Wednesday, September 23, 2015

Chicago Hikes Taxes to Pay Public Employee Pensions

Mayor Rahm Emanuel at City Council Meeting on 2016 Budget
Chicago Tribune
News broke this week of a proposal by Chicago Mayor Rahm Emanuel to hike property taxes for city residents by $588 million over the next four years. Tax increases are certainly not uncommon, but what caught median attention was the direct link between the need to raise taxes and the fact that the tax revenue would be directed to shore up underfunded public employee pensions. Community residents suddenly find themselves faced with the stark reality that their ability to fund their own retirement savings will be compromised by the city's need to fund the retirement of its employees.

The news followed recent downgrades of the City of Chicago in May 2015 to junk bond ratings. In lowering the city’s rating, Moody’s Investors Services cited “the city’s highly elevated unfunded pension liabilities” continuing, “we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably.”  This thus points to the most troubling concern about public employee pension liabilities: that even well-intentioned efforts at pension reform may take years to slow the growth of unfunded liabilities.

For taxpayers of the City of Chicago, the pension deficits of the city are additive to those of the State of Illinois.  In a working paper of the Harvard Kennedy School of Government in 2012, the authors estimated that the household public employee pension burden of taxpayers in the City of Chicago – that is, each individual family’s share of unfunded public employee pension liability - totaled $81,118, comprised of $41,966 for their share of City of Chicago liabilities and an additional $46,152 for the share of State of Illinois underfunding.  If you happen to live in the City of Chicago, you might want to start planning for how you will pay this obligation.  Failing an economic miracle or a Federal bailout, the taxpayer is the only resource for paying this deficit.

Pension liabilities have now been cited as the reason for credit downgrades in Connecticut, New Jersey, Pennsylvania and Puerto Rico, as well as for the cities of Cincinnati, Philadelphia, Detroit, Chicago, Evanston, Omaha, Jacksonville, Des Moines and Minneapolis, among others.  These credit downgrades stand apart from the local governments that have suddenly and dramatically been plunged into bankruptcy like the cities of Stockton, Detroit, San Bernardino, Vallejo, Harrisburg and Central Falls.

For states, like the State of Illinois, the problem is even more complex. While cities, individuals and private businesses can reorganize their liabilities in bankruptcy, no such provision exists for the states, at lease under current law. Without the legal ability to restructure their pension obligations in bankruptcy court, states faced with pension deficits similar to those of Illinois must opt for one of two unenviable choices. They can raise taxes, where possible to fund the replenishment of their pension fund, or they can reduce general services to residents to provide budget relief for funding the shortfall.  But in many instance the tax route isn’t just unpopular, it’s simply not practical. According to Moody’s, to fully fund the City of Chicago’s annual required pension contribution would necessitate raising its property taxes by 95%.

A recent report of Alliance Bernstein quantified the annual pension costs, debt service and fixed charges of the City of Chicago at 40% of its general fund budget. That would mean paying just these items, would require that all the other vital services of the city, including police, fire, sanitation, public works, etc., must all get crammed into an ever shrinking portion of the pie, now just 60% of the total budget.

So just what happened to turn these pension funds so horribly upside down?  First, in the case of the Chicago Police Benefit Fund, average salaries grew by 55% over the past fifteen years, or roughly 4% per annum – not unreasonable.  Average pension benefits, however, grew by 79% over this same period, while the number of former employees receiving retirement benefits increased by 45%.

Modest annual salary increases, coupled with rising benefits and an accelerated population of retirees, spelled soaring benefit payouts for the fund, with total retirement benefits growing by 160% over the same period. Plan contributions simply failed to keep pace. The solution, it now appears, falls squarely on the shoulders of its taxpayers.

You can read more about the US state and local government pension crisis in my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon, iTunes and Barnes and Noble bookstores. 

Wednesday, September 16, 2015

Election Year Spin on Social Security

Bernie Sanders' campaign for the White House has triggered a firestorm of rants, tweets and accusations about Social Security, thrusting the now seventy year old program to center stage in a forum of election year theatre. Sanders' charges, often wrapped in outright inaccuracies, are carefully aimed at a demographic the candidate knows to be voter-ific: aging Baby Boomers. Most, or at least half, of this generation are wholly unprepared for the expenses of retirement, while the other half is, well, just modestly underfunded. Both will be dependent on Social Security in varying degrees, a program that is suffering a mid-life crisis of its own.

The purpose of this post is not to offer my opinions on Social Security, but rather to simply state the facts, as more officially presented to Congress by the Trustees of the Social Security Administration in their 2015 Annual Summary on the Social Security and Medicare Programs. Both the summary and the full report of the Trustees can be easily accessed on the internet or through the link provided in this post.

Sanders' claim of the "myth of Social Security insolvency" is quickly followed by accusations that Republicans plan to "cut benefits" to retirees. Boy, I tell you, it's enough to get a retirees' blood to boil. Then again, maybe that's the point. But in Sanders' attempts to sway public opinion for his electoral purposes, the blatant misstatement of the facts surrounding Social Security actually does far more harm than good for the program and to the millions that depend upon it. 

In an article from earlier this year in the Des Moines Register, entitled "Social Security; Expand it don’t Cut it", the Senator was quoted, 

"Republicans are trying to convince voters that Social Security is in crisis. Let's not kid ourselves: We do have an urgent problem on our hands, but it's not Social Security. Millions of middle-class Americans are facing a retirement crisis as a result of inadequate income and growing wealth inequality. Social Security isn't the problem. It's an essential part of the solution."

