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Yesterday the Securities Exchange Commission issued an order that included findings that the State of Illinois committed fraud in  statements and omissions it made about its pensions in bond offerings during the Blagojevich years.

 

Governments have powerful incentives to understate their pension problems, and this chapter shows just one reason why.  The SEC focused on bond sales, and bond prices are based on overall financial health of the state.  Hiding pension problems lowers borrowing costs, but politicians have even bigger incentives.  By understating pension problems they lower the annual required contribution, falsely appear to have money to spend on other things and trick voters into thinking their budgets are balanced.

 

States and municipalities easily get away with lying about pensions.  Illinois got caught this time because it quite flagrantly ignored the impact of “pension holidays” — times when it  skipped required payments to the pensions — and because its future scheduled payments were too small to fix their unfunded liabilities.

 

But if governments want to lie about their pensions they can easily bury their deceit in ways the clumsy Blagojevich administration overlooked. Pension liabilities are driven by assumptions that are opaque enough to cover deceit.  Illinois’ unreasonable assumptions about future rates of return, which we write about here regularly, are only one of them.  Other required assumptions include mortality, how often employees switch jobs, how soon they retire, how often they get promoted, inflation rates and more.

 

If your non-expert gut tells you those are guesswork and are easily manipulated, you’re right.  The actuaries and consultants who produce the assumptions know full well that the goal is to lower liabilities, so that’s what they too often do.  In this case the state ignored warnings from its consultants and failed to disclose those warnings.  But the consultants themselves are often pressured or dishonest so they “make shit up,” as one honest actuary puts it. Or they just ignore a blaring issue the way the consultants for the Chicago teachers pension recently did.  They didn’t question that pension’s extremely high return assumption (8%) because that would take “a substantial amount of additional work that is beyond the scope of” their report.

 

The SEC’s order says that one of the state’s own consultants said the pensions might NEVER be adequately funded, but the Illinois hid even that!

 

The moral is that defined benefit plans controlled by politicians are hopelessly dark, corrupted and corrupting.  They are a blight on both taxpayers and workers’ retirement security.  They should be terminated as rapidly as fairness and the law allow.

 

No, that does not mean that 401(k)-like plans are the only alternative.  That’s a false choice peddled by reform opponents.  Cash balance plans included in some reform proposals contain a mix of a fixed safety net and investments that may fluctuate.  Transitioning part of some employees’ retirement security to Social Security is also an alternative.

 

Mark Glennon

 

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