Money and Capital Markets Monitor, April 5 , 2010Page 1The $2 Trillion Black HoleWhite Paper Presented By Michael Kantor, ...
Page 2Abuses of the SystemIn addition to under-funding fromfiscal contributions and revenueshortfalls, public officials re...
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The $2 trillion Pension Fund Black Hole

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It is impossible to stay solvent with increasing liabilities and decreasing assets. State and Municipal governments are faced with a crucial problem; how to pay off public sector pension plans which have been left underfunded for years. Adding insult to
injury, the market values of the portfolios used to fund these pensions plans have been crippled in the Great Recession. Even more troubling, these defined pension plans, by law, are guaranteed for nearly 80% of public officials no matter the performance of the underlying assets used to finance them. Legislatures are faced with few options; raise taxes, cut spending elsewhere or default on their GO debt.

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Transcript of "The $2 trillion Pension Fund Black Hole"

  1. 1. Money and Capital Markets Monitor, April 5 , 2010Page 1The $2 Trillion Black HoleWhite Paper Presented By Michael Kantor, Robert H. Smith School of Business, University of MarylandEdited by Mr. Joseph F. Rinaldi & CIO Quantum Financial Advisors, Inc.SummaryIt is impossible to stay solvent with increasing liabilities and decreasing assets. State and Municipal governments are faced witha crucial problem; how to pay off public sector pension plans which have been left underfunded for years. Adding insult toinjury, the market values of the portfolios used to fund these pensions plans have been crippled in the Great Recession. Evenmore troubling, these defined pension plans, by law, are guaranteed for nearly 80% of public officials no matter theperformance of the underlying assets used to finance them. Legislatures are faced with few options; raise taxes, cut spendingelsewhere or default on their GO debt.The ProblemGuaranteed pension plans have gone underfunded for years. Just last year, John Corzine of New Jersey contributed a mere $105million, or only 4.5% of the $2.3 billion needed to fund the gap in his state. Throughout the US, in 2008, only $72 billion wascontributed to the $108 billion needed tofund these plans. Underfunding has been aproblem dating back over two decades ago.Under certain laws, state and localgovernments are allowed up to 30 years toclose funding gaps. With the time span toclose the gaps extending way beyondlegislatures’ terms in office, it became soeasy for them to place these deficits on theback burner. For example, it was assumedin the 1990’s that the stock market boomwould cover any exposure in the fundinggap. This, however was not the case as seenby the tech bubble crash of the early 2000s.It is even more unsettling that statelegislatures did not learn from this mistakeand continued these practices well into thisdecade.In addition to increasing liabilities onpension payments. Retiree health benefitsare threatening to overburden the system.According to a 2010 report by the PewCenter for the States, as of 2008 only 5.44%of the $587 billion needed to fund retireehealth care and non-pension benefits wascontributed nationwide.These shortfalls in funding can also beblamed on increasing incentives to publicemployees. Such incentives include early retirement benefits offered in contractionary years, cost-of-living increases andpension systems offering retirees excess returns on investment assets during boom years.
  2. 2. Page 2Abuses of the SystemIn addition to under-funding fromfiscal contributions and revenueshortfalls, public officials receivingthese benefit plans have been findingways to abuse the system. Withpension contribution formulas usingthe retiree’s final year’s salary as thebasis for pay, public workers tend torack up over time in their final yearsto boost their pensions, post-retirement. Other employees havealso discovered “double dipping”where after retiring, they return tothe public sector and earncontributions towards an additionalpension.Implications and ReformState and municipal governments areover burdened and are seeing theirbudgets being eaten away by theseliabilities. For example, the city ofVallejo, CA has 90% of its budgetpaying off pension liabilities. As ameans to cope, the city has proposeda three year moratorium on all of its$53 million in municipal debt allwhile maintaining payments on all ofits $84 million in pension liabilities. Other governments are left with few options:• Raise property, sales and income taxes• Cut spending on programs such as emergency services , healthcare, education and infrastructure• Default on GO debtReform in some states, such as New York, Nevada, Nebraska, Rhode Island, and New Jersey are causing legislatures to raiseretirement ages, cut pension-benefit formulas, increase employee contributions, reform laws to curb income spiking andemployee “double dipping” and switch to less costly defined-contribution plans to help cope in the future. However, action isneeded now to close the gap the exists.ReferencesLaing, Jonathan R. "The $2 Trillion Hole." Barrons 15 Mar. 2010: n. pag. Web. 1 Apr. 2010.<http://online.barrons.com/article/SB126843815871861303.html#articleTabs_panel_article%3D1>.Urahn, Susan K. The Trillion Dollar Gap. Pew Center on the States. N.p., Feb. 2010. Web. 1 Apr.2010. <http://downloads.pewcenteronthestates.org/The_Trillion_Dollar_Gap_final.pdf>.Disclosures________________________________________________________________________________________________________This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of the person whoreceived it. The securities discussed in this report may not be suitable for all investors. QFA recommends that investors independently evaluate particular investments and strategies,and encourages investors to consult with their QFA investment advisor. The appropriateness of a particular investment strategy will depend on an investor’s individual circumstancesand objectives.This report is not an offer to buy or sell any security or to participate in any trading strategy. QFA or its partner or clients may have existing positions in any security discussed in thisreport. In addition, QFA makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. QFA has no obligation toinform you when opinions on strategies, sectors, investments and companies change. QFA on an annual basis will offer its updated ADV Part II and disclose what the company and itspartner owns. This information shall be accessible to QFA clients only under the client tab of QFAInc.com.QFA does not receive compensation for any broadcasts or written research that are offered to clients. The firm charges an asset management fee, per hour fee and / or a financialplanning fee for services rendered. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of QFA. All broadcasts are disseminatedboth electronically and in printed form.

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