Illinois Idiocy: Projecting Potential Cash Flows for Proposed Pension Obligation Bonds
by meep
Here we go.
I have listened to the audio of the POB presentation from last week.
I have transferred over the numbers from some of the slides into a spreadsheet, and I’m trying out multiple scenarios. For this post, I’m doing extremely simplistic scenarios … and I feel that’s fair, as the presentation included only very simplistic scenarios.
BEFORE I GEEK OUT: OTHER COMMENTARY
Buuuut, before I give you the numbers….
Here is what other people have to say about the POB idea since my last post on this dumbass idea.
- Latest magic pension plan has some problems
- John Bury: Ill. Idea: More POBs
- Republican state lawmaker says idea to bond out pension debt is ‘massively irresponsible’
- Republican state lawmaker says idea to bond out pension debt is ‘massively irresponsible’
- Bill Berman at Truth in Accounting: Illinois’ huge pension obligation bond proposal – 3 good things and 3 bad things
- Illinois Considers Perilous Path to Fund Pensions
- Leo Kolivakis: America’s Pension Shithole?
- Illinois Lawmakers Entertain Bold Bond Sale Plan
- LAWMAKERS CONSIDER BORROWING $107B TO POUR INTO ILLINOIS PENSIONS
- Godfather of Blago’s pension bond plan warns against replay
- A $107 billion pension bond proposal greets Illinois skeptics
- Wall Street Journal: Illinois’s Magic Pension Trick — Close your eyes, issue 27-year bonds and watch liabilities disappear.
- Illinois Eyes Bond Market For Pension Salvation
- Nicklaus: Illinois pension bond plan would be a dangerous gamble
So…. not necessarily looked upon positively by real finance people.
As per the recording I heard, the presentation was to be merely the first of a series of hearings on a potential POB.
I plan on transcribing parts of the hearing later (mainly the Q&A portion), and I’m looking forward to future hearings on this dumbass idea.
EXCELLENT STUDY FROM WIREPOINTS
This is not about the POB, directly. But it is heavily related.
Ted Dabrowski at Wirepoints has done a study looking at the growth of Illinois pension liabilties… and yeah, they’re out of control.
Illinois state pensions: Overpromised, not underfunded – Wirepoints Special Report. It’s long, but here’s the bullet-point takeaways:
A dramatic rise in pension benefits – not funding shortfalls – caused Illinois’ state pension crisis
By any measure, the growth in pension benefits accumulated by government workers and retirees in Illinois has been overwhelming. It’s been the cause of Illinois’ pension crisis.
A lack of money has not been the cause of the pension crisis. Illinois’ pension assets have grown at a rapid pace, far outstripping the growth of other Illinois economic indicators and pension assets in other states.
Fast-growing pension assets simply haven’t been able to keep up with the pace of benefit growth in Illinois. With a lower rate of benefit growth, Illinois would not have a pension crisis.
Read the whole thing. But to whet your appetite, here is a key graph:
The promises being made have far outstripped the actual growth of money shoved in to fulfill those promises.
Unfortunately for the authors they were unable to claim that Illinois had raised benefits more than any other state or had negative asset growth, primarily because of the existence of New Jersey.
Ha, yes. The eternal question of whether New Jersey or Illinois pensions will go under first.
Wirepoints had a followup: Illinois’ pension crisis: Incompetence or malice? – Wirepoints Original
What I go with:
LET’S GET TO THE NUMBERS!
Okay, hold on before I fully reveal….
Okay (yes, I’m a big Fifth Element fan)
Oh wait, let’s check where the presenters’ numbers came from.
SOURCE OF ASSUMPTIONS
I am not going to deal with the pension liability cash flows today (ugh).
I am addressing the assumptions being used for projecting the investment returns of the pension assets. I discovered they are based on actual Illinois pension history.
A carefully selected actual Illinois pension history. All the numbers are here in the Public Pension Database as of February 2018, and I’m using the Illinois Universities fund, though all the state funds commingle for investment results.
Base assumption: return on assets of 7.62%
That’s the 5-year average for the peers against which Illinois pensions are compared, as of fiscal year 2015.
Notice that the Illinois funds do worse against that comparison, and the 10-year average is lower than the 7.6%, though it’s on a par with its peers. That said, the 7.6% vs 7.62% amount may just be chance matching of numbers.
The next isn’t.
That “adverse scenario” in the presentation is this: the actual pension fund returns for fiscal years 2008-2012… and then just held at a level 7% thereafter.
That 7% is highly artificial. I will stress test that another time.
RUNNING HISTORICAL SCENARIOS
In the following, I am using a spreadsheet which you can download and test out yourself. I allow for a equity/10-year bond mix, and you pick the year in which to start.
The assumption are that the bonds are issued with a 5.5% coupon, and that the pension liability cash flows are as they were in the presentation (THAT’S A HUGE ASSUMPTION). The only thing that gets changed are the asset allocation and the historical return pattern.
I will use an allocation of 60% equity, 40% bond for the following, as it’s a generic allocation for pensions that used to be widespread. I’m using historical returns so the higher bond returns of the past will lead to those higher allocation.
I will be nice and put in a happy scenario to begin with. Let’s say we started in 1980.
Ooooh Aaaah.
Okay, now I’m going to be mean. Let’s start in 1929.
Now that’s an adverse scenario.
I may try out other scenarios later, but I thought to keep it simple for now. Because it’s not necessarily the investment return outcomes that provide the most risk in this situation…. and I will talk about that another time.
Anyway, play with it yourself. If you’re an Illinois politician considering this proposal and would like an explanation of how this tool works, by all means, email me at marypat.campbell@gmail.com. I’m very happy to explain what I did.
A REMINDER
This is not going to work.
Illinois can’t afford the pension promises it has made. A bond won’t change that through magic.
As Wirepoints has pointed out, using official measures (which do not really overvalue the liabilities), the pensions have grown well beyond reasonable bounds.
EVERYBODY will get screwed. That includes pension participants.
A POB, by adding more leverage to the system, would only make the disaster worse.
Aw, y’all are so sweet.
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