Chronic financial mismanagement creates physical calamities, whether it is a household, a business, or a government entity. But unlike a household or business, when the government mismanages money, the greatest numbers of people are adversely impacted. Today, the following state pensions are closest to running out of money: California, Connecticut, Illinois, Massachusetts, and New Jersey. Not only was their credit rating recently downgraded, analysts are projecting that current workers are highly unlikely to collect the full amount of their promised pension.
The pension assets for Illinois public retirees are currently under funded by $130 billion. This is so much money that the state cannot raise taxes high enough to cover the $130 billion. Let’s examine the mechanism of how an underfunded pension spirals down. Each year that the pension plan is underfunded means that the fund cannot earn an assumed 7% on that missing money that is required to fund retirees. By the end of 2017, the Illinois pension fund will be missing an additional $9 billion (the 7% return on the missing $130 billion) in earnings because the fund has a gap between what they need to have and what they owe retirees. This also means that by the end of 2018, there will be additional missing $630 million (the 7% return on the missing $9 billion). In this manner, each successive year that a pension fund is underfunded, the gap becomes exacerbated the following year. This growing gap between how much a pension fund’s actual value and how much it should have to remain solvent and pay its obligations is a financial death spiral that becomes exponentially larger each year. Sooner or later, the payments become too large for the size of the fund and a financial cliff is reached: there is not enough cash in the fund to make current pension payments to retirees. The Illinois pension problem is not the state’s only financial issue; they haven’t passed a state budget in 3 years so they have $14.6 billion in unpaid bills that has already prompted all kinds of layoffs. The State of Illinois now has the lowest municipal credit rating in the country. Even the two big lotteries, Powerball and Megamillions, are going to exclude the state by July 1st if they don’t pass a budget.
But wait – the death spiral gets worse! When you’re in financial trouble, you have to pay a higher rate on your debt – whether it is a personal loan, business loan, or for a government entity. When you can least afford it, a higher interest rate consumes even more money, accelerating the downward spiral. Last week, the Chicago Board of Education has variable-rate bonds that shot up to 9%. This means the bonds they were paying on had cost 4.6% in interest a few weeks ago but now they have to pay 9% interest. The rate would have gone higher but they were already contractually capped at 9%, so it is likely that they cannot borrow any more money at a reasonable rate. So Illinois and other government entities that rely on issuing bonds for funding may be precluded from doing so, accelerating the timeline to bankruptcy.
Connecticut has the highest income per-capita in the country, and yet, their pension fund is only 51% funded. What about solving it by raising taxes? Connecticut already ranks 2nd highest in tax burden among the states.
In other government fiscal news, the U.S. Federal Government will be bumping up against its own debt ceiling within a few months and is projected to add another $10 trillion to the federal debt over the next 10 years.