That’s the way Winston Churchill, whose 1939 words we borrowed for our headline this week, were he asked about America, might answer that question today. In foreign affairs we have spent much of the past two years trying to reset our relationships with the rest, or much of the rest, of the world. So far we have little, perhaps nothing, to show for it other than the alienation of some old friends and no new friends.
Domestically (according to the non-partisan Congressional Budget Office) we’ll overspend to the tune of $1.5 trillion this year, on top of the $1.3 trillion we overspent last year. At the rate we’re going, we’ll add more to our debt during President Obama’s first term than all the debt accumulated by all of his predecessors combined, according to Michael Boskin, professor of economics at Stanford University.
Does the Administration want to see real economic growth in the country? Of course. Obama can’t retain the White House without a strong economic turnaround. Has he been pursuing policies to achieve that goal? Hardly. Quite the contrary. His Administration is spending much more effort stoking the fiscal fire than dousing it. The President has largely ignored the recommendations of his own Debt and Deficit Commission, making it easy for those Republicans and Democrats who oppose the commission’s recommendations to have rendered the report dead on arrival. There is a growing expectation among analysts and economists including Douglas Holtz-Eakin, the former director of the Congressional Budget Office that U.S. debt will lose its AAA credit rating within the next three years.
And while we have written, at great length, about the sad state of the federal fisc, the financial condition of the many states is worse. At least the federal government can, in a pinch, print money to meet its obligations. The states, collectively, seem to be a train wreck waiting to happen.
In a recent essay we referenced the below the radar, stopgap, partial bailout of the states by the nation’s taxpayers who ponied up approximately $40 billion in advances (loans by the federal government) to pay for state unemployment benefits. Certainly, easing the burden of the unemployed while they seek new employment has merit, but there are considerable data to suggest that, at some point, continued funding for the unemployed prolongs unemployment as many workers use the continued benefits to hold out for a job more to their liking. Almost every state faces substantial budget shortfalls. The economic stimulus money that flowed to the states has run out. Meanwhile, few states have done anything to trim their often-bloated budgets, largely because the stimulus money shielded them from the need to practice any semblance of frugality.
As the Economic Policy Journal put it, the US Treasury has been conducting a shadow bailout of at least 32 states. According to the Journal, over 60% of Americans receiving state unemployment benefits have been getting these payments because the US government stepped in to cover the commitments the states are in no position to cover.
The mounting crises couldn’t come at a worse time for the states. Their voters have just sent over 60 new representatives to Congress to rein in spending and cut the deficit and they are in no mood to bail out the states.
The $40 billion in unemployment benefits advanced to the states by the feds is, of course, just a small part of the $3 trillion in estimated unfunded liabilities that now reside at the state and local level. Some argue that this state debt is long term and infrastructure related and has not been incurred to cover operating expenses. They argue that most of the liabilities related to public employee pension programs were adequately funded while times were good and the economy was booming. But, to paraphrase the vernacular of the street, bad stuff happens and the obligations don’t go away just because the economy takes a breather.
While some states have, in fact, been mindful of the need to balance obligations with realistic projections of income, some have recklessly committed themselves to pension obligations without taking responsible steps to fund those commitments. Some of the worst offenders are Illinois, New Jersey, Pennsylvania, Colorado, Kentucky, Kansas, and California.
It’s clearly not a pretty picture, but just how bad is bad? It’s tempting to answer, “Well, it depends on who you ask.” Meredith Whitney, a prominent independent analyst who accurately forecast the housing meltdown and the mess in which we now find ourselves has predicted 50 to 100 sizeable municipal defaults amounting to hundreds of billions of dollars. Kenneth Rogoff, the Harvard economics professor who co-authored “This Time It’s Different,” a tongue-in-cheek title to a very serious book that describes how world leaders have, throughout history, rationalized excessive debt, warns that a major municipal default would have dire international consequences. Others, however, seem undeterred. Bill Gross, co-chief investment officer at Pimco, the leading fixed income investment management firm, has, according to federal filings, put cash into five of its muni-bond funds.
As is so often the case, prudence is in the eye of the holder. The devil, or in this case, the assumptions one makes about future returns, is in the details. Unrealistically high return-on-investment assumptions for state and local pension funds have been used to justify often lavish benefits, while more realistic assumptions would at least temper the commitments to which cities and states obligate themselves.
Courtney A. Collins, an assistant professor of economics at the Stetson School of Business at Mercer University, and Andrew J. Rettenmaier, Executive Associate Director at the Private Enterprise Research Center at Texas A&M University and a senior fellow with the National Center for Policy Analysis have concluded that the liabilities of most state and local pension plans are seriously understated. Collins says most governments use a return on investment assumption of around 8% to value their pension plan liabilities. That kind of ambitious assumption, when it isn’t achieved, as is generally the case in an economic downturn, encourages governments that have halted contributions to plans or suffered investment losses to invest in riskier securities that pay higher rates, she said. A more realistic rate of return assumption would be that of a federally guaranteed investment, such as a Treasury bond, at 4%, she opined. As a result, the taxpayers’ role as insurer of last resort may be much greater than anticipated.
Then there are all the other retirement benefits such as health insurance, dental and vision insurance, and prescription drug plans. Unlike pension plans, most of these nonpension benefit plans are completely unfunded according to Collins and Rettenmaier.
The Pew Center on the States reports that nonpension unfunded liabilities were about $537 billion in 2008. However the Collins and Rettenmaier estimates of the total unfunded liabilities of state and local governments for pensions and nonpension benefits total $1.03 trillion. And when these unfunded liabilities are recalculated using the more conservative assumptions, the total unfunded accrued liability is much higher.
Collins and Rettenmaier analyzed 153 state and local pension plans, representing more than 85 percent of liabilities for state and local pensions and other benefits, and recalculated their liabilities using a lower rate of return assumption than these governments typically use. Their calculations show:
- Unfunded pension liabilities are approximately $2.5 trillion, compared to the reported amount of $493 billion.
- Unfunded liabilities for health and other benefits are $558 billion, compared to the reported $537 billion.
Thus, total unfunded liabilities for all benefit plans are an estimated $3.1 trillion — nearly three times higher than the government plans report.
We do not believe there is a painless way out of the mess our national, state and local politicians have created for us. Sooner or later we’ll have to face up to the fact that there are no “untouchables” in these budgets other than, perhaps, the debt service incurred to those who have loaned money to the government. The conservative Republicans and so-called Blue Dog Democrats are going to be villainized by the liberal press if they hold firm on serious debt and deficit reduction. We’ll wager, however, that today’s villains might just turn out to be tomorrow’s heroes.
by Hal Gershowitz and Stephen Porter
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