Feds Force State & Local Government Insolvency
By Daniel R. Amerman, CFA
Friday, 8 July 2011
The eventual insolvency of many or most state and local governments in the United States, as well as of many major corporations, can be relatively easily shown to be the necessary mathematical byproduct of current US federal monetary and economic policy.
For decades, state and local governments were encouraged to make binding pension promises which relied heavily upon the (deeply flawed) academic theory that the lucrative compounding of investment wealth over the long term was close to guaranteed. Employee and sponsor contributions by themselves have never been enough to pay pensions, and unless investment profits deliver most of the money, then pension assets come up woefully short of being able to meet pension obligations.
However, Federal Reserve and United States government policy for the last ten years has been to knock interest rates down to near historic lows, even while propping up the prices of investment assets. This policy has simultaneously knocked out both of the mathematical pillars that long-term pension fund investments relied upon (as well as destroying the heart of conventional individual retirement planning). Because investment yields have been driven so low by the government, the pension plans are already in dire straits.
Public employees have enjoyed a guaranteed retirement age, and the numbers of boomers reaching retirement age is rapidly increasing. This means financial pressure is also building rapidly, and in order to avoid insolvency, state and local government pension plans must radically increase investment yields. The problem is that current federal policy is to effectively make these higher yields near mathematically impossible for the states to obtain, at least while following conventional strategies. And, as we will cover herein, this is likely to lead to a massive transfer of even more power from the state to the federal level, as states must meet the requirements of federal level politicians in order to avoid insolvency.
Pension Fund Mechanics: Contractually Promising The Future