(Bloomberg) — Public pension plans threaten the financial health of U.S. cities and states more than taxpayers realize, billionaire investor Warren Buffett said.
“Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made,” Buffett wrote in his annual report to shareholders of Berkshire Hathaway Inc. released on March 1. “During the next decade, you will read a lot of news –- bad news -– about public pension plans.”
Obligations to retirees have weighed on governments from Puerto Rico to the bankrupt city of Detroit. Illinois lawmakers passed a bill last year to bolster the worst-funded U.S. state pension system. New Jersey Governor Chris Christie said last week that Detroit shows what could happen if his state doesn’t limit obligations to workers.
“Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford,” Buffett said. “Unfortunately, pension mathematics today remain a mystery to most Americans.”
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The municipal bond market has defied prior warnings of disaster. Meredith Whitney, a former Wall Street bank analyst, in 2010 incorrectly predicted defaults totaling hundreds of billions of dollars. Buffett said that year that cities and states battered by the recession faced a “terrible problem” and might require a federal rescue.
Berkshire cut holdings of state and local obligations by half in a five-year period to about $2.3 billion as of Dec. 31. The company also scaled back insuring municipal bonds, after setting up a firm to back the debt in late 2007.
“I don’t know how I would rate them myself,” Buffett said at a June 2010 Financial Crisis Inquiry Commission hearing. “It’s a bet on how the federal government will act over time.”
Apart from Detroit, communities including Stockton, Calif., and Jefferson County, Ala., have sought the protection of bankruptcy court to sort out their debts.
Moody’s Investors Service said a measure of retirement obligations for U.S. states deteriorated in the 2012 fiscal year. The median ratio of pension liabilities to revenue was 64 percent, compared with 45 percent a year earlier, Moody’s said in a Jan. 30 statement. The net liability for all U.S. states stood at $1.2 trillion, though investment gains have probably helped since then, the ratings firm said.
“Warren Buffett is a reasonable man, and he’s pointing out there are still some very visible pension issues among states and cities,” said Richard Ciccarone, chief executive officer of Hiawatha, Iowa-based Merritt Research Services, which analyzes municipal finance. “But the message shouldn’t be distorted into a panic about municipal bonds. The vast majority of credits in the muni market have manageable debt loads.”