Pensions Liabilities Force Layoffs at Chicago Public Schools

Buried beneath the glaring headlines of the debt crisis of Greece and Puerto Rico, lies the under-reported story of the public pension and debt crisis of the Chicago Public School System (or CPS). Facing massive public employee unfunded liabilities and a judicial climate unsupportive of reform, the bonds of CPS, along with those of the City of Chicago were downgraded by Moody's Investors Service to junk bond status this past May. Moody's took the action almost immediately following a landmark decision on public employee pension reform by the Illinois State Supreme Court.

The court struck down a pension reform measure passed by the Illinois legislature in 2014 designed to stem the hemorrhaging of funds to address the state's severely underfunded public employee retirement system. The pension reform plan included provisions to eliminate an annual cost of living adjustment of 3%, while boosting public agency contributions to the system, in an effort to bring the struggling state pension plan to 100% funding in thirty years. 

As to Chicago Public Schools, the Moody's action downgraded $6.2 billion of bonds to junk status. Citing its public employee pension exposure, the rating agency pointed to the stunning growth in CPS' annual pension funding requirements, from $197 million in 2013, to $634 million in 2015.  It is that latest pension payment of $634 million that gave rise to the recent funding crisis for CPS,as the district found itself simply unable to pay. With the deadline for the contribution of June 30 approaching and no extension possible, CPS sought a variety of measures to help it keep from default on its pension contribution.

When the smoke cleared last night, the payment was made, but we now learn at the expense of 1,400 salaried positions at the School District. In reporting on its plan to make payment on its public employee pension obligation, CPS made mention for the first time of its plan to eliminate 1,400 positions in an effort to reduce expenses by $200 million to bring its budget back within its limits. Faced with a sudden and previously unannounced plan to lay off teachers, the President of the Chicago Teachers Union claimed, " Mayor Emmanuel's handpicked board has led this district over a financial cliff."

Unfortunately, this may not be the last time we hear these or similar criticisms of local government in the years ahead. CPS will have a payment of this or larger proportions in 2016, as well.

Oakland, CA and the Public Pension Crisis

When I started out researching the finances of the City of Oakland, I fully expected to end up in a very different place than where this story actually ends. I knew that Oakland was struggling with pension liabilities so I thought by chronicling the effect of growing pensions on the city's finances, I might create a reasonable case study of how public employee pensions are weighing on mid-sized American cities.

If we step back to 2001, the city made contributions to CalPERS, the statewide pension administrator, of $24 million, funding 100% of it annual pension contribution or APC. Its net pension obligation was zero. Pension costs for the city's FPRS closed-end pension plan were funded in 1997 by way of a cash contribution of $22.8 million, and supplemented in that year by the proceeds of a pension obligation bond (POB) of $417 million. As a result, the program was projected to be fully funded through 2011 (although its unfunded pension obligation should be adjusted to include the $417 million of unpaid bonds).  

By 2005, however, an unfunded actuarial accrued liability (UAAL) appeared in FPFS of $268 million and its funded status had dropped to 69%. At the same time, the city's CalPERS account showed a combined UAAL of its public safety and miscellaneous employees plans totaling $370 million. The city's annual contribution to PERS had grown from $24 million in 2001 to $87.5 million by 2005, an increase of 265% in just four years. Over the same period, the city's general fund revenues had only grown by just 34%.

By 2014, the city's pension liabilities would begin to look downright ominous. The UAAL of FPRS had declined to $230 million, representing the closed-end nature of the plan and the smaller retiree population covered by the plan. Nonetheless, its funding status had fallen to 64%. And the city's combined PERS liability for its safety and miscellaneous plans had now grown to a staggering $1.13 billion, or nearly four times the size of its payroll. It's annual PERS costs had risen to $98 million.

Now, I know what you're thinking. What about the debt service on all the POBs that the city had issued to fund its UAAL. The city issued $417 million of POBs in 1997 to fund a deposit to FPRS and, in 2012, another $212 million to refund, in part, the 1997 bonds. The debt service on these bonds totalled $50 million in 2014. So this number should effectively be added to the $98 million PERS costs mentioned above, producing adjusted annual pension expense for the city of $148 million in 2014.

So this is about where I thought this story would end. The city's annual pension costs had risen from $66 million in 2001 to $148 million in 2014 (inclusive of debt service on POBs), while its unfunded pension liability had grown from $417 million to $1.7 billion (inclusive of POBs). But here's what I didn't expect to find: how well the city administrators and elected officials would address these costs.

Oakland, like many cities in California and across the country, is still struggling to recover from the 2008 recession. For Oakland, property tax revenues lost following the recession did not recover to their 2008 levels until 2013. Today, six years after the recession, Oakland property tax revenues remain just marginally higher than in 2008. Sales tax and state directed motor vehicle license revenues still haven't climbed back to their pre-recession levels. Revenues, overall, are now only modestly higher than their peak. Nearly all of the revenue gain came on the basis of locally enacted taxes for business licenses, utilities, real estate transfer, transit occupancy, parking and franchise taxes.

