. From the Treaty of Detroit to the Bankruptcy of Detroit: State and Municipal Economies and Finance and the Fate and Future of Pensions

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1 Presentation by Shelby Chodos, Adjunct Lecturer in Public Policy, Harvard Kennedy School at Session #9. From the Treaty of Detroit to the Bankruptcy of Detroit: State and Municipal Economies and Finance and the Fate and Future of Pensions at the 12 th Annual Conference of the Pensions and Capital Stewardship Project, Harvard Law School, May 9, 2014 LWL- Pensions and Capital Stewardship Conference

2 Overview 1. Diversity - States and localities differ in terms of: Size and Diversity of Economy Volatility, Diversity and Quality of Revenue Quality and Depth of Management Size and Complexity of Debt Portfolio The actuarial health of their pension systems 2. Revenue Picture States - rely primarily on sales and income taxes, which fell by 10-15% at the start of the recession and have now recovered. Local Governments rely on property taxes which lag the economic cycle by 2-4 years and have fallen along with state aid. 3. Most fiscal stress is chronic, not acute National economic conditions anemic growth; Local economic conditions from energy booms to continued industrial decline Complex implications (good and bad) of health care reform Bonded debt has remained at relatively manageable levels for most jurisdictions; Municipal bankruptcies are rare, highly publicized events. LWL- Pensions and Capital Stewardship Conference

3 Wide Variation in Demographics and Metropolitan Significance 2011 Houshold Income ($000) Population (Million) Decade Change % of metro Chicago $ % 28% Dallas $ % 98% Denver $ % 24% Detroit $ % 16% Houston $ % 35% Los Angeles $ % 30% Miami $ % 7% New York $ % 43% San Antonio $ % 62% San Diego $ % 42% San Francisco $ % 19% Tampa $ % 12% Median $ % 18% LWL- Pensions and Capital Stewardship Conference

4 Pensions are not the cause of most bankruptcies Detroit 50 year decline, derivatives, pensions San Bernardino, Calif. corruption, pensions Mammoth Lakes, Calf adverse legal judgment Stockton, Calif.- pensions, bonds, housing bust Jefferson County, Ala.- derivatives, corruption Harrisburg, Pa. incinerator, derivatives Central Falls, R.I. -3. km sq., poverty, corruption Boise County, Idaho - adverse legal judgment LWL- Pensions and Capital Stewardship Conference

5 Detroit: Pensions only part of the story

6 Detroit: Pensions only part of the story Source: Fitch

7 Bankruptcies are rare among US Cities Municipal Bankruptcy is Rare We are a nation of 25,000 municipalities, 80 % with fewer than 10,000 citizens. About 10 municipal bankruptcies per year since WWII. Only 12 states specifically authorize municipal bankruptcies; Another 17 state s have some limited framework; Remaining 21 state s have no direct path to a municipal filing. LWL- Pensions and Capital Stewardship Conference

8 State and Local Credit Factors Median Local Government Rating is Aa3/AA- Median State Rating is Aa1/AA Factors: Size and Diversity of Economy Volatility, Diversity and Quality of Revenue Quality and Depth of Management Size and Complexity of Debt Portfolio Timeliness and Quality of Financial Reporting Management of rainy day funds and other reserves Funding progress and management of long-term obligations LWL- Pensions and Capital Stewardship Conference

9 Billions State and Local Debt : A smaller, less liquid market Debt Outstanding 2012 $16,000 $14,000 $12,000 $10,428 $11,493 $13,493 $10,000 $8,000 $7,561 $6,000 $4,000 $3,743 $2,000 $0 Source: Federal Reserve Treasuries Agencies and GSEs Municipal Securities Corporate and Foreign Bonds Mortgages LWL- Pensions and Capital Stewardship Conference

10 State and Local Debt: Diverse Purposes, Generally High Quality ostates 40% olocal Governments 60% Local Authorities 17% Misc. Issuers 40% State Governments 10% Districts 17% Cities & Towns 16% State Authorities 30% Counties 6% Source: The Bond Buyer LWL- Pensions and Capital Stewardship Conference

11 Weighting of Municipal Credits Factors Debt Burden 10% Management 20% Financial Strength 30% Local Economy/ Tax Base 40% Budget Discipline Reserves and Liquidity Pension and OPEB funding

12 Demographics and Weak Funding Discipline: Active/retired ratio declines from 2.7 to 1.7 Source Moody s LWL- Pensions and Capital Stewardship Conference

