(Bloomberg) — Every time he eats out in his hometown, billionaire investor Warren Buffett helps pay for police and firefighters to retire.
Like everyone else who dines at a restaurant in Omaha, Nebraska, Buffett is charged a 2.5 percent tax that’s used in part to defray $850 million in unfunded retirement expenses for city workers. The levy, in effect for more than three years, hasn’t closed the gap. So the mayor is trying to persuade employees to accept lower retirement payments.
Omaha is a prime example of what Buffett, the 83-year-old chairman of Berkshire Hathaway Inc., described this month as a tapeworm threatening government finances. States and localities from California to New York are struggling with how to shore up pensions that are underfunded by at least $1 trillion, according to the Nelson A. Rockefeller Institute of Government in Albany, New York.
“We are in a black hole and it’s going to take 45 years to get out of it,” said Omaha Mayor Jean Stothert, a Republican. “I’m not going to turn around and raise everybody’s taxes sky high and put it into the pension. The key is convincing unions this is something that must be done.”
Cities across the country are considering varied approaches to paying the bill. Philadelphia may sell a utility. Charleston, West Virginia, is weighing closing of fire stations, while Bloomington, Illinois, is considering new levies on concert tickets, bowling and trips to the zoo.
When Buffett called attention to pension shortfalls in a March 1 annual report to shareholders of Omaha-based Berkshire, he wrote: “Citizens and public officials typically under- appreciated the gigantic financial tapeworm that was born when promises were made.”
In a subsequent interview on CNBC, Buffett said Omaha pensions are in “terrible shape” even though the city has “a lot of resources” and is a “healthy community.” Buffett didn’t return a message left with an assistant.
Pension deficits emerged as the 18-month recession that ended in 2009 drove down stocks, trimming the value of investments used to pay benefits. Governments for years had also failed to put aside enough money.
In Chicago, the third most populous U.S. city, a “massive and growing” pension-fund shortfall could lead to insolvency, Moody’s Investors Service said in a report this month as it cut the municipality to three levels above junk grade. Detroit’s pension deficit, estimated at more than $3 billion, gained public attention last year as the city filed the largest U.S. municipal bankruptcy.
The shortfalls are affecting the $3.7 trillion municipal-bond market, even as a rally pushed benchmark 10-year yields to the lowest since June. Investors demanded an average of about 0.9 percentage point of extra yield to own local-government bonds instead of state debt in the first two months of the year, Bank of America Merrill Lynch data show. The gap was more than double the level of March 2011.
Elected officials said they’re being forced to make unpopular decisions.
Charleston, West Virginia, is considering the fire station plan to close a pension shortfall of about $250 million, said the city’s Republican mayor, Danny Jones.
“It’s going to be tough,” said Jones, citing years of failure to set aside money to fund retiree benefits. “We’ll come up with the money — fees will have to go up, services will have to be cut — but we’ll just have to do it.”
In Philadelphia, whose pensions have an unfunded liability of $5 billion, Mayor Michael Nutter, a Democrat, has said he supports extending an extra 1 percent sales tax that was due to expire, using the proceeds partly to cover pension costs. The city also is considering selling its natural gas utility to raise pension money.
Bloomington, with a pension deficit of more than $120 million, is considering a utility tax that would increase bills for electricity, natural gas, water and telecommunications. An amusement levy would increase cable bills, zoo entry fees and movie ticket costs. If approved, the taxes would be used in part to help fund the shortfall.
Dean Baker, the co-director of the Center for Economic and Policy Research, a Democratic-leaning research group in Washington, said the severity of pension shortfalls is overstated, given that public agencies have decades to pay off the unfunded liabilities.
“In cases where there are shortfalls, it’s not something that has to be fully made up in the next few years,” Baker said. “We can do that over decades.”
Investors said the stress will worsen as more Baby Boomers retire and revisions in accounting standards bar officials from understating costs.
“With these rule changes, they are going to have to be more forthcoming with what their liabilities are,” said Joe Deane, who manages more than $50 billion in municipal assets as head of munis for Pacific Investment Management Co. in New York. “Demographic changes are also going to add a lot of people onto the rolls of retirees.”
Bondholders said they’re monitoring pensions. Cities and states that fund their pensions by 80 percent or higher are good candidates for investment, said Chris Ryon, a managing director at Santa Fe, New Mexico-based Thornburg Investment Management, which manages $9.5 billion in munis.
Since the onset of the recession, every state has taken steps to shore up retirement plans, such as scaling back benefits, raising retirement ages and requiring employees to pay more, according to the National Association of State Retirement Administrators, based in Lexington, Kentucky.
Stock market gains have eased some strain. Last year, the value of the assets in state retirement systems rose to 75 percent of liabilities, up 3 percentage points from the year before, according to Wilshire Consulting, a Santa Monica, California-based pension adviser. It was as little as 64 percent in 2009.
Omaha, a city of 421,600, is also home to Mutual of Omaha Insurance Co. and ConAgra Foods Inc.
The municipality had two pensions that went from fully funded to $850 million in the red — the result of the recession and a 2004 agreement between the city and the police and fire unions, said Stothert, the mayor.
The pact reduced the early retirement age to 45 from 55, and included overtime in salary calculations.
The city later renegotiated contracts and raised the retirement age for new hires to the police and fire department. It also increased pension contributions.
Ratings companies told Stothert they aren’t giving their highest grades to cities with unfunded pension liabilities, the mayor said. The companies asked the city to fund its pension in 30 years, a milestone the mayor said Omaha is unable to reach without raising taxes. Unions are also loathe to give up hard- fought benefits, she said.
The city’s bonds lost their AAA rank from Standard & Poor’s in September. Yet investors still assess them as a top credit. Omaha general-obligation debt maturing in November 2020 last traded on March 4 to yield 1.74 percent, the lowest in a year and about even with where benchmark munis traded that day, data compiled by Bloomberg show.
S&P grades them AA+, the second-highest level, with a stable outlook. Moody’s gives them a similar rank, with a negative outlook.
Omaha is negotiating contracts with police officers to retire with less pay. Stothert said she wants to shift civilian workers to pensions that vary with the market instead of paying a fixed amount.
“The only way you can address it is to put more money into pensions or lessen benefits,” Stothert said.
–With assistance from Brian Chappatta and Noah Buhayar in New York, Romy Varghese in Philadelphia, Toluse Olorunnipa in Tallahassee, Florida and Tim Jones in Chicago.