Why the Stock Market Recovery Won't Solve the Pension Crisis

The stock market has recovered – at 13,200, the Dow Jones Industrial Average is above its 2008 high before the crash – yet state and local spending on pensions keeps growing at a fast clip. Because many government officials blamed the stock market crash for pension cost increases, one would expect pension costs to moderate now that the market is back to pre-crash levels. Yet not only are pension costs still increasing, pension funds now admit that costs will keep increasing even as the stock market rises.

The reason? Public pension funds guarantee very high investment returns regardless of how markets actually perform. In 2008, that guarantee implicitly forecast the Dow would reach nearly 20,000 by now. (For more on implicit forecasts, see Warren Buffett’s commentary here.) Worse, by 2008, public pension funds had already fallen far short of the returns guaranteed from 2000-2007, which implicitly forecast the Dow to be over 20,000 before the crash. Thus, pension funds really need the Dow to be over 29,000 now – more than twice its current level – in order to meet the return guaranteed from 2000-2012. 

Because that return is guaranteed, taxpayers must make up the difference, which means less of their tax money goes to education, public safety, health, welfare, environmental protection, and other programs. Over the past decade, California’s state government spent more than $20 billion on pensions, and local governments spent billions more, in both cases taking money from programs to do so. Governments also pay for health care for retired government employees, the costs of which are doubling every few years and likewise are grabbing money from programs.

This problem isn’t caused by the pension benefits themselves, but by politicians not putting away enough money when the promises are made. Pensions are funded by contributions and investment earnings on those contributions. All is well if enough is contributed upfront so that, with reasonable levels of guaranteed investment returns, there will be enough money when the promises come due. But when politicians guarantee absurdly-high returns in order to keep upfront costs low, future generations are left holding the bag. That’s a big reason why students at California’s public universities today are paying more tuition, citizens are getting fewer public services, and welfare recipients, courts, and parks are getting less money. Also, young people today are paying the price because hard-pressed governments are offering fewer jobs and lower pay and benefits, diverting money instead to retirement benefits for existing workers and retirees.

Unfortunately, pension costs will keep rising because to meet those guaranteed returns, the market needs to keep rising at a fast clip. By 2016 – just four years from now – the Dow needs to triple to meet the guarantee issued in 1999. Anything less and services for citizens and job and wages for new government employees will continue under pressure.

Citizens deserve excellent public services and adequate public sector staffing. They must demand truthful pension funding and accounting.

Photo Credit: vincent

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David Crane

David Crane is a lecturer in the Public Policy Program at Stanford University and president of Govern For California. From 2004 – 2010 he served as a special advisor to Governor Arnold Schwarzenegger and from 1979-2003 he was a partner at Babcock & Brown, a financial services company.

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