News headlines are reporting daily on a pension crisis unfolding in the US. To understand how we got here, there are five major factors that led us to this point:
- Generous payouts
- Inadequate contributions
- Low interest rates
- Longer life spans
- Overly optimistic return assumptions
Lawrence McQuillan detailed how all of these are converging together in one hot mess for America’s largest and most underfunded state when he wrote his must-read book, California Dreaming: Lessons on How to Resolve America’s Public Pension Crisis.
As he said to us at the time, during a book interview with FS Insider, the money just isn’t there and now politicians are “scrambling”:
“If you look nationally at all state and local governments across the country, the unfunded public pension debt is at $4.7 trillion. Keep in mind that this is money that should be in the bank today…and earning compounded interest, but isn't, and now politicians are scrambling to come up with the money to fund these pensions.”
Illinois, whose economic growth is currently worse than the Great Depression, is receiving the most attention when it comes to the inability to pay its bills and promises, but, according to McQuillan, California (the “granddaddy of them all”), New York, New Jersey, and others also have a crisis on their hands.
Credit default swaps (insurance against default) on state debt for Illinois (in blue) are now higher than they were at the height of the financial crisis in 2008. New Jersey credit default swaps (in red) are elevated with California (gold) and New York (green) not showing any signs of alarm…currently.
We will keep a close eye on the evolving pension crisis in the US and, particularly, for any signs of contagion from states like Illinois to others, especially the biggest of them all, California.
One thing is for certain: if the US economy starts to stumble around the 2019 timeframe, as Barry Bannister, Alan Beaulieau, and Intensity Corporation's machine learning forecasting engine all believe, the strains on public pensions will become even greater.
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