Public Pensions – Biggest Financial Crisis Since the Great Depression?

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The following is a summary of our FS Insider podcast with Lawrence McQuillan (see “America's Public Pension Crisis” Part 1 and Part 2) which can be accessed on our site here or on iTunes here.

The rapid growth of government debt is a serious problem, with an increasing part of that growth coming from public pensions squeezing funds from essential government services, including America's neglected and nearly failing infrastructure.

“It’s the biggest financial crisis since the Great Depression,” Lawrence McQuillan, a public pension expert and author of California Dreaming, told Financial Sense Newshour. “I think most people are understating the problem. … Something’s got to change, because the costs are just going to keep squeezing out more and more services.”

McQuillan, a Senior Fellow and Director of the Center of Entrepreneurial Innovation at the Independent Institute, recently attended a forum hosted by Stanford on Understanding the Public Employee Pension Debate. His takeaway from that meeting: the problem is growing and many leading financial economists—those that have studied the numbers closely—say the problem is much bigger than the official numbers.

According to the most recent data, if we look at all state and local pension systems combined, the unfunded liability is about $4 trillion. And it continues to grow, because of insufficient contributions and large, unsustainable payouts.

State and local governments are contributing around $100 billion a year to their pension systems. They need to be contributing around three times that amount to keep the liabilities from rising, McQuillan said. Here's a clip of that interview:

Discount Rates Need to Be Reduced

Most of the presenters at the forum were Stanford University finance professors, and they were unanimous in saying that the discount rates state and local government pension funds use to calculate how much they assume they’re going to make are way too high.

The 7 to 7.5 percent rates used across the country are unrealistic, McQuillan stated. As a result, these pension funds are left with a much rosier picture of pension fund health.

Instead, they should be discounting their liabilities and assuming a rate of return between 3 and 4 percent.

“It’s important that you at least have a realistic picture of what the extent of the problem is,” McQuillan said. “You won’t know what that is until you calculate these liabilities accurately.”

Solutions Possible, But Require Political Will and Time

The reality is, there are no quick fixes, though McQuillan and others have suggested a number of reforms...some of which are being implemented currently.

“It takes years to solve these problems,” McQuillan said. “It takes years or decades to get into this mess. It’s going to take years or decades to get out of this mess. Also, it takes leadership from the top.”

The first thing pension funds need to do is use a realistic discount rate. But beyond that, McQuillan’s preferred solution is to switch both current and future employees to a defined contribution, 401K-style plan.

“The bottom line is that if they use the same pension fund assumptions to calculate the unfunded debt in the private sector that they do in the public sector, the private sector pension fund managers would be in prison because you can’t get away with making the same rosy assumptions in the private sector that you can in the public sector.” (Source)

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