So here's the unexpected ending to the story. Clearly, Oakland still faces extraordinary unfunded pension liabilities in the face of limited revenue growth, all of which is pressuring its budget and bond credit ratings. But the city has managed to dramatically reduce the size of its budget to live within its means. In fact, its general fund expenses in 2014 were below those of 2008, allowing the city to record an $8.2 million addition to fund balances. The city accomplished this no small feat with the reductions coming largely from general government, allowing the restoring of funds for pubic safety to pre-recessionary levels.

What the future now holds for Oakland and other US cities is predicated on assumptions for economic growth that cannot be known. At thee same time, pension expense will most surely grow, irrespective of revenue growth, as a function of salary increases, enhanced benefits and demographics. Not a pretty picture, yet thus far, the city has done an extraordinary job of containing the damage.

What's Wrong with Social Security and Why it's Important to Gen X and the Millenniums- Part Two

We're all familiar with the payroll taxes that support Social Security, simply by looking at our pay stubs. FICA taxes, or required employee and employer payments under the Federal Insurance Contributions Act, provide the foundation of financial support for Social Security. 

The total FICA tax is evenly split between the employer and the employee, with each paying a tax equal to 6.3% of earned wages for a total of 12.6% (as of 2014). The payments are directed to the Internal Revenue Service and then paid into the Social Security Trust Fund (also known as the Federal Old Age and Survivors Insurance Trust) where they are administered by the Department of Treasury.

For many years, approximately 70, the system worked just fine with annual inflows to the Social Security Trust Fund from taxes and interest, exceeding outflows, in the form of benefits payments to retirees and the expenses of running the system. But in 2013 these lines would begin to cross as the number of program beneficiaries would rise to 62 million, and outflows would exceed inflows. The deficit of the Trust Fund in that year would total $75 billion, a level at which deficits are projected to continue through 2018 (whereafter they are projected to spike sharply upwards).

The problem with all of this is largely the basis of accounting by which the Trust Fund is managed and operated. Unlike defined benefit plans run by corporations and governed under ERISA, no such regulation guides the planning, management and investment of Social Security. Social Security today runs as it always has, as a PAYGO system. Revenue flows in from taxes paid by current workers (and employers) and flows out to retirees and services, each on an annual basis. In effect, we are borrowing from Peter (today's workers) to pay Paul (retirees). Some refer to this as a Ponzi Scheme, although that's perhaps a bit too harsh. Nonetheless, this is essentially how the system functions.

Under ERISA, companies are required to retain actuaries to quantify the present value of future, accrued benefits. They are then required to invest to meet those future liabilities. But this is not at all the way Social Security works. And it's this failure to to do so, that has allowed the Trust Fund to rise and fall with demographics. It's almost as if we knew this day of reckoning would come, when demographics would threaten the solvency of Social Security, but no one ever chose to address it.

Today Social Security reform is the third rail of politics. Everyone knows some level of reform is necessary, but to propose any modification prompts outright ridicule. Yet, with the median retirement savings of 55-64 year olds only $14,000 this generation, like those currently in retirement, will need to receive Social Security benefits just to make ends meet.

If you are interested in reading further about this topic, a full plan for Social Security reform is presented in my new book, "Up in Smoke: How the Retirement Crisis Shattered the American Dream". You can access it here.

CBO 2015 Long Term Budget Outlook

A new report of the Congressional Budget Office was just released. The report projects future budget deficits for the Federal Government through 2040. 

The report highlights future growth in spending on Social Security and health care as two principal drivers in growing deficits. Spending on these two programs alone is expected to grow from its current level of 10.1% of US GDP to 14.2% by 2040.

With current law unchanged, the CBO projects that total federal tax revenue will grow as a percentage of GDP from 17.7% in 2015 to 19.4% by 2040. At the same time, federal spending is projected to grow from 20.5% of GDP in 2015 to 25.3% in 2040. And therein lies the rub. Expenditure growth at rates considerably in excess of that of revenues. I guess you could say the government loses money on every dollar and can't make it up on volume. 

Annual budget deficits are projected to grow from 2.7% of GDP in 2015 to 5.9% by 2040. With growing deficits, the CBO forecasts that total federal debt will exceed 107% of GDP by 2040. Now this raises an important point about how various government agencies and economists measure total US debt and its relationship to GDP. 

According to data of the Federal Reserve Bank, as shown in the chart above, total debt to GDP already exceeds 100%. So why is there a discrepancy in the CBO report? It's a question of whether debt is measured on a gross or net basis. Since a healthy chunk of US Treasury debt is owed to Social Security and other federal programs, like Medicare, this portion of the debt is often netted out, under the theory that "we" owe it to ourselves.

Well, perhaps, but if you are now or are expected to be a recipient of Social Security or Medicare benefits, then it's owed to you. The Social Security Trust Fund is now the world's largest holder of US Treasury obligations, some $2.7 billion of them. The CBO report projects the Trust Fund to become insolvent by 2029. In the CBO's 2008 long term outlook, Social Security was expected to remain solvent until 2050. 

Please see my new book Up in Smoke: How the Retirement Crisis Shattered the American Dream, on Amazon now.