trillion in unfunded public pensions just waiting to go bust.  But not every state is in the same (sinking) boat.  Illinois, Connecticut, Kentucky, Alaska and my fine state of New Hampshire lead the list in the percentage of unfunded obligations, but there are states like Wisconsin and South Dakota that are 100% funded and a few warmer states close behind, like North Carolina and Tennessee. 

http://money.cnn.com/2015/07/14/retirement/worst-state-pensions/

All this leads to more bad news for our good friend Janet.  She wants to raise rates, she needs to raise rates, but doing so - especially when other countries are going in the opposite direction - is darn near impossible.  I have no sympathy for her situation as she made her own mess and now has to live with it.  My problem is that we all have to live with it.