STUMP » Articles » Around the Pension-o-sphere: California, Chicago, and Valuation! » 20 May 2017, 14:14

Where Stu & MP spout off about everything.

Around the Pension-o-sphere: California, Chicago, and Valuation!  


20 May 2017, 14:14

I’m gonna be lazy today and use other people’s stuff!

Before I begin, thanks to my linkers:

And howdy to all the incipient Chaucer fans who get to my blog through this post.


On April 28, Jack Dean of Pension Tsunami was on
San Diego Tonight hosted by Joe Vecchio — the San Diego Tonight audio can be found through this link.

But eh, I don’t like listening. I prefer to read!

So here’s a transcript:

2017April28 Jack Dean Pension Tsunami San Diego Tonight by Mary Pat Campbell on Scribd

I want to explain how I did the transcript — I just tried out’s transcription services – $1/min (plus I asked for time stamp add-ons… I actually started the radio show about 2 minutes in, so it won’t match the original file.) It was more proof-of-concept than anything else. I like typing up transcripts myself, but I’m very happy with these results and may use them again in the future.

I see a few bits missing – like where Jack mentions Calpers and Calstrs, but that’s partly my own fault for not letting the transcriber know about the acronyms in advance. I think they did pretty well, considering. You generally see time stamps where words are missing.

Here are some excerpts:

Jack Dean: Yes that was the beginning. It all goes back to the SB400 in 1999.
Joe Vecchio: Right.
Jack Dean: And that’s when most public safety [00:03:30] started getting these increases from 2% to 3% -
Joe Vecchio: Right.
Jack Dean: And 50 in the formula. And of course a lot of people think that that increase from 2% to 3% is a one percent increase. But if you actually know math you realize it’s a 50% increase in the formula.

Yup, the 2% per year versus 3% per year… as Jack says, the way these pension boosts are sold, you think that the increase is actually a lot less, as in orders of magnitude less, than they actually are.

The people wanting the boosts — the public employee unions and the politicians they keep get re-elected — don’t want the full extent of the impact to be known. So they take advantage of people’s natural innumeracy.

Even I have to explicitly think about these things, but that’s no imposition on me, because I love thinking about numbers. But most people don’t.

And the politicians know that.

Another item from the transcript:

Joe Vecchio: Uh-huh. And I know the prison guards make a lot. I mean a lot of public employees make a lot and, but we’re gonna see some [00:04:24] in trouble because they can’t print more money. Some have declared bankruptcy, right?

Jack Dean: [00:04:30] Well yeah we had a few in California. The Vallejo comes to mind, San Bernardino comes to mind and while again the … There will be those who will argue that it wasn’t the pensions that caused the problem. The pensions always play a big role in it, unfortunately. They are never really dealt with the way they should be along with other creditors. There’s no cut in the pensions they always continue on. And now yesterday along [00:05:00] the headlines … The top five headlines dealt with Antioch, which, the city of Antioch in California which may reach bankruptcy. And then we’ve got Walnut, [00:05:10], [00:05:10], Auburn and Sunnyvale.

Didn’t catch all the town names in there, but again, pretty good, considering. San Bernardino and Stockton were just the beginning. There will be more, and Calpers won’t be able to stick its fingers in all the holes.

Should be interesting to watch how many more plans get put on the run-off pool for Calpers. They have already made an example of a few itty-bitty plans, but there will eventually be something large that can no longer keep up with their Calpers obligations… and then what?


I’ve got a lot of Chicago updates for later, because there is jockeying around the Chicago Public Schools right now. So, basically, the city is going to be borrowing money to finish out the school year. Just to cover operating costs.

And yes, pension contributions are operating costs.

I’m going to love to hear the terms of that borrowing.

But for now, let me grab what Mark Glennon has recently written:

New Stanford Study Exposes Illinois Pensions as the Farce They Are – Wirepoints Original:

Let’s suppose you’re smart enough not to trust what the government says about how far underwater public pensions are — even using the new accounting standards that are more conservative. Suppose, instead, you change one key assumption — the “discount rate” — to use what all reputable financial economists say you should use.

Do that and our pension liabilities become utterly absurd. Illinois, Chicago and Cook County pensions stand out.

That’s basically what Prof. Joshua Rauh of Stanford University’s Hoover Institution did in a major study of state and local pensions across the country released yesterday. His study calls it Market Value of the Liability, or “MLV.” The full study is linked here.

Among the study’s conclusions:

• Illinois pensions have just 29% of what they need to meet promises made, which is the worst in the nation, having a total MLV unfunded liability over $360 billion instead of the reported liability of $188 billion.

• Chicago pensions have 19.9% of what they need, the worst of any major city. It’s pension debt is over $90 billion as opposed to the $45 billion officially reported.

• Cook County’s pension debt is only the second worst among counties in the nation (behind Wayne County, Michigan), being about $30% funded. It owes about $18 billion.

Truly staggering is what the study says about how badly those pensions continue to be underfunded. In other words, how much more would it take from taxpayers just the keep these pensions from sinking further into debt?

• For Illinois, the state would have to contribute “well over twice of what it actually contributed.”

• Chicago “would have had to contribute a full 44.5 percent of its own revenue.”

• Cook County “would have had to contribute more than 40 percent of its own revenue budgets just to prevent unfunded liabilities from rising.”

Keep in mind this is about unfunded liabilities, which are for obligations on work already performed.

Go to Glennon’s post for the bit that the study doesn’t even cover — retiree health benefits.

Neither Chicago nor Illinois can afford their PAST promises, much less the ones public employees are going to be trying to accrue in the future. The balance sheet accounting, using current standards, is still pretty bad even before you make the adjustments that Joshua Rauh recommends.


