The New York City pension funds took it on the chin in a New York Times article two weeks ago.
The thrust of the story was that the funds had lost more in the stock market decline than similar funds because they had higher than average equity exposures. This, said the Times story, was an added burden on the New York City budget at a time when the city could least afford it.
This was unfair. The equity exposures of the city funds was not significantly higher than similar very large public employee funds, such as the California Public Employees' Retirement System and the California State Teachers' Retirement System, or large corporate funds, such as those of General Electric Co. and Verizon Corp.
And, in fact, the city funds gained far more in the bull market from their high equity exposures than they lost in the past two years from the stock market decline, which, as measured by the Standard & Poor's 500, compounded to a 10.5% loss annualized. But remember, the market returned 12.8% compounded annually over the last 12 years, from the start of 1990 to the end of 2001, compared with only 8.9% for long-term corporate bonds, or 9.4% for long-term Treasury bonds.
State politicians, led by State Comptroller H. Carl McCall and aided and abetted by Gov. George Pataki, did far more damage to the city funds, and the state employee funds also, than the market decline has done. They assumed the high stock market returns would last forever, and so two years ago, just before the dot-com bubble collapsed, they passed a permanent annual cost-of-living increase for retired state and city employees, over the strong opposition of most city officials. Every year, retiree pensions will be increased to offset inflation.
That little gift to public employee unions will cost the city $500 million this year alone (as the Times acknowledged). But that cost-of-living increase is an infinite liability. If we assume that annual cost does not change going forward, the present value of the liability for just the next 25 years is more than $7 trillion!
But, of course, the cost almost certainly will increase as public sector salaries rise, so the $7 trillion is an underestimation.
State and local governments, and companies sponsoring other pension funds, can't be smug. They also will have to increase their contributions to their own funds. Most have actuarial investment return assumptions that now appear wildly optimistic. In some states the government cut contributions during the boom times, even though the plans were not fully funded, believing the soaring stock market would do the heavy lifting in the future.
In addition, many corporations were able to claim they were fully funded, in part because of the unrealistic interest assumptions, and cut their contributions. Some rec- ognized pension income when their pension funds outperformed the assumptions. They now will have to recognize greater pension expenses on their income statements as the funds underperform the assumptions.
Some experts are saying the likely excess real return from stocks over risk-free bonds is likely to be no greater than 2% for the indefinite future, not the almost 6% experienced during the past 76 years. As governments and corporations reduce their interest assumptions, they must increase contributions.
The lesson of these shenanigans is that pension funds exist for only one reason - to pay reasonable retirement benefits to their beneficiaries. They're not there so politicians can use them to buy votes with unaffordable benefits. Nor are they there so corporate executives can goose corporate reported income with pension income.
Unfortunately, the costs of these foolish, self-serving decisions by politicians and corporate executives will be borne by the taxpayers, and corporate employees and customers.