It’s official: New York state is turning itself into a Japanese prefecture. Well, at least fiscally they are:
ALBANY — Gov. David A. Paterson and legislative leaders have tentatively agreed to allow the state and municipalities to borrow nearly $6 billion to help them make their required annual payments to the state pension fund.
And, in classic budgetary sleight-of-hand, they will borrow the money to make the payments to the pension fund — from the same pension fund.
Go ahead and read it again. New York State might as well go to JP Morgan Chase, Bank of America, Citi, Wells Fargo, Barclays, Cap One, and a host of others and get credit cards from each of them, paying off the balance each month with a different credit card. We all probably had friends that did this in college. Maxing out the line, getting another credit card, and repeating the process all over again. And now we see that’s what municipal finance has turned to: a pathetic scheme most of us probably tried in college.
Indeed, the issue New York is grappling with is one that we’re going to read and hear more about: underfunded pensions. Governments and businesses alike which have defined pension schemes are all facing challenges when you have more flowing out than you have flowing in. Part of it is a demographic change. Western countries have seen birth rates decline for the past couple of decades while the number of retirees is ballooning. As a whole, we’re getting older, faster.
Japan is already having to face this:
But pension funds also have to deal with another issue: outflows. They are pensions after all, paying out defined cash amounts to beneficiaries after they’ve fulfilled years of service requirements, etc. to get it. The country is getting older, the birth rate is abysmal, and they have the one of the longest life expectancies on Earth. But don’t take my word for it, look up Japan from the CIA Factbook, which is a great source for info.
For a pension fund manager, this is a demographic nightmare. Long life expectancies lead to long cash payouts. More people getting older means more to pay out at each payout. The lack of younger workers means funds aren’t coming in for the pension fund manager to invest, which implies the fund is falling behind is underfunded. Because people age faster than money accrues interest.
Make no mistake about it: underfunded pensions are a serious problem. Borrowing your way out of the problem won’t help. Especially since this scheme will probably be a drag on asset returns one way or another. The NY Times piece continues:
Another oddity of the plan is that the pension fund, which assumes its assets will earn 8 percent a year, would accept interest payments from the state that would probably be 4.5 percent to 5.5 percent.
A significant drag, indeed.
The focus then has to turn to how to deal with this from an risk/return perspective. In my mind, it will only prompt more risk chasing, which may not be the best idea for a pension fund.
But meanwhile, it looks like the state government is having trouble calling a spade, well, a spade. Again, from the article:
“We’re not borrowing,” said Robert Megna, the state budget director and one of the governor’s top advisers.
Mr. DiNapoli, the comptroller, said: “We would view it more as an extended-payment plan.”
Asked about the pension plan, Mr. Ravitch said, “Call it what you will, it’s taking money from future budgets to help solve this year’s budget.”
Messrs. Paterson, Ravitch and DiNapoli, your VIP suites at the Borgata are waiting…