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De Omnibus Dubitandum - Lux Veritas

Monday, June 12, 2017

Public pensions in some ways mirror Madoff’s Ponzi scheme

“In a world full of lies, the most dangerous ones are those we tell ourselves.” ― Diana B. Henriques

By   /   May 25, 2017  /   7 Comments @ Colorado Watchdog

HBO debuted its original movie on Ponzi-schemer Bernie Madoff over the weekend. Based on Henriques’ book “The Wizard of Lies,” the film (and book) tells the chilling tale of Madoff’s fraudulent investment scheme in which more than 2,200 people lost almost $20 billion in retirement savings.

That is a lot of victims losing a lot of money.

But it’s peanuts compared to what public pensioners – in Illinois, Pennsylvania, New Jersey and elsewhere – stand to lose if drastic reform measures aren’t taken soon. More on this in a moment.
A Ponzi scheme is a form of fraud in which early investors see quality returns, not because their money was invested wisely as the investors are led to believe, but because new investors fund the payouts. The cycle perpetuates itself – more and more new investors are needed to continue to fund previous investors’ returns at an unbeknownst higher risk to themselves – until it inevitably collapses.

In Madoff’s case, the collapse occurred in 2008, after almost 30 years, when the housing bubble burst and the economy was sent into the Great Recession. Simplistically, far fewer new investors could be found, and prior investors, many hurting because of the turn in the economy, asked for their full investments back.

Madoff was sentenced to 150 years in prison after pleading guilty to multiple counts of fraud. His victims suffered untold losses.

What’s the point of my Madoff history lesson?

A strong case can be made that public pensions are eerily similar to a Ponzi scheme, and that a similar collapse in some of the most underfunded systems in the country might be inevitable. That would mean an untold number of new victims that would make the Madoff case seem relatively minor by comparison.

The difference between a Madoff-like Ponzi scheme and the public pension crisis is that government is complicit in the latter, and that dedicated public servants, state retirees and taxpayers are the ones at risk.

I think we all can agree that taxpayers and state workers who have spent their careers serving residents, teachers included, don’t deserve that.

Doubt that will happen? Let’s start with Puerto Rico.

The U.S. territory in the eastern Caribbean declared a form of bankruptcy (after Congressional approval) earlier this month because of massive debt that included $50 billion in underfunded pensions. In a story headlined “In Puerto Rico, pension fund works like a Ponzi scheme,” the New York Times reported the following:

“Puerto Rico, where the money to pay teachers’ pensions is expected to run out next year, has become a particularly extreme example of a problem facing states including Illinois, New Jersey and Pennsylvania: As teachers’ pension costs keep rising, young teachers are being squeezed — sometimes hard. One study found that more than three-fourths of all American teachers hired at age 25 will end up paying more into pension plans than they ever get back.”

For pensioners in Puerto Rico, where a recovery plan is still being devised, it could mean pennies of the dollar of what they were promised.

For current and future public pensioners, a similar fate awaits if drastic reforms don’t happen.
Take Illinois, whose five state pension funds are now underfunded by more than $130 billion, worst in the nation. At that deficit, the pension funds have in hand just about 37 cents of every dollar they will owe to current and future pensioners.

But it actually could be much worse than that.

Money set aside to fund pensions – from taxpayers and public employees – is invested to grow the dollar pool. But most pension systems have over-estimated the rate of returns on these investments. As recently as 2014, Illinois’ Teachers Retirement System projected an inflated 8 percent annual return rate. That projection was dropped to 7.5 percent three years ago. Just last year, Illinois’ State Employees Retirement System downgraded its rate of return estimate to 7 percent. Each of these downgrades cost Illinois taxpayers hundreds of millions of dollars annually because the taxpayers are legally required to make up the difference.

What’s worse is that many investment professionals and ratings agencies say a more realistic rate of return is in the 3 to 4 percent range. If that’s the case, Illinois’ already staggering pension debt would balloon by tens of billions of dollars more. That could be devastating to younger state employees who still have decades to go before they retire. A younger teacher who is funding current retirees’ bloated pensions faces a potential collapse in the system, risking much or all of her retirement nest egg.
And as return estimates continue to drop, taxpayers are forced to pick up the ever-growing tab.
There is a partial solution.

Illinois state Sen. Dale Righter has filed legislation that would place all new state employees, including teachers, in a 401(k)-style defined contribution plan. State employees would contribute 8 percent of their salaries into the private investment account, and the state (taxpayers) would contribute an additional 7 percent.

While Righter’s plan wouldn’t solve Illinois’ $130 billion (likely more because of the overstated return on investments) pension deficit, it would relieve new hires of any concerns of a pension collapse and it would drastically slow Illinois’ ever-growing pension obligations. More action, particularly other structural reforms that will improve Illinois’ overall economy and increase its tax base, are needed to chip away at the deficit.

States that have adopted similar plans to Righter’s already are seeing fiscal improvements.

Unfortunately, many in the Illinois General Assembly continue to think that higher taxes are a major part of the solution. But we’ve been there and done that, and it hasn’t worked. It’s led to a stagnant economy and a mass exodus of Illinoisans to other states.

States such as Illinois and and their employees need drastic pension reform measures if they are to stave off a Madoff-like collapse.

It’s time we stop telling ourselves dangerous lies and get these reforms done.

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