Five years after the financial crisis, there’s still a hue and cry about sending people to jail. After all, financiers were, at best, self-servingly optimistic about the future. At worst, they said things that weren’t true, and made promises they couldn’t keep. Investigations are still ongoing, and although it’s doubtful, maybe some big guys will go to jail. But there’s another group of people who have injured, and are continuing to injure, millions of Americans with purposefully blind optimism and false promises. Those are politicians in every city and state that is facing a pension shortfall.
You can’t read the news without hearing about the pension problem. Last week, federal judge Steven Rhodes ruled that Detroit can proceed with the largest municipal bankruptcy in history, thereby allowing the city to cut billions of dollars in payments that are owed to city employees, retirees, investors and other creditors. In Illinois, Governor Pat Quinn signed into law a plan that will trim Illinois’s pension hole, which is viewed as being one of the deepest and darkest in the country. (Labor unions say they will challenge the plan in the courts; credit rating agencies have pointed out that the legal protection of pension benefits is particularly strong in Illinois, so it remains to be seen what will happen.)
Inevitably, there is more to come. Rhodes’s ruling could have implications for California cities, like San Bernardino and Vallejo, that are wrestling with bankruptcies. In Chicago, the pension hole is estimated at $20 billion, and according to the New York Times, payments to the local pension fund are expected to increase by $590 million in 2015 to a total annual contribution of almost $1.4 billion. “Should Chicago fail to get pension relief soon, we will be faced with a 2015 budget that will either double city property taxes or eliminate the vital services that people rely on,” Mayor Rahm Emanuel told the Times.
There is disagreement about the size of the problem — it depends on how optimistic you are about the future, and how you truly account for pension liabilities — but most people agree that a problem exists. Estimates of the size of the hole range from almost $1 trillion to well over $4 trillion, according to a 2012 paper by the Kennedy School. In a recent report, the credit rating agency Moody’s, which calculates the pension hole using something called adjusted net pension liability — basically, the difference between the value of a pension plan’s assets and its future benefit payments adjusted for a present-value calculation — wrote that “several large local governments have pension burdens large enough to cause material financial strain.” For instance, in Chicago, the adjusted net pension liability is 678 percent of its annual revenue; 28 other local governments in Moody’s list of the top 50 (based on the amount of debt outstanding and whether or not Moody’s rates them) have an adjusted net pension liability that is greater than their annual revenue. Four of the top 50 local governments have actuarial contribution requirements in excess of 15 percent of operating revenues. In fiscal 2011, 33 of the top 50 local governments contributed less than what was actuarially required. And so on.
The argument generally centers on whose fault it is. You can pick your villain: Labor unions, Wall Street, the rich, the recession, an uncooperative market that can’t deliver the ridiculous 8 percent returns that many plans have counted on, the politicians. In simple terms, the right wing generally blames the unions for negotiating what some view as overly generous packages, while the unions have mostly argued that their benefits are legally protected by the state, and therefore cannot be cut back. Both miss the point. The unions should be angry about the underfunding of their pension benefits, while no one should be angry at the unions: it was their job to get the absolute best deal for their constituents that they could, and so they did. It doesn’t really matter if the promises were too generous or not generous enough: they were promises, and people relied on them.
There’s only one group whose job it was to navigate a course between different groups with different interests, and not to make promises that couldn’t be kept. That’s the politicians. And they have repeatedly failed.
Take Detroit. The Detroit Free Press, which analyzed the city’s history back to the 1950s, says that “its elected officials and others charged with managing its finances repeatedly failed — or refused — to make the tough economic and political decisions that might have saved the city from financial ruin.” The paper concluded, “When all the numbers are crunched, one fact is crystal clear: Yes, a disaster was looming for Detroit. But there were ample opportunities when decisive action by city leaders might have fended off bankruptcy.” The story quoted Bettie Buss, a former city budget staffer who spent years analyzing city finances for the nonpartisan Citizens Research Council of Michigan, and who said, “That was the whole culture — how do we get what we want and not pay for it until tomorrow and tomorrow and tomorrow?”
Indeed. That seems to be the culture in lots of places. “For years, cities have promised rock-solid pensions without setting aside enough money to pay for them, aided by lax accounting practices, easy borrowing and sometimes the explicit encouragement of labor unions,” wrote the New York Times last week. “Officials were counting on rich investment gains to fill the holes; unions and their retirees were counting on legal provisions — like Michigan’s Constitution — that said pensions were unassailable and that benefits would always be paid, whether through higher taxes or budget cutbacks elsewhere.”
Doesn’t that sound just like bankers counting on home prices going up forever, and investors believing that a triple A rating was invincible? Maybe you can argue that the politicians didn’t know any better. But they’ve certainly gotten warnings, just as bankers did. According to the New York Times, way back in 1978, an actuary named Russell Mueller filed a report. He quoted a Michigan state representative, Dan Angel, complaining about the way pensions in his state were being granted. “This takes place in a totally political atmosphere, without any regard for how the bill will be paid, by whom, and when,” Angel said in the report. “Employees had better get concerned that there is enough cash on hand to meet retirement needs, and taxpayers had better get concerned with these massive and increasing debt obligations.” “Public pension legislation is inevitable,” Mr. Mueller concluded in his report. But as the Times reported, state and local officials shot down the proposed federal funding requirements. Let’s remember that the next time we complain about bankers lobbying against new regulations.
I certainly don’t know what the solution is, and I don’t envy anyone who has to grapple with these intensely difficult issues. But especially at this point, there’s just one word that describes politicians who promise to pay that which cannot be paid: Fraud.
Bethany McLean is a contributing editor at Vanity Fair, and co-author with Joe Nocera of “All the Devils are Here: The Hidden History of the Financial Crisis.”
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