Tuesday, January 04, 2011

The Next Train Wreck

From Joshua Rua's Are State Public Pensions Sustainable?
Based on September 2009 asset values, if state pension fund asset returns have an average return of 8% going forward (the states’ typical assumption), states in aggregate will run out of funds in 2028. If average returns are 10% through 2045, the funds in aggregate will be roughly sufficient to cover liabilities to existing workers under the states’ actuarial assumptions. If average returns are only 6%, state funds in aggr gate will run out in 2024. This analysis assumes that state inflation forecasts, which average 3%, are met. If inflation is greater holding the investment outcomes fixed, then even under the higher asset returns the funds will run out sooner, as many state systems provide inflation-linked cost of living adjustments (COLAs) to beneficiaries.

Illinois, Connecticut, New Jersey, and Indiana are worst, whereas New York(!), Florida, North Carolina, Nevada and Alaska are best. He estimates the present value of the shortfall at $3T.

This is merely state pensions, mind you. The US social security system has about $13-17T in unfunded obligations, and $30T or so for Medicare (old folk free medical). The Federal deficit is about $1-2T, on GDP of around $14T.

I think our only hope is the Mayan apocalypse. Or inflation.

13 comments:

Anonymous said...

"...which average 3%, are met. If inflation is greater holding the investment outcomes fixed, then even under the higher asset returns the funds will run out sooner, as many state systems provide inflation-linked cost of living adjustments (COLAs) to beneficiaries."

Mr. Falken, don't be naive. COLA is a JOKOLA.

We will have massively under reported inflation.

Perhaps you can supercharge your econ career by coming up with the "new logic" that helps to rationalize the needed adjustments? If you don't someone else will.

Anonymous said...

Aren't all these things inflation protected?

Anonymous said...

Or, more likely, higher taxes.

Mercury said...

Even if over the very long term pension funds do get that magic 8% yield (remember when it was 11%?) there can be (as there have been) very long stretches (like the mid 60's to early 80's) where returns are well below that. Five years into one of those doldrums and the government will "do something" about it...and THAT won't be pretty.

Inflation in this context is a specie of wealth confiscation pure and simple.

Anonymous said...

Japan is farther along this road than any other country. Oddly enough they are enjoying stable prices (actually stable, not 2-4% inflation "stable") despite massive deficits. There is no sign that the Yen is a doomed currency. So much hinges on confidence and expectations...inflation is not a mechanical result of printing money!

Charles said...

Trillions of dollars of fixed obligations are discounted at an 8% projected return on a 50/50 stock/bond mix. Even with these absurd assumptions pension funds are inadequate to meet future commitments.

J said...

Mayan apocalipse? The Argentine one will arrive first. There, the government nationalized pension funds and is paying the old folks when the money is found, which is on every lunar+solar eclipse. I think on December 20th, 2010 there was one. A partial one.

Michael Meyers said...

Having recently just turned into an "old folk" let me clarify that Medicare is not free, but about half of what I was paying before.

Anonymous said...

The big picture is that in the blue states, the looting class (public sector employees) has engineered lavish and, importantly, bulletproof pensions for themselves, at the expense of the producing class (private sector employees), via the ungodly marriage of the public unions with the Democratic party. Public employees fully intend to live large in their old age, funded by private employees who'll have to work till they have one foot in the grave to pay. However, the public is starting to vaguely understand this dynamic. I hear and feel it when I travel through small-town America. Obviously the governor of NJ has helped raise the profile of this issue, too.

Jan-Peter Onstwedder said...

There is a fantastic paper on the way state pensions really work - not the simplistic quasi-analysis usually touted - on http://www.zyen.com/long-finance/publications/finance-shorts.html. Read it before you conclude that state pensions are unsustainable!

Anonymous said...

Ummmm, did you read that "fantastic" paper? It's about pension schemes in the United Kingdom.

Eric Falkenstein said...

Jan: paper is long and not very focused. Push retirement age back and basically lower their benefits helps. Can you succinctly summarize the take-away?

Anonymous said...

Re: the inflation discussion towards the top.
Yes, those are indexed for inflation.

One of the real problems for Social Security and public pensions is that inflation has been overestimated. The adjustments for quality are approximations.
For example, in 1980 the cheapest new car you could buy was about $3,000. Today it's about $12,000 (approximately). But we can't say the auto prices have increased 3 fold; today's cars are safer, more comfortable, need less maintenance, and last much longer.
That's happened in just about every durable category including housing; homes use less energy and are bigger than 30 years ago.
PS