This is the study Glennon was talking about.

The researcher, Joshua Rauh, has been doing this for many years.

And I was gonna bitch about something, but then I noticed on the study launch page… he has his data tables!

Thanks a trillion [in pension debt], bro!

I’m definitely going to be using that for something.

Anyway, here is the summary:

Despite the introduction of new accounting standards, the vast majority of state and local governments continue to understate their pension costs and liabilities by relying on investment return assumptions of 7-8 percent per year. This report applies market valuation to pension liabilities for 649 state and local pension funds. Considering only already-earned benefits and treating those liabilities as the guaranteed government debt that they are, I find that as of FY 2015 accrued unfunded liabilities of U.S. state and local pension systems are at least $3.846 trillion, or 2.8 times more than the value reflected in government disclosures. Furthermore, while total government employer contributions to pension systems were $111 billion in 2015, or 4.9 percent of state and local government own revenue, the true annual cost of keeping pension liabilities from rising would be approximately $289 billion or 12.7 percent of revenue. Applying the principles of financial economics reveals that states have large hidden unfunded liabilities and continue to run substantial hidden deficits by means of their pension systems.

Oooh, and the paper is on Scribd, so I can embed it:

Hidden Debt, Hidden Deficits: 2017 Edition: How Pension Promises Are Consuming State and Local Budgets by Hoover Institution on Scribd

I look forward to using some of his results in the near future.


Posted at the Milken Review, from April:

Public Pension Plans
by Ed Bartholomew

ccording to the 2013 annual report for Detroit’s general retirement system, the city’s pension plan “is stable and secure and expects to meet all future retirement obligations to its members.”

Wait. Isn’t Detroit bankrupt?! Well, I fudged here just a bit. The annual report quoted preceded the city’s bankruptcy by some months. In fact, though promised pension payments were cut, the retirees didn’t do too badly. The bankruptcy judge blessed a settlement (at the expense of other creditors) that preserves the lion’s share of their benefits. At least for now.

But the mess in Detroit, alas, is only the beginning of a great unraveling of retirement plans for state and local employees in much of the United States. And even relatively happy endings can hardly be taken for granted.

The main cause for this large difference is, as noted above, the discount rate, which determines the present value of a dollar owed in the future. Higher discount rates make that future dollar owed less costly, and lower discount rates more costly. According to financial economics, the appropriate discount rate for a future cash flow is the rate on a default-free bond (like a U.S. Treasury) due at the same point in time, plus a spread for any risk of nonpayment. Returns expected on assets used to fund the liability simply aren’t relevant for the purpose of valuing the liability.

So, if a pension promise is thought to be free of the risk of default, a financial economist would discount it at a default-free rate. And this is what Rauh did.

But wait, you say. We just looked at the failing pension plans in Detroit and Dallas. If benefits are at risk, they’re not default-free. Right, but note that’s not what Keith Brainard and others advocating for expected-return discounting are basing their argument on. To put it another way, saying that pension debts are smaller because they might not be paid should give no one comfort.

Framing is important: saying simply “stocks outperform” leaves no room for uncertainty, while inserting “will likely” acknowledges they may not. Consider an analogy to another type of risk, the risk your house will burn down.

You would not claim that insuring your house against fire is a waste of money because houses don’t burn down — that’s clearly false. But you’d also not justify forgoing insurance because your house will likely not burn down, or because, historically, no houses in your neighborhood have burned down.

Forgoing insurance is unwise, even though doing so would almost certainly save you money. You insure not because you expect your house to burn down, but because it might. And you prefer a sure loss you can afford — the insurance premium — to the small chance of a huge loss you can’t afford. Only if you could afford the loss — say, because you’re rich — might forgoing house insurance make sense.

We can (and should) think about investment risk the same way. It’s not correct to say stocks outperform as a timeless truth, like “the sun rises in the east.” While acknowledging that equities have historically outperformed bonds and likely will do so in the future, there’s still a nontrivial risk they won’t — and not just over short periods, but over long ones as well. It only makes sense to hold equities, then, to the extent the investor can afford the potential loss.

I agree with Ed Bartholomew (as well as Joshua Rauh and Jeremy Gold and others who I know I’m forgetting) — there is a value to the taxpayer backstop.

If you want to value the liability at a non-risk-free rate, recognizing the possibility that the pension benefits may get cut in the future (wait, you say… is that what that means? Yes, yes it does), then it would be prudent to have the risk-free valuation and then the difference between the risk-free and the risk-on valuations would be the value of the default option.

If you saw how big that was, you’d understand how vulnerable pensions are.

This had been a nice, theoretical problem for a while. Until public pensions did start “defaulting”, and the benefits of current retirees were cut, as in the Detroit bankruptcy.

The Bartholomew piece is long. If you are new to the dispute over public pension valuation, it’s a good place to start.

The point is that lifetime guaranteed income is a very pricey promise to make, much less a guarantee where it’s going to be a certain multiple of your final salary (or average of years, yadda yadda).

The valuation rate(s) is the easiest lever to play with among the many to determine just how expensive that promise is.


I mentioned State Data Lab above, but here’s also U.S. Government Spending, which I haven’t dug into much yet.

Every so often I go to, but it’s kind of a crappy search engine.

I pulled state lottery data going back to the 1990s via the Census Bureau (and some nooks & crannies, and digging via the Web Archive). Look for my next Geeking Out post to see what I found… it’s kind of interesting.

Related Posts
Kentucky Pension Blues: Let's Get This Fire Started
Taxing Tuesday: A Promise to Raise Taxes, Who is Paying Most Taxes, And Who Gets the Cuts?
Taxing Tuesday: California to Tax Texts?