Underfunded Pensions Might Force the Fed to Hike Rates

It has been talked about for a long time that America is facing a pension fund tsunami, that stands to threaten the fabric of this economy in a very systemic way. We’re not even talking about medicare and social security shortfalls, just people working at government and municipal jobs hoping to retire in peace.

Back in April, Moody’s issued a report on this ballooning crisis.

While the United States (Aaa stable) government’s unfunded pension liabilities are significant, they are still overshadowed by the projected funding shortfalls for both the Social Security and Medicare programs, says Moody’s Investors Service.

The unfunded liabilities of the various federal employee pensions systems, covering civilian and military employee benefits, amount to about $3.5 trillion, or 20% of US GDP. Additionally, Moody’s estimates that unfunded state and local government pension plan liabilities are of the same magnitude, bringing the total shortfall to 40% of GDP.

However, historical precedent suggests that it is unlikely that the federal government will offer significant financial support for distressed state and local government pension plans. As a consequence, this portion of the liabilities only poses a small risk to the creditworthiness of the US.

The bigger challenge to the US comes from the unfunded liabilities for the Social Security and Medicare programs. The Social Security funding gap is estimated at $13.4 trillion, or 75% of GDP, while the shortfall from the Hospital Insurance component of the Medicare program amounts $3.2 trillion, or 18% of GDP.

“As the stand-alone sustainability of these two programs wanes with an aging population, Social Security and Medicare will be among the primary drivers behind a sharp widening of federal budget deficits that is expected to occur after the fiscal year 2018,” says Steven Hess, a Senior Vice President at Moody’s.

The unfunded US pension liabilities are not abnormally large when compared with other developed countries with high credit ratings, according to the report “Government of United States – Government Employee Pension Liabilities Are Moderate Compared to Social Insurance Programs.”

Canada (Aaa stable) has the lowest burden from unfunded liabilities overall (12% of GDP in 2014), after it pushed through reforms more than a decade ago. Australia (Aaa stable) now operates a primarily defined contribution pension scheme, but also has unfunded general government pension liabilities (21% of GDP) from its legacy defined benefit system. The UK (Aa1 stable) faces higher risks from its public pensions with large unfunded liabilities equal to 66% of GDP in 2014.

I’ll translate that for you. Our government has been taking money from the paychecks of its citizens, which were supposed to be earmarked for their retirement, but instead spent it on wars, welfare and wasteful projects. That’s not hyperbole, but fact. If this happened at a hedge fund or any private enterprise, it would be called fraud and the criminal sentenced to 20 years in prison.

Bill Rodgers, former economist at the Labor Dept, and Professor at Rutgers, weighs in on the jobs landscape and later touches on Fed policy, with Steve Liesman later saying the Fed might need to move with rates because of a potential systemic risk of underfunded pensions.

CALPERS, one of America’s largest pension funds with about $300 billion in assets, has about 18%-20% of their money in fixed income and about 52% in stocks.

Best case scenario, pension funds could enjoy a slighter higher return on their bond portfolios, whilst also receiving gains on the equities side of the equation. Without question, the Fed has their work cut out for them–trying to provide pensions with enough return on their bonds and also keep the market heading higher.