State and Municipal Finances in the News

The New York Times recently ran a story entitled “Mounting Debts by States Stoke Fears of Crisis,” which focusses on the unfunded pension liabilities facing state and local government units across the country.  Most of these pension liabilities were not incurred since the housing market went south and the recession hit, but those events have put municipal governments in a serious bind.

As the downturn has ground on, some of the worst-hit cities and states have resorted to fiscal sleight of hand to stay afloat, helping them close yawning budget gaps each year, but often at great future cost.

Unfunded pension liabilities share certain similarities with deferred maintenance on municipal capital infrastructure.  Deferred maintenance creates two major problems.  The first, obviously, is that the infrastructure can’t serve its purpose , serve the needs of residents, as effectively.  The second – and here is the parallel with unfunded pension obligations – is that the repairs will be necessary and the bill will eventually come due, and will be higher than if it had not been put off.

— Much of the debt of states and cities is hidden, since it is off the books, just as the amount of mortgage-related debt turned out to be underestimated. States and municipalities often understate their pension liabilities, in part by using accounting methods that would not be allowed in the private sector. Joshua D. Rauh, an associate professor of finance atNorthwestern University, and Robert Novy-Marx, an assistant professor of finance at theUniversity of Rochester, calculated that the true unfunded liability for state and local pension plans is roughly $3.5 trillion.

— The states and many cities still carry good ratings, and those issuing warnings are dismissed as alarmists, reminding some analysts of the lead up to the subprime crisis.

Rauh & Novy-Marx (both with the National Bureau of Economic Research), quoted in the story, released a report in October on the unfunded pension liabilities in metropolitan areas across the country.   Here’s an excerpt from the release by the Kellogg School of Management (where Rauh teaches):

Six major cities have current pension assets that can only pay for promised benefits through 2020: Philadelphia, Boston, Chicago, Cincinnati, Jacksonville and St. Paul. An additional 18 cities and counties, including New York City, Detroit, Cook County in Illinois and Orange County in California would be solvent through 2020 but not past 2025.

“Philadelphia has the most immediate cause for concern, as the city can pay existing promises with existing assets only through 2015 — less than five years from now,” Rauh said.

Here’s a sobering couple of lines from the study’s conclusion:

What is clear is that state and local governments in the US have massive public pension liabilities  on their hands, and that we are not far from the point where these will impact the ability of state and  local governments to operate. Given the legal protections that many states accord to liabilities, which in a number of cases derive from state constitutions, attempts to limit these liabilities with benefit cuts for existing workers will only go so far (Brown and Wilcox (2009), Novy‐Marx and Rauh (2010b)).

Click HERE for a PDF of the full study.

Posted on December 9, 2010, in Uncategorized. Bookmark the permalink. 1 Comment.

  1. No matter how bad you think it is, it’s worse. GAO-10-899, using pre-recession data and the most optimistic assumptions, found that in aggregate states and municipalities must cut operating expenses at least 12.3% a year every year for 50 years to avoid default. The American Society of Engineers found $2.5 trillion in vital infrastructure beyond design life that must be replaced or refurbished within the next five years. Governments, like the Bethlehem School District, have fallen for sucker-punch financial deals that could leave them billions of dollars in the red. The list goes on and on. If states do not act immediately, they could pass a fiscal event horizon from which there is no return.

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