13 The Median Public Plan Compares with the Weaker Corporate Plan Low-Funded Corporate Plans Company Funding % Entergy 77 Dow Chemical 75 Alcoa 74 Verizon 74 Sears 70 Amer. Airlines 68 Exxon 75 Delta 48 Large US Cities City Funding % New York NY 60 LA 77 Chicago 35 Houston 78 Philadelphia 48 Phoenix 61 San Antonio 90 San Diego 70 LWL- Pensions and Capital Stewardship Conference

14 Underfunded systems exists in both declining and growing cities Funding Deficiency Burden Per household Infrastructure needs Economic growth Chicago significant significant significant moderate New York moderate moderate significant strong San Diego significant significant moderate strong Philadelphia significant significant significant weak Portland, Ore. significant significant moderate strong Pittsburgh significant significant moderate weak Cincinnati significant significant moderate weak Atlanta significant significant moderate moderate Cleveland significant significant moderate weak LWL- Pensions and Capital Stewardship Conference

15 Funding Discipline Varies Significantly across the States Source: Moody s LWL- Pensions and Capital Stewardship Conference

16 States Have Big Challenges, but greater capacity to meet those challenges Top five states Funded level (%) Wisconsin 100 South Dakota 96 North Carolina 95 Washington 93 New York 92 Bottom five states Funded level (%) Illinois 43 Kentucky 53 Connecticut 55 Louisiana 56 New Hampshire 57 LWL- Pensions and Capital Stewardship Conference

17 Cause and Effect? Actuarial Assumptions and Asset Allocations Source: Wilshire/EBRI LWL- Pensions and Capital Stewardship Conference

18 Restructuring Efforts Vary Across the US Since 2010 almost every state has passed some reform legislation Increased employee contributions, Modification of benefit levels, Extended vesting periods, Raised retirement age, Reduced or eliminated COLAs Shifted to hybrid plans LWL- Pensions and Capital Stewardship Conference

19 Challenges and Responses Vary Double Exposure: California STRS and PERS cover more than 4000 cities and school districts. Without reforms, STRS ARC may exceed State University System costs. First Step : Illinois Last December, Illinois reduced UAL from $26B to $20B. Chicago s plan caught in Gubernatorial Politics; Robbing Peter : Michigan State capped local school amortization payments, but used school aid to fund the overage Asset Sales one-offs Allentown (water system) Cincinnatti (rail lines) Philadelphia (Gas Utility) Discipline and Timing : Wisconsin Funding discipline and good market timing on Pension Bonds. LWL- Pensions and Capital Stewardship Conference

20 California: This Week, the Non-Partisan Budget Office Called CALSTRS unfunded liabilities the State s biggest fiscal challenge Source : CAL LAO State s current contribution (1.4b) to CALSTRs would have to rise to $6 billion to achieve full funding in 30 years; that s greater than spending on UC/CSU systems LWL- Pensions and Capital Stewardship Conference

21 Comparing Public and Private Sector Retirement Systems LWL- Pensions and Capital Stewardship Conference

22 Retirement Savings Profile Private Sector State and Local Implications 5 % DB 15% Hybrid 30% DC 55% None 80%Defined Benefit 15% hybrid 5% other retirement insecurity is the norm Social Security Almost all 70 to 75% Diversity within workforce and across generations Federal Involvement Funding Discipline ERISA, PBGC Very Little Fragmented oversight Mandated Full Spectrum Fragmented policymaking Balance Sheet 20 30% 50-75% Crowding out public investment Eligibility for Bankruptcy Claim Priority Chapter 7, 11 Typically equal to unsecured debts Not for States; Not all cities eligible Overlapping legal framework Years of litigation Creditors at odds LWL- Pensions and Capital Stewardship Conference

23 Outstanding Legal Questions Will States revise laws to permit or even encourage bankruptcies at the local level? Will States revise laws to off-load pension obligations into bankruptcy eligible vehicles in order to pressure workers? Will the bond investors seek greater protection than they had pre-detroit? Are unfunded liabilities a contractual obligation? If they are a contractual obligation, are they secured or unsecured? Do COLA s have a different legal status? Can promised, but unpaid benefits for current employees be adjusted? LWL- Pensions and Capital Stewardship Conference

24 Public Pensions Debates Distract from the Broader Challenge: Retirement Insecurity Median retirement account balance is less than $4,000 Less than $15,000 for near-retirement households. 2/3 of 55+ worker have retirement savings less than one years income Bottom 5th 4th quintile middle quintile 2nd quintile Top 5th estimate % with no account by income quintile For the majority of Americans. the three-legged stool of retirement security has become a pogo stick. LWL- Pensions and Capital Stewardship Conference