While the Senator is correct about the latter part of his comments, he's dead wrong about the former. Social Security is most definitely in crisis, at least according to the Trustees of the Social Security Administration. Perhaps before moving on, we should spend a moment and define who the Trustees actually are and what their role is in all of this. 

By law, there are six Trustees of the Social Security Administration or Trust Fund. These are, the Secretaries of the Treasury, Departments of Labor, Health and Human Services and the Commissioner of Social Security. The two remaining Trustees are public representatives who, along with the aforementioned cabinet members and Commissioner, are all appointed by the President, or in this instance, specifically by President Obama, a Democrat. That being said, it's really not rational to dismiss the comments in the report, or at least not to 
discount them as a Republican ploy.

Here, then, are direct quotes from the 2015 Trustee report to Congress. Decide for yourself if Social Security insolvency is a myth, as Senator Sanders argues:

“Social Security and Medicare together accounted for 42% of total Federal program expenditures in 2014”

“Both Social Security and Medicare will experience cost growth substantially in excess of GDP through the mid-2030s”

“Social Security’s Disability Insurance Trust Fund now faces an urgent threat of reserve depletion by 2016”

“Beyond DI, Social Security as a whole as well as Medicare cannot sustain projected long-run program costs under currently scheduled financing”

“The Trustees project that the Medicare Trust Fund will be depleted in 2030”

“After 2019, Treasury will redeem trust fund asset reserves until depletion of Social Security Trust Fund reserves in 2034”

Seems fairly straightforward to me that there's an urgent problem with not just Social Security, but Disability Insurance and Medicare. Now why would Bernie Sanders be arguing something altogether different?

For more detail on Social Security and the broader retirement crisis in America, please see my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon, iTunes and Barnes and Noble bookstores. 

Thursday, September 10, 2015

Are Stocks Headed Lower?

This is, of course, the question foremost on investors' minds. After all, it's been several years since we've seen a correction to the major averages that stocks have experienced since mid-July. True to form, market swoons of this sort seem to come out of nowhere. Yet as one market sage was quoted, "no one rings a bell at the top". But did we see the market top on July 20, or are we poised to consolidate and move higher?

Visit any financial news website and there are plenty of commentators quick to provide an expert opinion. But of course, no one really knows where markets are headed. We simply try, as best we can, to make informed judgements (or as some have called them, "bets"). 

If you look closely, though, the data have been quietly sending indications of direction. The plunge in oil prices earlier this year seemed to have caught investors (and oil company executives) completely off guard. Oil prices that had hovered in the range of $80-100 per barrel for five years, began a move in the latter part of 2014 that can only be described as a plunge. Now settling in the low 40s, equity investors are considering the implications of these new levels for global industrial demand and GDP.

But there were warning signs of oil's imminent decline that now appear more clearly in hindsight. A robust and vibrant US oil sector, with highflying fracking stocks like Pioneer Natural Resources, EOG and Oasis began to wobble in 2014, but only after their drilling and exploration counterparts that lead production, like Halliburton and Schlumberger, faltered. Prior to this, warning shots were fired by HiCrush and US Silica that make the key raw materials integral to the fracking process. But the real leading indicators we now see were in specialty energy companies like Geospace Technologies that make seismic data analysis tools and provide critical research for drillers and oil exploration companies. Their stock began crashing in late 2013 and should have signaled the "canary in the coal mine" for anyone interested in the direction of oil demand, supply and price.

Oil aside, however, the abysmal levels of a broad range of commodity prices, from copper to steel, has investors questioning global industrial demand. With prices for many of those commodities now believed to have been artificially inflated by China government investment (i.e., building empty cities and bridges to nowhere) everyone is a bit concerned about the veracity of sustainable global demand. Commodity dependent economies like Brazil, South Africa and Australia are unquestionably suffering ill effects, as a result of the reduced demand. These effects are echoing throughout the emerging markets. They are also being felt in the US high yield bond market, where many small energy companies financed their growth and development and now struggle to meet debt service.

With the US and EU economies piddling along, all eyes for now will remain on China. As government mal-investment there subsides, investors are questioning whether there is really internal demand to support consumption or growing global demand to boost exports? The answer, from the most recent data, appears to be a resounding no.

Thursday, September 3, 2015

Will China Selling put Upward Pressure on US Treasury Yields?

There's been more than a little attention devoted to this question lately. The concern follows reports that China has been selling portions of its massive US Treasury holdings to support a destabilized Yuan. 

Marketwatch had a nice piece this morning that should dispel much of investors' concerns. This chart from Marketwatch shows net flows of foreign private and official sector purchases of Treasuries. Despite recent selling pressure, private sector purchases appear to be more than offsetting the selling of foreign governments.

Here are some other factors to consider that should equally support US Treasury prices, if not exert downward pressure on bond yields. First, as reported elsewhere, China cannot dump its holdings of UST for fear of price instability and also the question of where to go to reinvest some $1.2 trillion of proceeds. Second, if the world is really trending towards deflation, as is being reported, US Treasury bonds will climb in value. As inflation erodes the value of fixed income securities, deflation produces just the opposite effect. Third, lower US budget deficits (for however long that lasts) will decrease UST new issuance. Fourth, US pension funds are increasingly talking about "de-risking" their investment portfolios, by selling equities and corporate bonds to move into US Treasuries and other safer investments. 

Given these considerations, don't be surprised if near-term the 10-year heads back towards its January 2015 low of 1.68%, particularly if there's a flight to safety trade following a stock decline.