Tags: States | Hock | Unions | Bonds

States Going In Hock to Appease Unions

By Wednesday, 10 June 2015 10:38 AM Current | Bio | Archive

Pennsylvania has a problem. The state owes its pension funds billions more than it has.

Gov. Tom Wolf’s answer: sell bonds. In other words, go into hock.

Other states have the same problem, and they’re trying the same solution. I predict it will not end well for anybody: governors, legislators, bondholders, retirees and taxpayers.

The only question is: Who will end up holding the biggest bag?

Before we beat up on Gov. Wolf, however, let’s keep in mind that he inherited the problem. The debt’s origin lies in the distant past, with politicians who promised generous pensions to state workers. They assumed the money would be there when needed. They assumed wrong.

In Pennsylvania as elsewhere, well-organized public worker unions pressured governors and legislatures for higher pay and benefits. The politicians thought they could have their cake and eat it too. They mollified the unions by promising higher pension benefits in the distant future, and then failed to set aside enough cash to cover the promises.

The plan failed for other reasons, too. Retirees are living longer than expected, healthcare costs rose more than expected, and pension portfolios performed worse than expected. Now the bill is due.

What is the solution now? Kick the can down the road again. Pennsylvania wants to issue bonds (borrow money), but now the state faces a new question: borrow from whom?

The answer used to be you. If you own a tax-free municipal bond fund, you earned interest from state and local governments who issued the bonds. Washington gave you a little bonus by exempting the interest from federal taxation.

Back in the day, this was a great deal for everyone. Now? Not so much. Spendthrift politicians burned fund managers one time too many. The bankrupt city of Detroit settled one bond issue for 13 cents on the dollar. San Bernardino, California, is asking a bankruptcy court to let it pay just a penny on the dollar for its pension obligation bonds.

That extra point or two of tax-free interest doesn’t look so great when you lose 87 percent of your principal — or 99 percent of it.

Like everyone else, cities and states will always be able to borrow money at some price. Their problem is that their risk levels are driving interest rates higher. States can still end up “walking backward” on pension refunding bonds.

Illinois has an even bigger problem. Courts have ruled the state constitution prevents the legislature from reducing pension benefits. That makes compromise solutions even harder and forces interest rates higher.

What’s the answer? All the options are bad. I think bondholders should bear most of the loss because they knowingly placed their principal at risk, but it will still be ugly.

If I owned real estate in Illinois, Pennsylvania or other states with excessive pension loads, I would sell it right now, for whatever amount I could get. Buyers are going to be scarce and property taxes go sky-high in the next decade as people flee south.

I also would be very careful about buying tax-free muni bonds or muni bond funds. They have enormous embedded risk. The tax benefit no longer outweighs the downside.

If you are a retiree from one of these states, start adjusting your lifestyle so you can live on half your current benefit.

You didn’t create the problem, but you may well pay part of the price.

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Pennsylvania has a problem. The state owes its pension funds billions more than it has. Governor Tom Wolf's answer: sell bonds. In other words, go into hock.
States, Hock, Unions, Bonds
Wednesday, 10 June 2015 10:38 AM
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