Tuesday, 09 March 2010 17:34

Trillion Dollar Gap Pt. II: The Hoax Continues

by Manuel Rodriguez
State pension funds are significantly magnifying risk and manipulating their expected rates of returns in order to reduce massive shortfalls between actual pension funds on-hand and expected pension liabilities to their retirees.

Following the Pew Center's Trillion Dollar Gap report on the pension crisis, The New York Times reports, here, that states continue to purposely distort their expected rates of return to prevent their already large pension funding shortfalls from growing steeply. Significantly, states are also concentrating greater portions of their assets in a riskier range of investments, such as commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing in an effort to seek higher returns.

The outright inflation of expected rates of return on pension assets, often pegged at over 8 percent, allows governments to diminish their annual cash contributions to the plans, but ultimately succeeds only in deferring the pain to later years. The fiction of inflated returns on pension assets temporarily closes the funding shortfall and allows governments to ease their current budgetary constraints, but fails to address the fundamental urgency of the crisis: that pensions and retiree health care benefits are grossly underfunded.

Pegging their expected rate of return to a realistic rate could have immediately disastrous consequences, though, and cause marked increases in annual contributions and significantly increase the gap between available assets and expected liabilities. A case-in-point is Colorado, which assumes an 8.5 percent rate of return and a $17.9 billion shortfall. Resetting this rate to a more realistic (yet still high) rate of 8 percent would increase the shortfall to $21.4 billion.

In desperation, state and local governments are also attempting to maximize returns by investing their assets in volatile financial instruments. This, as private companies are increasingly moving their assets towards safer fixed-income instruments, such as bonds, and away from risky instruments or equities. This strategy will merely increase volatility, and subject the pension funds and individuals' retirement savings to the vagaries of the market and another collapse. The lessons from the last few years remain unlearned by those who manage America's assets, yet the consequences of these failures are ultimately borne by others.

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