The Next Looming Economic Contagion: Pensions Collapse

As the stock market implodes in response to COVID-19, there is an underlying economic virus that will soon be evident: America's grossly underfunded pensions.  With the market down 40% in from its high point (before rebounding March 24), many corporations may default on their pension promises.  consumption and thus gross sales will decline (further dampening corporate profits), and the widespread weakness of pensions will be exposed.  This in turn will cause a vicious cycle in which retirees and those planning retirement will have fewer disposable dollars and will divert more money to retirement savings — further weakening consumption and undermining the effectiveness of interest rate adjustments by the Federal Reserve.

The problem of underfunded pensions has been loudly proclaimed for years.  It is hard to ignore article titles like "The Coming Pension Crisis Is So Big that It's a Problem for Everyone" (Forbes, 5/20/2019), "'Their house is on fire': The pension crisis sweeping the world" (Financial Times, 11/17/2019), and "Pension Plans for Millions of Americans Are on the Brink of Collapse" (NPR, 11/28/2018).

Yet these warnings have been ignored.  Now we must face the consequences.

America is on the brink of a realization of just how much corporations and legislatures have "planned for the best, in denial of the worst."  In both corporate boardrooms and legislative budget-making, employees will look back and see that what has been done is nothing short of fraud.  But it's too late now — we cannot roll back the investment clock.

John Boehner and Joe Crowley issued a bipartisan warning last summer:

Left unchecked, this crisis will decimate the retirement future of millions. Over the years, the number of retirees has grown dramatically, while the number of active participants and employers has decreased.  This imbalance, combined with the market decline from the Great Recession, has put many of these vital pension plans on an unsustainable path[.] ... To make matters worse, the Pension Benefit Guaranty Corporation (PBGC) multiemployer program, the funding backstop for plans that have run out of money, is also projected to collapse by 2025.  The dissipation of the PBGC would leave retirees with about 2% of what they had counted on for retirement[.] ... The collapse of the entire system would further compound the pension crisis at hand and have a domino effect on our economy, potentially leading to widescale business closures, layoffs and rising unemployment.

The current decline was foreseen — and the warnings ignored.  The imminent implosion will quickly exceed all municipal defaults in U.S. history combined.  Worse, state pensions are some of the greatest offenders in playing "kick the can" with beneficiaries' contributions.  Legislators everywhere have played this game of promising costly benefits to unionized state labor organizations (especially teacher unions) and then diverting required contributions to other budgetary preferences using unrealistic predictions of returns on existing investments, accounting gimmicks, and absurdly low estimates of future benefits.

There is no federal Pension Benefit Guarantee Corporation for state plans — the PBGC insulates only private-sector defined benefit plans under ERISA.  State workers may perceive that the government will always pay, but states don't print currency, and they are limited by reality:

When states and local governments reduced their employer contributions to their public pension funds during the Great Recession, they in effect borrowed from those pension funds.  If governments hope to meet their contractual obligations to their employees, they must pay these delayed pension contributions back at some point.

But most states did not pay them back.  This analysis from the Federal Reserve Bank of Cleveland addresses the legal recourse of pension beneficiaries when the state lacks the financial resources to keep its word in a time of crisis:

[O]ur legal system provides judges with the flexibility to adapt broad constitutional principles to the extreme and exigent necessities of their times.  In such times, federal courts typically defer to states' "police" (sovereign) powers, a decision which essentially allows the state, as a sovereign entity, to resolve an issue as it sees fit.  The US Supreme Court has made a similar ruling, deciding that "[t]he contract clause must be construed in harmony with the reserved power of the State to safeguard the vital interests of her people.  Reservation of such essential sovereign power is read into contracts."  In other words, when "vital interests" are at risk, defending contracts may be of secondary importance.  [A] state may have all the legal authority it needs to shed its insurmountable liabilities and force its creditors to accept any deal it offers.

What remains now is to ponder the extent of the federal bailout that will be granted to employees whose pensions are evaporating before their eyes.  When Sears sought bankruptcy protection, the PBGC undertook to step in for some 90,000 employees.  How many can it rescue now, even with a federal infusion of cash?  The present situation promises to be exponentially larger.

If President Trump is the voice seeking aid for private pensions, Nancy Pelosi and the Democrats will likely strangle a rescue plan or try to attach socialist conditions.  But how much money would be required for the federal government to also rescue underfunded state pensions? 

In June 2019, the Pew Charitable Trusts provided a 2017 snapshot of state pension shrotfalls:

[T]he pension funding gap — the difference between a retirement system's assets and its liabilities — for all 50 states remains more than $1 trillion, and the disparity between well-funded public pension systems and those that are fiscally strained has never been greater[.] ... In 2017, the state pension funds in this study cumulatively reported a $1.28 trillion funding gap[.] ... Even after nine years of economic recovery, most state pension plans are not equipped to face the next downturn.

A serious hurdle to a federal rescue is this moral hazard — states that had been most neglectful in funding their pensions would have the most to gain.

Whichever way this shrinking pie is sliced, there will be only crumbs for retirees and workers.  The coming economic whirlwind is going to pick up this Dorothy's house of pensions neglect, and no one knows where it will land.

We aren't in Kansas anymore.  Nor are we over the rainbow.

