No Bailout for State Pensions

The past five years or so have seen federal government bailouts and so-called “stimulus” funding for banks, domestic automobile manufacturers, insurance companies, Fannie Mae, Freddie Mac, mortgage servicers and state and local governments. The multitrillion-dollar price tags of these policies was exceeded only by their monumental failures. This ominous precedent has many people worried that bailouts of state pension systems may be on the horizon.

The California Legislature recently had an opportunity to make a statement about fiscal responsibility by adopting a resolution that would’ve called upon the president and Congress to oppose any measures to bail out state pension systems. The resolution went down to defeat in committee.

While the resolution was largely symbolic, it was concerned with a very real problem – public pension debt, which has become a growing concern for numerous state and local governments. Last year the Legislature adopted pension-reform legislation, Assembly Bill 340, which took some positive steps but fell far short of adequately addressing the state’s massive unfunded public-employee pension liabilities.

The California Public Employees’ Retirement System has an unfunded liability of $87 billion and has enough assets to cover only 74 percent of its projected liabilities. The California State Teachers’ Retirement System has an unfunded liability of $73 billion and just a 62 percent funding ratio.

Add to that debt load another $64 billion in unfunded retiree health care liabilities, and you’re looking at a $224 billion problem, which works out to a debt of around $18,000 for every household in California.

Further, several academic studies have argued that those estimates are actually too low because the pension systems’ assumptions about their investment are overly optimistic. These studies estimate that the unfunded liabilities are more likely to be $400 billion to $500 billion.

Some states are taking action on pension problems. For example, Utah and Rhode Island adopted significant pension reforms incorporating the use of the 401(k)-style, defined-contribution pension plans that are so common in the private sector. Utah closed its previous traditional pension system in 2010 and created a more affordable defined-contribution plan for new employees. In 2011, Rhode Island reduced pension benefits (even unaccrued benefits for existing employees) and switched to a hybrid system that includes both a reduced traditional, defined-benefit pension and a defined-contribution plan.

But many other states are ignoring the pension storm, and there is growing concern that the federal government might bail them out. State bailouts would undermine our federalist system, effectively turning sovereign states into wards of the national government.

Accepting a bailout could cause state legislatures to lose control over many of their own budget decisions. Federal funds already make up more than one-third of the annual California budget, and many of those federal funds come with strings attached. The strings that might be imposed by the current or future presidential administrations and Congresses for a bailout might be very different from the priorities the state legislature would prefer for spending the money.

Just as the federal bailout of the so-called “too big to fail” banks rewarded irresponsible and risky financial behavior, a federal backstop for state debts would reward – or even encourage – reckless pension policies. It would also force citizens of states that do manage their finances well to pay for states that do not. Californians certainly don’t want to pay for the pension promises Illinois has made, and residents of the other 49 states don’t want pay for California’s pensions.

Adam B. Summers is a senior policy analyst at Reason Foundation. This article originally appeared in the Orange County Register (paid subscription required).