Depending on the methodology that’s used to determine the underfunded position of state public pension plans, the number as of 2015 ranged from a staggering $1.7 trillion to an unfathomable $5.2 trillion!I thank Bloomberg's Lisa Abramowicz for bringing this to my attention on her Twitter account (make sure you follow her here, she provides excellent insights on public and private markets).
To put that into context, the national debt of the United States is currently about $20 trillion.
But why is there such a great disparity in those two numbers mentioned above with one indicating an underfunded ratio of only about 26% ($1.7 trillion) while the other indicates an underfunded ratio of about 61% ($5.2 trillion).
It’s all about assumptions that are made concerning the returns earned on investments. ‘One accounting trick is the use of high discount rates, the assumed rate of future investment returns on fund assets, when calculating pension liabilities.’ (Source)
The pension funds assume a rate of return on invested assets of more than 7%, while the chart below courtesy of State Budget Solutions calculates underfunding using a more reasonable assumed rate of return equal to the 15-year U.S. treasury bond yield.
So Do These Underfunded Plans Actually Pose A Risk To Real Estate Values?
Assuming that at some point the proverbial fiscal can will no longer be able to get kicked down the road, the monies due to retirees will have to come from somewhere. In a worst-case scenario, Puerto Rico’s recent default most certainly had a pension component as the island has over $2 billion of Pension-Obligation Bonds outstanding.
So then, assuming that return assumptions are skewed too high, where will the monies owed by states and local governments to pensioners come from? We the taxpayers of course in the form of higher assorted fees, higher property taxes and higher other taxes.
In already high tax states like New York, the taxpayer can only bend so much before breaking, ultimately moving away to find lower state and local tax alternatives. Higher and higher personal tax burdens (and fees designed not to appear as taxes) means becoming a less desirable the location to live and work meaning that real estate prices would theoretically need to be adjusted to account for those facts (Nassau County Real Estate Closing Costs Set to Become New York State’s Highest!).
But, of course, politicians will do whatever possible to avoid this prospect and just keep on kicking! (click on image)
So, can underfunded US public pensions pose a threat to residential real estate? You better believe it, especially in states like Illinois where public pensions pose a serious threat to state finances and a court ruling just sent the state into a finacial abyss.
Quite shockingly, instead of amalgamating all public pensions at the state level, bolstering governance and adopting a shared-risk model which would mean hiking contributions and cutting benefits, Illinois lawmakers are working on a massive tax grab.
What that means in practice is income and residential real estate taxes and other taxes are on their way up to fund chronically underfunded pensions. And this isn't just happening in Illinois, it's happening all over the United States. US taxpayers are about to feel the wrath of chronically underfunded pensions which are going to come back to haunt them for years.
Honestly, it reminds me of Greece where the situation is going from bad to worse but the media thinks everything is ok because the Greek stock market is on fire this year (short it).
In Greece, the SYRIZA government led by Alexis Tsipras has adopted the old ways of PASOK and New Democracy expanding the public sector (even if Troika warns them not to) and imposing higher income and property taxes and utility rates to fund chronically underfunded public pensions.
What does Greece have in common with the United States? Not much except when it comes to their overzealous public sector unions and public pensions where there is poor governance making a terrible situation far worse than it needs to be.
And while the article above talks about the effects of underfunded pensions on residential real estate what will happen to commercial real estate values when the next crisis hits and these mature, chronically underfunded pensions have to unload commercial real estate to meet their pensions obligations?
I'm not suggesting this will happen but I am suggesting it could happen, especially if we enter a prolonged debt deflation cycle where liabilities soar and taxpayers won't be able to absorb higher taxes.
Below, ABC7 reports the Illinois House just approved a $5 billion tax hike and a spending bill Sunday night, capping a dramatic weekend of wrangling to end the nation's longest-running budget stalemate.
What we are witnessing in Illinois is just the tip of the iceberg. It will happen all over the United States and unfortunately, the US pension crisis, just like the global pension crisis, is deflationary and will ensure a very long period of low growth and low rates. Happy 4th of July!