As the stock market implodes in response to COVID-19, there is an underlying economic virus that will soon be evident: America's grossly underfunded pensions.  With the market down 40% in from its high point (before rebounding March 24), many corporations may default on their pension promises.  consumption and thus gross sales will decline (further dampening corporate profits), and the widespread weakness of pensions will be exposed.  This in turn will cause a vicious cycle in which retirees and those planning retirement will have fewer disposable dollars and will divert more money to retirement savings — further weakening consumption and undermining the effectiveness of interest rate adjustments by the Federal Reserve.

The problem of underfunded pensions has been loudly proclaimed for years.  It is hard to ignore article titles like "The Coming Pension Crisis Is So Big that It's a Problem for Everyone" (Forbes, 5/20/2019), "'Their house is on fire': The pension crisis sweeping the world" (Financial Times, 11/17/2019), and "Pension Plans for Millions of Americans Are on the Brink of Collapse" (NPR, 11/28/2018).

Yet these warnings have been ignored.  Now we must face the consequences.

America is on the brink of a realization of just how much corporations and legislatures have "planned for the best, in denial of the worst."  In both corporate boardrooms and legislative budget-making, employees will look back and see that what has been done is nothing short of fraud.  But it's too late now — we cannot roll back the investment clock.

John Boehner and Joe Crowley issued a bipartisan warning last summer:

Left unchecked, this crisis will decimate the retirement future of millions. Over the years, the number of retirees has grown dramatically, while the number of active participants and employers has decreased.  This imbalance, combined with the market decline from the Great Recession, has put many of these vital pension plans on an unsustainable path[.] ... To make matters worse, the Pension Benefit Guaranty Corporation (PBGC) multiemployer program, the funding backstop for plans that have run out of money, is also projected to collapse by 2025.  The dissipation of the PBGC would leave retirees with about 2% of what they had counted on for retirement[.] ... The collapse of the entire system would further compound the pension crisis at hand and have a domino effect on our economy, potentially leading to widescale business closures, layoffs and rising unemployment.

The current decline was foreseen — and the warnings ignored.  The imminent implosion will quickly exceed all municipal defaults in U.S. history combined.  Worse, state pensions are some of the greatest offenders in playing "kick the can" with beneficiaries' contributions.  Legislators everywhere have played this game of promising costly benefits to unionized state labor organizations (especially teacher unions) and then diverting required contributions to other budgetary preferences using unrealistic predictions of returns on existing investments, accounting gimmicks, and absurdly low estimates of future benefits.

There is no federal Pension Benefit Guarantee Corporation for state plans — the PBGC insulates only private-sector defined benefit plans under ERISA.  State workers may perceive that the government will always pay, but states don't print currency, and they are limited by reality:

When states and local governments reduced their employer contributions to their public pension funds during the Great Recession, they in effect borrowed from those pension funds.  If governments hope to meet their contractual obligations to their employees, they must pay these delayed pension contributions back at some point.

But most states did not pay them back.  This analysis from the Federal Reserve Bank of Cleveland addresses the legal recourse of pension beneficiaries when the state lacks the financial resources to keep its word in a time of crisis:

[O]ur legal system provides judges with the flexibility to adapt broad constitutional principles to the extreme and exigent necessities of their times.  In such times, federal courts typically defer to states' "police" (sovereign) powers, a decision which essentially allows the state, as a sovereign entity, to resolve an issue as it sees fit.  The US Supreme Court has made a similar ruling, deciding that "[t]he contract clause must be construed in harmony with the reserved power of the State to safeguard the vital interests of her people.  Reservation of such essential sovereign power is read into contracts."  In other words, when "vital interests" are at risk, defending contracts may be of secondary importance.  [A] state may have all the legal authority it needs to shed its insurmountable liabilities and force its creditors to accept any deal it offers.

What remains now is to ponder the extent of the federal bailout that will be granted to employees whose pensions are evaporating before their eyes.  When Sears sought bankruptcy protection, the PBGC undertook to step in for some 90,000 employees.  How many can it rescue now, even with a federal infusion of cash?  The present situation promises to be exponentially larger.

If President Trump is the voice seeking aid for private pensions, Nancy Pelosi and the Democrats will likely strangle a rescue plan or try to attach socialist conditions.  But how much money would be required for the federal government to also rescue underfunded state pensions? 

In June 2019, the Pew Charitable Trusts provided a 2017 snapshot of state pension shrotfalls:

[T]he pension funding gap — the difference between a retirement system's assets and its liabilities — for all 50 states remains more than $1 trillion, and the disparity between well-funded public pension systems and those that are fiscally strained has never been greater[.] ... In 2017, the state pension funds in this study cumulatively reported a $1.28 trillion funding gap[.] ... Even after nine years of economic recovery, most state pension plans are not equipped to face the next downturn.

A serious hurdle to a federal rescue is this moral hazard — states that had been most neglectful in funding their pensions would have the most to gain.

Whichever way this shrinking pie is sliced, there will be only crumbs for retirees and workers.  The coming economic whirlwind is going to pick up this Dorothy's house of pensions neglect, and no one knows where it will land.

We aren't in Kansas anymore.  Nor are we over the rainbow.