“Chicago Pension Nightmare” is a Wall Street Journal article that is inaptly headlined from the perspective of a government worker:
On Thursday the Illinois Supreme Court struck down the city’s pension reform, which required city workers to chip in more to their retirement plans, raised the retirement age and cut back on cost-of-living adjustments. … The ruling further limits Mr. Emanuel’s fiscal options as pension payments take an ever-growing share of city revenues.
Absent an epidemic disease killing all of their retired employees, Illinois and Chicago will run out of money, of course. The only question was who wouldn’t get paid. The courts have answered “The former workers will get paid.” That means that bondholders won’t be paid.
Politicians can’t resist promising lavish payments to be drawn from future tax revenues. Unless the U.S. makes it illegal for politicians to hand out defined-benefit pensions, in my opinion investors should avoid state and local government bonds. (The federal government is different because it has a printing press for dollars so it can pay both bonds and pensions as long as it can afford paper and/or computer memory.)
Readers: What do you think? Who wants to defend bonds from U.S. states and cities?
Related:
- “US Treasury pushes Congress to pass Puerto Rico bankruptcy plan” (Guardian), which can be translated as “people who lent money to Puerto Rico won’t get it back”
I haven’t invested in bonds in years, largely due to their paying less than inflation. Its impressive that we’ve found ways to make them unprofitable AND dangerous.
I remember you wrote an article a long time ago (it mentioned Pentium Pro’s) about how stocks were for suckers and bonds were a lot safer but that’s when they paid a decent rate.
Anyone else feel like their money is being either flushed from safe havens and/or safe havens are being made a lot less safe?
Of course, living in California muni bonds haven’t been entirely safe for some time as various cities and counties often self immolate. Forget excessive pensions, we have cities that build huge sports stadiums with no prospective teams and enormous boat marinas with no boat services, both of which fall into disuse and disrepair.
there’s an article in this week’s Barron’s, “Balancing Act” where the advisor is recommending clients put 45% of his or her account into municipal bonds! I thought it was a terrible idea, although S&P says the muni bond index is up 1.24% year to date source, while the S&P 500 is down 0.39%. I remember when bank stocks were yielding 7.5-9% (2006). Stay away!
cfb: I don’t remember ever being a big bond fan (unless you are talking James Bond, in which case I do like On Her Majesty’s Secret Service and also From Russia with Love!). Remember that I lived through the Jimmy Carter hyperinflation years. Lending out 1976 dollars and being paid back in 1980 dollars was not a good experience for an investor!
the Illinois Supreme Court struck down the city’s pension reform, which required city workers to chip in more to their retirement plans, raised the retirement age and cut back on cost-of-living adjustments…
The State of Florida was fully successful at implementing these exact pension reforms on state workers in 2011. Effective 07/01/11, the Florida Retirement System (FRS) defined benefit pension plan required workers to contribute 3% of gross wages toward the Plan, raised the full-retirement age to 65, eliminated the COLA, and raised the vesting period to eight years. Florida state legislators also passed legislation to limit overtime that can be counted towards pension calculation for local city defined benefit pension plans to 300 hours.
The FRS offers a defined contribution option, but only about 5% of covered workers select it. As of 07/01/15, the FRS defined benefit pension plan was 86% funded and had 1 million members (active, retired, vested but inactive). All state, county, and school board workers; university and community colleges; state judiciary; and almost 200 Florida cities participate in the FRS.
I read somewhere that the FRS has less than 2% of pensioners receiving a disability pension from the plan. Whereby, on the other hand, my local city police pension plan has 25% of pensioners receiving a disability pension from the local city plan. The high number of disability pensions is a huge cost driver for city pension plans, and this is surely a major problem in Chicago.
https://www.rol.frs.state.fl.us/forms/2015_Valuation.pdf
The more likely scenario is a democratic administration will bail out the various state and municipal pension plans that are under similar stress.The state and local debt will be refinanced with federal debt and future taxpayers will be on the hook.
@Jack , we are already seeing it happen with Puerto Rico. It is getting bailed out for its $72 billion in debt – “A broad plan being put forward by the Treasury Department to ease Puerto Rico’s financial crisis would put pension payments to retirees ahead of payments to bondholders — a move that some experts fear could rattle the larger municipal bond market.”
http://www.nytimes.com/2016/02/25/business/dealbook/treasury-plan-for-puerto-rico-prioritizes-pensions-over-bondholders.html
Puerto Rico has a population of 3.5 million. Let me remind you that in 2001 Argentina defaulted on $100 billion, but with 35 million people at the time.
@cfb “Anyone else feel like their money is being either flushed from safe havens and/or safe havens are being made a lot less safe?”
Yes, can someone please tell me where I can park my euros besides my bank account (where it earns less than 1%), where I can at least get a modest 2-3% return rate over 25 years ? I have spread my retirement/pension risk across 401k/IRAs vanguard index funds, four german pension schemes (two private, one company, and one state social security), and a growing nest egg in my bank that I will eventually put into real estate purchase at some point. But what else can the common man do? I am risk averse and don’t have much time to manage a portfolio.
It’s very difficult to explain muni bonds and their extreme variety to people who are not professional muni-specialists (and I am not, but have some experience in this area)
There are 39,290 different IL bonds in 8,207 series making up $173.5 bn in debt. That includes IL and Chicago general obligation bonds (only $54 bn out of total)
Then there are bonds whose sources are specific and not general taxing ability of the government: Electricity charges, Tobacco settlements, Natural Resource leases, Casino revenues, Highway tolls, property assessments, hospital fees, school districts etc. IL has about $88 bn such bonds, and their uses are varied too – some are just for building roads, hospitals, casinos, etc.
Finally there are varied credit enhancements: Letter of Credit/Liquidity (insurance) from banks, segregated prefunded accounts that contain the funds due, and so on.
The point is, anyone who invests in muni bonds should probably know exactly what they are doing or let professionals do it for them. Every bond needs to be reviewed against your risk tolerance – certainly IL state obligations are riskier than others, but it’s possible to even invest in some IL state fund and still invest in safer securities and avoids the riskier ones (relative to your concerns about pension obligations). The converse is true also, Massachusetts might be in “better” shape economically/General Obligation/pension-wise than IL but I’m sure there are some issues which are fairly risky.
I think the risk in Illinois bonds is not as great as you all make it out to be. For one, there are strong provisions in the Illinois Constitution that contractual obligations like interest and principal payments on bonds, and pensions, get first dibs on any government revenues. Second, until recently, Illinois was a low tax state (that is why the pensions have been underfunded going back 90 years in the first place), and still has room to raise taxes further without having as massive a tax burden as California, New York, New Jersey, and many other states. Finally, unlike other states like New Jersey, Illinois is finally addressing its pension underfunding – it is contributing over $6 billion annually to the plans, vs. less than $2 billion in New Jersey where the pensions are almost as underfunded. Yes, there is currently great political dysfunction in the state because the governor is a right-wing lunatic with an extreme agenda who refuses to compromise at all with the legislature, but that is a temporary issue that will pass in a few years when he is voted out of office.
Philg…here’s the article I referenced. Maybe not so much a love for bonds but that they were the lesser of many evils.
Its actually a pretty good writeup, I still look at it once in a while.
http://philip.greenspun.com/materialism/money