Pension fund collapse looming

Warnings about looming public-pension disasters have regularly cropped up since the 1950s, pointing to problems 25 years or more down the line. To politicians and union leaders, the troubles were someone else’s predicament. Then crisis fatigue set in as the big problem remained down the road.

Today, the hard stop is five to 10 years away, within the career plans of current officials. In the next decade, and probably within five years, some large states are going to face insolvency due to pensions, absent major changes.

Many states are in pretty good shape, and many others still have time and resources to fix things. There is no serious chance of retirees being impoverished. What’s in doubt is whether states will pay promised benefits to retirees with large pensions or significant outside income or assets.

It’s important to distinguish between actuarial problems (the present value of projected future benefit payments exceeds the funds set aside to pay them plus projected future contributions) and cash problems (not having the money to send out this month’s checks). Actuarial problems are always debatable and usually involve the distant future. Cash shortfalls are undeniable and immediate.

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New Jersey has $78 billion in its state pension fund, which is supposed to cover future payments with a present value of $280 billion. But that latter number is a projection. You can ignore it if you wish, or hope that soaring investment returns or a pandemic among retired workers will fix it. A more certain figure is that the $78 billion represents less than seven years of required cash payments.

If we extrapolate from the past, rather than use promises in the state budget, current employees plus the state will contribute about $25 billion over those seven years, which could provide another few years before the till is empty. But it will also add about $60 billion of future liabilities to current employees. The system probably breaks down before the pension fund gets to zero, for example, if assets were to fall below $30 billion while projected future liabilities exceeded $300 billion.

This could happen in three years in a bad stock market, or perhaps 10 with good stock returns. But fund assets are so low relative to payouts that good returns aren’t that helpful.

Some large states are going to face insolvency due to pensions, absent major changes.

The next phase of public-pension reform will likely be touched off by a stock market decline that creates the real possibility of at least one state fund running out of cash within a couple of years.

The math says that tax increases and spending cuts cannot do much. For one thing, as we learned from Detroit, at a certain point high taxes and poor services force people and businesses out. The numbers are just too big in some states to come out of the budgets. For another, voters won’t stand for it. The voters in these states have refused for decades to pay the full costs of the services they were already enjoying; they’re not going to have sudden conversions to paying full costs, plus the accumulated costs from the past. State constitutions will be amended if necessary and big legal battles will be fought.

I cannot see any plausible scenario in which full promised benefits are paid.

I hope that the problems of the least-responsible states will shock the rest of the country into more rational reforms. Actuarial problems 25 years in the future can be solved with only moderate pain today. Cash-flow problems three years in the future require chainsaws, not pens.

Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. Distributed by Bloomberg View.