Dumbest Idea Ever' Used as Pensions Plug Deficits (Update2)
By Michael McDonald and Adam L. Cataldo
May 1 (Bloomberg) -- Pension bonds are making a comeback, as states and cities from Alaska to Philadelphia bet they can use the proceeds to help fill deficits in their retirement funds and still generate a higher return than what they pay in interest.
Officials may sell a record $35 billion of the securities this year after offerings declined since 2003, according to data compiled by Bloomberg. Connecticut issued $2.2 billion of pension debt last month, paying an average rate of 5.88 percent on money state officials project will earn 8.5 percent when invested.
With the economy slowing and states facing budget deficits that Standard & Poor's says will top $30 billion next year, officials are turning to the quick fix of borrowing even though the $50 billion of pension bonds sold produced mixed results for taxpayers. New Jersey sold $2.8 billion of the debt in 1997 and its pension gap has since ballooned to 10 times that amount.
``It's the dumbest idea I ever heard,'' said New Jersey Governor Jon Corzine, the Democrat and former chairman of investment bank Goldman, Sachs & Co. ``It's speculating the way I would have speculated in my bond position at Goldman Sachs.''
There are more than 100 public retirement systems in the U.S. managing a combined $2.3 trillion. The amount is $380 billion short of the funds needed to pay pensions over the next 30 years, according to the National Association of State Retirement Administrators in Baton Rouge, Louisiana.
While the systems earned on average 11.9 percent a year from 2003 to 2006, many of the pensions failed to make the contributions required to keep pace with benefits they promised, the Pew Center for the States, a nonprofit public policy research group, said in a December report. New Jersey's seven retirement funds have a combined deficit of $28.3 billion, up 14 percent from last year, according to state actuarial reports.
States also face a $381 billion liability for retiree health care and other benefits they've promised public employees, and have only set aside $11 billion to fund that commitment, according to the Pew report.
``It's politically expedient to go out and borrow money,'' said Robert Smith, president of Austin, Texas-based Sage Advisory Services, which oversees $5 billion in assets. ``It's like taking a second mortgage on a house you haven't paid for yet.''
Alaska lawmakers sent Republican Governor Sarah Palin legislation last month authorizing the sale of as much as $5 billion in pension bonds. Wisconsin Governor Jim Doyle, a Democrat, signed a law in March permitting Milwaukee County to borrow money to close a $406 million deficit.
Puerto Rico issued $1.58 billion of debt in January, including $668 million of 6.15 percent, 30-year securities, and said it plans to sell an additional $5.4 billion over the balance of the year.
Issuers have little problem finding buyers for the bonds because they typically yield more than Treasuries and are backed by states and cities.
Connecticut received more than $4 billion of orders for its $2.2 billion Aaa rated general obligation pension bond offering, according to state figures. The portion that comes due in 10 years pays interest of 4.75 percent, more than the 3.81 percent yield on Treasuries of similar maturity.
Most issuers earn more than their bond costs after reinvesting the proceeds. Some, including Oregon, which sold $2.1 billion in 2003, have made the necessary changes to fix their funding problem, according to Robin Prunty, an S&P analyst.
``The temptation is to enhance benefits'' after selling the pension bonds, she said.
Public officials first turned to the bonds to close pension deficits when Los Angeles County borrowed $461 million in 1986. Sales peaked at $17.8 billion in 2003 as Illinois sold $10 billion of the securities, data from Thomson Reuters show.
Former Republican New Jersey Governor Christine Todd Whitman sold $2.8 billion of the debt to help close a $4.2 billion deficit in the state's pension fund in 1997, the year she ran for re-election. The state later increased benefits by 9 percent for some public employees after market gains closed the gap.
The strategy collapsed when stocks tumbled in 2001 and the economy slipped into a recession. Pension fund returns fell below the interest rate on New Jersey's bonds, and the state, faced with budget deficits, stopped making the annual contributions it needed to keep pace with rising costs.
``New Jersey is an extreme example, but it is highly illustrative of how critical consistent contributions can be to a state's pension system,'' Susan Urahn, managing director of the Philadelphia-based Pew Center for the States, wrote in December.
Philadelphia fell into a similar trap when former Mayor Edward Rendell, now Pennsylvania's Democratic governor, sold $1.29 billion in pension bonds in 1999. John Street, a Democrat who succeeded Rendell, failed to make full contributions to the fund as he tried to balance the budget.
The city has about 54 percent of the funds it needs to pay pension benefits over the next 30 years, about the same as in 1999 before it sold the bonds.
Mayor Michael Nutter, a Democrat who took office in January, said he wants to borrow as much as $4.5 billion to close the deficit, promising this time the city will make the necessary annual contributions.
``We're going to be committed to making sure the fund stays well-funded,'' said Rob Dubow, Philadelphia's finance director.
Illinois Governor Rod Blagojevich is making similar promises four years after selling $10 billion in pension bonds. The state still faces a $42 billion deficit and the governor asked the Legislature to approve another $16 billion of the securities.
A study released last month by consulting firm Greenwich Associates in Greenwich, Connecticut, found that public pension managers expect to outperform market benchmarks by 1.46 percentage points over the next five years, an outcome it said was ``probably not'' realistic.
``It's lousy public policy,'' Corzine said.