August 15, 2016

Pension Liabilities: A Call for Transparency

By: Robert P. Inman and Susan M. Wachter
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In October 1975, with New York City on the brink of bankruptcy, Mayor Abraham D. Beame asked the federal government for help. The answer came back in the negative. In a headline the next day, the New York Daily News proclaimed, “Ford to City: Drop Dead.” And it nearly did. But crisis was averted in the days that followed. Mayor Beame met with all the major creditors and union leaders, and everyone agreed to take the necessary cuts to make the debt payments and return the city to solvency, showing that this is possible. While cities have as a group strengthened their economies and fortunes considerably since then, there is one area where weakness is still a major concern: the preparation for paying promised pension liabilities.

Decisions made today in ignorance of future costs cannot be undone. To some extent, the lack of knowledge of the costs of today’s decisions is inevitable. Uncertainty is a fact of life and particularly so in the actuarial world. The magnitude of the problem of underfunding depends in part on fragile assumptions about the future path of the economy and the political process. But to the extent that this un certainty stems from opaque policymaking and private information, it is resolvable.

The first step, therefore, must be to make informed decisions possible. Transparency is a necessary foundation for the important task of putting our urban economies back on sound fiscal footing. The most important aspect of providing information is that it comes from a credible source so that the recipients of the information believe it to be true. One family knowing that there is a $40,000- per- family unfunded pension liability in Chicago does not enable that family to buy a $500,000 house for $460,000; that family is not going to get the house by telling the seller or other bidders of the $40,000- per- family pension liability. For the information to have a meaningful effect, it must come from a more credible source than one self- interested purchaser.

However, the question remains: Who will serve as that source? It is essential that the source be in de pen dent. Richard Ravitch and Paul Volcker formed the State Bud get Crisis Task Force to provide such sources for a variety of states. However, to date, there is no single source for this vital information for cities.

More broadly, this information must be provided to a marketplace for current taxpayers, future taxpayers, and public employees. Amy Monahan has noted that perhaps the “best” result of the Detroit bankruptcy was that suddenly public employees realized that they might not receive their pensions (Monahan 2014). These employees and investors, either in bond markets or in real estate, are going to be attentive to the final outcome. If this information is made public and municipalities do not react, this will detrimentally affect the municipalities’ abilities to raise funds. But the trade- off s faced in crisis are far worse than they would be if the crisis had not been allowed to worsen over time.

Ultimately, the economics perspective dictates that it is critical to disseminate this information to the marketplace. For example, clearly presenting liability calculation methodologies and realistic interest rate assumptions can enable all involved parties to understand and ultimately trust estimates of unfunded pension liabilities. Th is could allow real estate markets and bond markets to react accordingly and provide the discipline that has been lacking in the past. The longer this information is not forthcoming, the larger the problem may grow. Kicking the can down the road has in many cities increased underfunding. While the availability of this information will not immediately balance pension underfunding, it will impel all involved parties to work toward developing feasible budgetary solutions and prevent these liabilities from further increasing and undermining the future of the city itself.

Susan Wachter is Co-Director of Penn IUR, Sussman Professor of Real Estate and Professor of Finance at the Wharton School. Robert P. Inman is a Penn IUR Faculty Fellow and Professor of Finance, Business, Public Policy and Real Estate at the Wharton School. This article is adapted from "Public Pensions and City Solvency," edited by Susan M. Wachter, a title in the City in the 21st Century book series, published by Penn Press and Penn IUR.

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