Gov. Christine Todd Whitman's plan to issue $2.9 billion in pension obligation bonds is good news for participants and beneficiaries of New Jersey's pension system. The bonds will secure immediately the underfunded part of their pension fund through the proceeds received from investors in the debt issue. In effect, it will be as if the state made a huge contribution to the plan to eliminate the unfunded liability.
The state, and taxpayers, should view the pension obligation bonds more cautiously, however. But if approached prudently, such a financing can be a profitable arbitrage.
As successful as the pension obligation bond issue could be, in the long run, however, there is no substitute for funding a pension plan regularly as determined by appropriate actuarial and investment assumptions, as well as managing the plan under a well-rounded investment policy.
Had New Jersey pursued that careful contribution strategy, there would be no need to issue pension obligations bonds now. In fact, as evidenced by corporate plans that have to follow a tougher policy, the plan now likely would have a surplus in assets.
The state's pension underfunding resulted from the state taking into account only part of a promised inflation adjustment in benefits.
The governor, who needs legislative approval for the bond issue, hopes to produce a gain through arbitrage. But the bond issue has several obstacles to overcome to meet its objectives.
For one, the 30-year bonds are taxable, costing the state more than traditional tax-exempt debt. The bonds are taxable because the state seeks to use the proceeds for arbitrage. The governor hopes the New Jersey Investment Board can earn a higher rate than the 8% the bonds will offer investors. Over the past 10 years the board reported a return of 10.1% a year.
But the bonds aren't without risk. Orange County, Calif., issued such bonds shortly before its financial debacle. The pension fund was safe, but the county didn't earn the arbitrage return and wound up deeper in the hole and risked defaulting on the bond payments. A financially distressed employer - with the additional pension obligation burden - does no employee any good in the long run. Now the city of Miami, which is in financial crisis, has such bonds outstanding and faces a similar burden.
New Jersey's bond issue isn't free money. The move makes sense if the state in using the proceeds for the pension plan starts keeping the plan fully funded.
