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May 29, 2012

Pension funds channel their inner Madoff

E.J. McMahon

Public pension funds in New York and across the country are continuing to rely on overly optimistic assumptions about their future investment gains, as detailed in a major New York Times story yesterday.

The Times report came days after Comptroller Thomas DiNapoli announced that the state’s largest pension fund had realized a gain of 5.96 percent — short of its 7.5 percent target.  (More analysis of that announcement here.)

But the problem is not just that the funds make less than they hope when financial markets are especially volatile.

As the Times put it:

Worse … is that states and cities have special accounting rules that have been criticized for greatly understating pension costs. Governments do not just use their investment assumptions to project future asset growth. They also use them to measure what they will owe retirees in the future in today’s dollars, something companies have not been permitted to do since 1993.

Private pension funds discount their liabilities at an average rate of 4.8 percent, according to the Times. If the DiNapoli-run Common Retirement Fund used that discount rate instead of 7.5 percent, it would have to raise taxpayer-funded contributions even higher.

The New York State Teachers’ Retirement System is stuck on an even more optimistic 8 percent — which means, in effect, that is is more severely underfunded.  Meanwhile, New York City’s chief actuary has recommended that municipal pension systems drop their discount rate to 7 percent, which will require a further long-term increase in taxpayer contributions.

Mayor Michael Bloomberg admits that even 7 percent is too high to literally bank on.  As the mayor put it during a lobbying trip to Albany a few months ago:

“If I can give you one piece of financial advice: If somebody offers you a guaranteed 7 percent on your money for the rest of your life, you take it and just make sure the guy’s name is not Madoff.”

At a time when treasury bonds are delivering sub-zero real returns, pension funds must assume greater risks to hit their return targets.  When the funds lose money, taxpayers must bail them out — which is what is now happening.

Filed under: Public Pensions, Uncategorized

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