US Pensions Unfunded By $4 Trillion And Counting

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Around the country, state and local fiscal pictures are starting to look better. Tax revenues rose in every state in 2011, and while states continue to have structural budget gaps to close, this year’s gaps are a small fraction of the ones states were dealing with in 2009 and 2010. But one big problem continues to show little improvement– unfunded pension liabilities.

Measured on a market value basis, these unfunded liabilities (combined with those for retirees’ health care) exceed $4 trillion, which is more than the total amount of bond debt outstanding from states and localities. And because of the way pension accounting works, most states and local governments can expect to see continued sharp rises in required payments into pension funds at least through 2014. While most parts of states’ fiscal pictures are improving, this one continues to deteriorate.

In 2010, the pension problem prompted Meredith Whitney to warn of an impending spate of state and local defaults, as governments struggle with promises they can’t afford to keep. But in practice, we are seeing that states are treating payments to bondholders as job one. It’s rare for debt service to make up more than a few percentage points of a state’s budget, meaning that there is little to gain from stiffing bondholders, while there is a lot to lose. I expect no general obligation bond defaults by states and only a smattering by localities, hardly something that will amount to a crisis.

Last year, when the small city of Central Falls, Rhode Island entered receivership, the state passed a law to move bondholders to the front of the priority list for payment, making it essentially impossible for municipalities to default on bond debt. Meanwhile, the state enacted an aggressive pension reform that both cut benefits that workers can earn in the future and froze cost of living adjustments– effectively reducing the benefits that current workers and even retirees had earned in the past. It didn’t matter that Rhode Island is a state with politically powerful unions; a loss of access to the bond markets was far scarier to state lawmakers than anything the unions could do.