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December 9, 2010
Accounting for Public Pensions
By FLOYD NORRIS
www.nytimes.comA generation ago, when Ronald Reagan was president, the accounting rule makers forced American companies to come clean on the cost of the pension plans they were promising to employees. That decision, perhaps more than any other, heralded the eventual demise of defined-benefit pensions for employees of American companies.
Now something very similar may be in store for public sector employees, thanks in part to the Republican victories in last month’s Congressional elections.
Forcing companies to account in a reasonable manner for their pensions was a contentious issue at one time. Companies feared it would slash reported profits, and they preferred a system where the only expense they had to count was the money the company actually put into the pension plan. Roger Smith, then the chairman of General Motors, came to a hearing of the Financial Accounting Standards Board to denounce the idea. G.M. argued that such accounting would violate its agreement with the United Automobile Workers union, an argument that seemed to perplex the accountants.
The rule adopted was far from perfect, but it forced companies to estimate the cost of pension benefits being accrued each year. Companies were allowed to “smooth” the numbers by phasing in market changes in the values of pension fund assets, so there was reason to complain that the figures could be misleading. But the principle was established.
Today, not nearly as many companies offer defined-benefit plans to new employees. It is far more common to see a company that has stopped allowing workers to accumulate new benefits, even though companies are still liable for benefits earned before plans were changed or closed. The accountants forced companies to confront the risks they were taking — in effect guaranteeing that pension fund investments would grow — and the companies decided the risks were too great.
As a result, a part of the safety net that previous generations took for granted became far less secure. Workers now tend to have defined-contribution plans, like 401(k)’s, to which they and their employers contribute. The worker chooses the investments, and bears the consequences when they go up or down in value.
That fact almost certainly contributed to the severity of the 2007-9 recession and the slowness of the recovery that has followed. Far more Americans than ever before had a direct stake in the stock market, and the sharp fall in stocks meant that their retirement plans had to change. The number of people over 60 with jobs is up 10 percent over the last three years while the number of jobs held by people under 60 has fallen by 7 percent.
The stock market has regained most of the lost ground since then, but many 401(k) plans have not benefited. Many people reduced their stock market investments at precisely the wrong time. Mutual funds that invest primarily in American stocks have suffered net withdrawals of $90 billion since the stock market hit bottom.
As companies moved away from defined-benefit plans, most cities and states did not follow. One reason for that may have been that the Government Accounting Standards Board — the public sector equivalent of FASB — has done much less to force good disclosures, or comparable ones.
Having limited information available can obscure problems, but when concerns arise, a lack of good data can have the opposite effect; people assume the worst.
Estimates of unfunded pension liabilities can be breathtaking. Two economists, Robert Novy-Marx of the University of Rochester and Joshua Rauh of Northwestern, put the figures at $3 trillion for state governments and almost $600 billion for municipalities. Those figures are far greater than official government figures, and are highly dependent on interest rate levels, which can and do fluctuate. They may be too high, but there is no way to be sure of that.
Some people say the 1974 passage of the Employee Retirement Income Security Act, known as Erisa, led to the demise of private pension plans because companies for the first time really had to honor pension promises. But the trend did not pick up steam until the accountants forced disclosure of real numbers. Most state constitutions have long barred cutting public pension benefits that have been earned, but that fact alone did not force change.
This week, three Republican members of Congress, led by Representative Devin Nunes of California, a senior member of the Ways and Means Committee, proposed legislation to force states and cities to report pension fund liabilities on the same basis, and to force them to disclose market values of assets. The bill would not even allow smoothing, so the state of pension funding will seem volatile as markets rise and fall. Such volatility could be reduced by putting more pension money into bonds than stocks, but doing so would force governments to admit they were likely to earn less on investments, and thus need to put even more money into pension plans.
The congressmen would not like to have it said they are forcing anything. The bill gives local governments a choice: they can report the way the members want them to report, or they can give up the ability to issue tax-exempt bonds. That is, of course, no choice at all.
Introducing a bill is not the same as passing one, but this may be an idea whose time has come. There is rising concern over the state of local government finances, and governments may be forced to make better disclosures if they simply want to issue new bonds.
Disclosures are likely to lead to growing pressure to rein in pension costs, even though that will be resisted by public employee unions, which often have considerable political clout.
Even assuming legislatures want to act, doing so is not easy, in part because of state constitutional provisions. Governments could follow corporate precedents by treating new employees differently and by stopping existing employees from accumulating new benefits. But that may not be enough to stem the flood of red ink, particularly in cities and states where pension fund contributions have been deferred to avoid cuts in other spending.
Some abuses can be stopped, such as the practice of allowing retiring employees to work hundreds of hours of overtime in their final year, and then counting that pay in determining the pension payment, which is often based on a percentage of annual pay. It is not clear how many abuses there are, but the publicity given to some of those that do exist has damaged the image of, and public sympathy for, public employees. There is also a widespread suspicion that mayors and governors have agreed to excessive pension benefits, often as a substitute for pay increases, simply because the bill would be paid by some future administration.
Companies have the option of going bankrupt and getting the Pension Benefit Guaranty Corporation, a federal agency, to take over their obligations. The P.B.G.C. can then reduce payments on larger pensions. But it is not clear what will happen when cities go bankrupt, in part because there are not that many precedents, and states apparently cannot file for bankruptcy at all. Of course, the fact a state cannot file in bankruptcy court does not mean it cannot go broke.
There has been talk of shared sacrifice, in which employees accept lower benefits, taxpayers pay more and bondholders also take hits. You can argue that is what happened in New York City a quarter of a century ago, when some bondholders were forced to extend maturities. But widespread expectations that such a thing was possible could drive up borrowing costs for all localities, making their fiscal problems that much worse.
In the end, I suspect ways will be found to abrogate some pension promises. But even if that does not happen, the trend away from defined-benefit pensions is likely to affect most younger public employees, as it already has their counterparts in the private sector. The retirement safety net will thus become a little more frayed.
http://www.nytimes.com/2010/12/10/business/10norris.html?_r=1&ref=business&adxnnlx=1291989637-5iCo 1HlWBF/AGd7eNvhVg&pagewanted=print
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This is another scam on the taxpayer that needs to be ended asap.
