The Origins and Severity of the Public Pension Crisis

Presentation to EARN

Dean BakerCo-Director

Center for Economic and Policy ResearchSeptember 13, 2011

Key Points on Public Pensions 

1) The main cause of the shortfall was the economic collapse.

2) The shortfalls are manageable (use percents, not dollars).

3) The return assumptions are reasonable .

2000

2200

2400

2600

2800

3000

3200

3400

3600

3800

2007 2008 2009 '2010:3

$ b

illio

ns

Change in Public Pension Assets Since the Recession

Actual With Risk-Free Rate of Return (4.5 percent)

The Crisis Caused the Shortfall

1) The plunge in the stock market cost pension funds almost $860 billion, compared with a situation where they earned the risk free rate of return.

2) If state and local governments had continued to contribute to funds at the 2004-2007 rate in 2008-2010, they would have gotten another $77 billion contributions.

3) The total impact of the downturn was more than $930 billion, more than many estimates of the pension shortfall.

The Crisis Caused the Shortfall

Putting the Shortfall in Context

1) Trillions of dollars are not informative, but they are scary.

2) Pension shortfall is equal to about 0.2% of GDP over the next 30 years (differences by state).

3) The shortfall is equal to about 1.5% of state budgets and a bit more than 2% of tax revenue.

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

0.35%

0.40%

AL AK AZ AR CA CO CT DE FL GA HI ID IL IN IO KA KY LA ME MD MA MI MN MS MO

Payment Needed to Reach Adequate Funding in 10 Years(percent of GDP)

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

0.35%

0.40%

MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY

Payment Needed to Reach Adequate Funding in 10 Years(percent of GDP)

The return assumptions are reasonable

 1) Should pensions assume risk-free rates

of return (4.5%) or expected rates of return on assets (8%)?

2) Return assumption is reasonable – it depends on current price to earnings ratios and projected growth.

0

5

10

15

20

25

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35

Economy-Wide Price to Earnings Ratios

Source: BEA, Federal Reserve Board, and author’s calculations.

-5

0

5

10

15

Price to Earnings Ratios(Risk Free Rate of Return)

Source: CBO, Federal Reserve Board, and author’s calculations.

Implications of assuming risk free rates

1) Investing in equities would give volatility – but not gains – in projected returns.

2) Increased near-term funding = less funding in the future. (This is like pre-funding schools or fire departments.)

3) Managers would have to make up shortfalls in periods of down markets just as they do now.

4) There will be pressure to not invest in equities:a) Would raise the cost of pensions to taxpayers,b) An incentive to drop DB pensions,c) Then workers would have to invest individually in stock market.

 

Longer-term picture

1)Private sector workers have lost DB pensions.

2)Private sector workers need pensions.

CEPR plan: A Voluntary Default Savings Plan: An Effective Supplement to Social Security(www.cepr.net/index.php/publications/reports/a-voluntary-default-savings-plan)

 

Conclusion

• Public sector pension plans are an important part of employee compensation.

• They are affordable.

• The problem is that the private sector workers don’t have pensions, not that the public sector workers do.

www.cepr.net/index.php/component/option,com_issues/Itemid,22/issue,50/lang,en/task,view_issue/