I have nominated so-called "Affordable Housing" in Manhattan as the worst possible public policy, but suddenly there is a second nominee: A federal bailout of state and local pensions.
This is one you probably have not heard of yet. Time to wake up.
Previous Manhattan Contrarian articles on the looming state/local pension crisis are collected here. How big a problem is it? A 2011 CBO report available here puts the nationwide underfunding figure at "only" $0.7 trillion, using the numbers reported by the states and localities themselves, which include discounting liabilities at an average of at or close to 8%. I would call that methodology completely fraudulent. To its credit, CBO also gives numbers at discount rates of 7, 6, 5, and 4%, and by the time you get to 4% the underfunding figure has gotten to $2.9 trillion. By the way, at this point are you, like me, asking what possible legitimate interest CBO has in this subject to begin with?
Meanwhile, an NBER/Cato Institute study available here puts the underfunding number at +/- $3 trillion. Basically, they take the view that liabilities that must be paid come hell or high water must be discounted at a (kind of) risk free rate, which sounds right to me. Separately, Moody's announced in 2012 a plan to recalculate government pension liabilities at a 5.5% discount rate as part of its bond rating processes. That rate gives an underfunding number of around $2 trillion.
Importantly, the problem is not spread uniformly among the states, but rather is heavily concentrated in (surprise!) a handful of big deep-blue states. Illinois has the worst problem, California second, while New York, New Jersey and Connecticut vie for third, fourth and fifth place. Pennsylvania is probably sixth. Many red states have no pension problem at all, although Texas is not without its issues.
Yesterday the Manhattan Institute and Real Clear Politics co-sponsored a conference on this subject here in sunny New York City. A panel on "How Bad Is It?" did not cover much that would be new to Manhattan Contrarian readers. But then came a panel on "How To Fix It" -- and suddenly the number one topic of discussion became the seemingly inevitable "federal role."
Former Mayor (1993-2001) Dick Riordan of Los Angeles spoke by video feed from California. Apparently he is making a big personal push for California pension reform. After describing a failed effort last year to gather signatures to get a pension reform measure on the California ballot, he moved on to his current ideas, prominent among which was a plan to get the federal government involved in some kind of insurance scheme for state and local pensions. Although the proposal was vaguely described, and he never used the acronym, it sounded to me very much like the PBGC. When other speakers' turns came, I was fully expecting them to dump well-deserved scorn and ridicule all over this idea, but no! The opposite -- one after the other they said something like, "well, it may be necessary," but "of course, if they do this they will have to impose stringent conditions." (Other panelists who spoke to this issue included generally sensible types like Dan DiSalvo of City College and Steve Malanga of the Manhattan Institute.) One participant, Joshua Rauh of Stanford Business School, described meetings with Congressional leaders, including, he said, Republicans, where the discussion was more what form the bailout should take as opposed to whether there should be such a thing at all. One speaker said that Governor Quinn of Illinois had included a line item in his most recent budget for an assumed federal contribution to alleviate the state's pension woes. Asked (by me of course) how anybody could possibly think federal intervention in state and local pensions would be a good idea, the answers mentioned "preventing another financial crisis" or "avoiding a meltdown."
Yikes! Like many other gigantic federal power grabs, this proceeds to seeming inevitability before anybody even finds out about it. Any sort of a federal bailout for state and local pensions is a world class bad idea. Let me count the ways:
(1) Politicians in general have no ability to run (or guarantee) any pension system because they cannot resist the temptation to buy votes today with current payouts and hide and delay the funding until after they have left office. But at least the states have the semi-discipline imposed by not being able to borrow in a currency that you can print, which is why the state/local pension problem is "only" around $3 trillion. The feds, as we all must know, having the ability to print the currency in which their obligations are denominated, therefore have the illusion of the infinite credit card, and have used it to turn their pension and health care programs into Ponzi schemes with unfunded liabilities of $80 trillion or more. So the right answer to the state/local pension problem is to turn it over to the feds? And why exactly won't the feds then promptly turn it from a $3 trillion problem into, say, a $50 trillion problem?
(2) I loved the business about the feds supposedly imposing "stringent conditions." Because, I guess, federal congressmembers and bureaucrats are responsible people who just want to do the right thing with taxpayer money? It was like it hadn't occurred to anybody that the public employees who are the beneficiaries of these pensions, and their unions, are the core constituency and prime operatives of one but not the other of the political parties. Money going to public employee union members is not just buying individual votes, it is buying political contributions, phone banks, driving people to the polls, and everything else needed to swing elections and entrench incumbents and enhance their power. Politicians simply cannot behave responsibly when faced with these kinds of temptations.
(3) Any federal pension bailout will be a massive wealth transfer from the responsible to the irresponsible and from the red states to the blue. The Republicans cannot possibly be stupid enough to go along with this. (I know, don't underestimate them.) Can they not perceive the political advantage of pointing to the upcoming struggles of the big blue states and saying, that's what happens to you when you vote for the Progressives?
I could think of a bunch more reasons, but that's enough for now. Of course, the prime argument of the forces of bailout will be to stampede their opposition with fear of a "crisis" or a "meltdown." All I can say is, back in the days before the federal government bailed everybody out, we had very sharp contractions, followed by equally rapid rebounds and booms. Now that downside risk is gradually being eliminated from life we have endless sluggishness. Maybe if we can socialize all risk we can achieve the high-tax collectivist nirvana of the Eurozone, which according to the August 14 Wall Street Journal, still has not recovered to pre-recession 2008 gdp.