A study on public pensions was released today by the Center for Economic and Policy Research . Please share this with others in your association as appropriate:
With state and local governments continuing to face budget shortfalls, some folks are suggesting that public pensions are the main culprits behind the current budget woes. This new report demonstrates that this is an unjustified claim and that barring another sudden steep decline in the stock market, public pensions' shortfalls should be quite manageable in the long term. There's no need to destroy our public pension system.
Executive Summary
There has been considerable attention given in recent months to the shortfalls faced by state and local pension funds. Using the current methodology of assessing pension obligations, the shortfalls sum to nearly $1 trillion. Some analysts have argued that by using what they consider to be a more accurate methodology, the shortfalls could be more than three times this size. Based on these projections, many political figures have argued the need to drastically reduce the generosity of public sector pensions, and possibly to default on pension obligations already incurred.
This paper shows:
•Most of the pension shortfall using the current methodology is attributable to the plunge in the stock market in the years 2007-2009. If pension funds had earned returns just equal to the interest rate on 30-year Treasury bonds in the three years since 2007, their assets would be more than $850 billion greater than they are today. This is by far the major cause of pension funding shortfalls. While there are certainly cases of pensions that had been under-funded even before the market plunge, prior years of under-funding is not the main reason that pensions face difficulties now. Another $80 billion of the shortfall is the result of the fact that states have cutback their contributions as a result of the downturn.
•The argument that pension funds should only assume a risk-free rate of return in assessing pension fund adequacy ignores the distinction between governmental units, which need be little concerned over the timing of market fluctuations, and individual investors, who must be very sensitive to market timing. This argument also fails to recognize the fact that over a long period, future stock returns are inversely related to current price-to-earnings (PE) ratios. If the current PE ratio is relatively low, as is now the case, then the assumption that the market will provide below average returns implies a further decline in the PE ratio, given the generally accepted growth projections for the economy. As a practical matter, the stock market has provided an average real return of more than 8 percent for 30-year periods when the PE ratio at the start was under 15 to 1. It is worth noting that if pension funds stop investing in equities, as some have advocated, this would imply higher taxes and/or lower benefits for public employees. It would also mean that other investors could expect to see higher future returns on their stock holdings.
•The size of the projected state and local government shortfalls measured as a share of future gross state products appear manageable. The total shortfall for the pension funds is less than 0.2 percent of projected gross state product over the next 30 years for most states. Even in the cases of the states with the largest shortfalls, the gap is less than 0.5 percent of projected state product. It is also worth noting that some of this shortfall has likely already disappeared as a result of the recent rise in the stock market. If this rise is not subsequently reversed, then a substantial portion of the funding shortfall has already been eliminated.
In sum, most states face pension shortfalls that are manageable, especially if the stock market does not face another sudden reversal. The major reason that shortfalls exist at all was the downturn in the stock market following the collapse of the housing bubble, not inadequate contributions to pension funds.
