Will Nebraska Bail Out Illinois? News Analysis

A fiscal microscope on Detroit or Chicago ignores a continent-sized pension problem that is akin to Europe’s

Ideas about the uniqueness of America’s largest ever municipal bankruptcy continues to erode as more and more analysis and opinion questions whether Chicago is the next Detroit?

But the dawning awareness that Chicago has similar unmet obligations, or indeed that the state of Illinois is drowning in unfunded pension liabilities nearly two and a half times the size of its annual revenue, may mask a different question: How will Americans overcome a continental crisis, akin to Europe’s in scope, with unfunded pensions across America’s states and cities amounting to trillions of dollars?

The Economist recently cited estimates of the states’ pension funding gap at $2.7 trillion, or 17% of U.S. GDP. A recent Pew Charitable Trusts analysis found that pension liabilities for 61 cities were 26% unfunded to the tune of $99 billion while their retiree health care liabilities were 94% unfunded, leaving a gap of $118 billion.

These numbers likely understate the true debt since, The Economist writes, “By the states’ own estimates, their pension pots are only 73% funded. That is bad enough, but nearly all states apply an optimistic discount rate to their obligations … If a more sober one is applied, the true ratio is a terrifying 48%.”

In contrast, private pensions funded by America’s largest corporations are in much better shape. Global consultant Mercer recently reported that S&P 1500 company pension plans are funded at 89%. What’s more, American corporations are sitting on large levels of cash that could be used to pay pension obligations.

But who will pay for government promises to public sector employees? That is a question that has roiled Europe as Germans and other fiscally conservative EU member states have balked at paying the pensions and health benefits of Greek, Spanish and Portuguese government workers.

Barring massive reforms in or funding for the state and municipal pension systems, will Nebraska, whose pension liabilities amount to just 6.8% of annual state revenue or Wisconsin with a 14.4% ratio, be asked to bail out Illinois and Connecticut, with 241% and 190% ratios, respectively? When the scale of the problem becomes manifest in current budgeting, and the means to pay for it unavailable, will politicians seek to nationalize the problem with a taxpayer bailout?

David Jacobson, a spokesman for Moody’s, which calculated these ratios and which assigns state and municipal credit ratings, offered this response to ThinkAdvisor’s question as to whom its analysts expect will ultimately pay the tab for these liabilities: "We don’t offer 'solutions' to our rated entities; we just assess the credit risks for bondholders.”

Solutions suggested by The Economist seem practical, if not politically ripe:

“Public employees should retire later. States should accelerate the shift to defined-contribution pension schemes, where what you get out depends on what you put in. (These are the norm in the private sector.)”

In the meantime, extravagent pensions—like the Rhode Island fire chief who could collect close to $800,000 annually if longevity is on his side or the tens of thousands of pensioners in California who will be collecting six-figure incomes—will continue to take their toll on state budgets.

Municipal spending, and basic city services, are also under tremendous current and mounting future pressure.

Anthony Flint, a fellow at the Lincoln Institute of Land Policy, a think tank, recently wrote that pensions already consume 20% of municipal budgets, but their costs are growing rapidly: “If trends continue, over half of every dollar in tax revenue would go to pensions, and by some estimates in some cases would suck up 75% of all tax revenue.”

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