Borrowing to Replenish Depleted Pensions
HARRISBURG, PA — Facing a shortfall of more than $50 billion in his state’s pensions, and with no simple solution at hand, Gov. Tom Wolf of Pennsylvania is proposing to issue $3 billion in bonds, despite the role that such bonds have already played in the fiscal woes of other places.
And he is not alone. Several states and municipalities are considering similar action as they struggle with ballooning pension costs.
Interest in so-called pension obligation bonds is expected to intensify in the wake of a recent Illinois Supreme Court decision that rejected the state’s attempt to overhaul its severely depleted pension system. The court ruled unanimously that Illinois could not legally cut its public workers' retirement benefits to lower costs, forcing lawmakers to scramble for the billions of dollars it will take to keep the system intact.
While the Illinois ruling is not binding on other states, analysts think it may influence lawmakers elsewhere to look to alternatives to cutting public pensions. The Illinois justices offered a list of all the times since 1917 that state lawmakers had ignored expert warnings and diverted pension money to other projects. They said, in effect, that the lawmakers had to restore the money.
Pennsylvania and other states and cities fear similar restrictions.
“My reaction was, ‘Yeah, that’s going to play here,’ “ said John D. McGinnis, a lawmaker in Pennsylvania, which has also been diverting money from its pension system, setting the stage for a crisis as more and more public workers retire. The state has no explicit constitutional mandate to protect public pensions, as Illinois does, but that is irrelevant, said Mr. McGinnis, a Republican and former finance professor at Pennsylvania State University.
“The judiciary in Pennsylvania has been solidly of the belief that there are ‘implicit contracts,’ and you can’t deviate from them,” he said. If lawmakers in Harrisburg were to unilaterally cut pensions now, he said, they could be taken to court and be dealt a stinging rebuke, like their counterparts in Illinois.
Against that backdrop, pension obligation bonds may appear tempting, even though such deals have contributed to financial crises in Detroit, Puerto Rico, Illinois and other places.
The deals are generally pitched to state and local officials as an arbitrage play: The government will issue the bonds; the pension system will invest the proceeds; and the investments will earn more, on average, than the interest rate on the bonds. The projected spread between the two rates makes it look as if the government has refinanced its pension shortfall at a lower interest rate, saving vast sums of money.
But that’s just on paper. In reality, the investment-return assumption is just that — an assumption, and a deceptive one at that because it does not take risk into account.
Fiscal analysts say it is possible, in theory, to shape a pension obligation bond deal responsibly, but that is not what they usually see.
Read more at http://www.nytimes.com/2015/05/28/business/dealbook/borrowing-to-replenish-depleted-pensions.html?_r=0