Randomly Noted

Underfunded pension commitments to public employees is a central, long-term issue for local governments and for the U.S. municipal bond market.

According to a new academic study, even substantial revisions to those pension plans likely will leave taxpayers with a big bill to fill the hole, a $1.5 trillion-sized hole.

Dramatic policy changes such as eliminating pensions’ cost-of-living adjustments and kicking retirement ages up to levels in line with the Social Security regime still leaves a $1.5 trillion hole, said Joshua D. Rauh, co-author of the study and associate professor at Northwestern University’s Kellogg School of Management.

And such changes can hardly be assumed. “While these ‘drastic’ actions may be less politically viable than more incremental policy measures, even these do not come anywhere close to solving the problems associated with states’ legacy pension liabilities,” says the  study by Rauh and Robert Novy-Marx of the University of Rochester.

Their findings were presented Thursday at a meeting of the National Bureau of Economic Research. 

Without changes, they estimate the unfunded liability stands at $3 trillion.

Throw another worrisome fact into the public pension mix. Most states figure they are going to earn a return on their existing assets of about 8% to help fund future payouts. At least in the current investment environment, that’s quite an assumption.

None of the gloom should stop states from enacting sane reforms for pension schemes. A nascent movement is under way. This column has previously noted a significant ‘agency’ problem exists with public employee retirement benefits. Temporary state political leadership has little incentive to tackle these nasty issues or to be tough in union negotiations, unless  they see tangible short-term political advantage.

As more voters understand the pension liability predicament many states are in, that political will may make itself known.

At a minimum, retirement age and other standards should better mirror private industry.

“The debate over the solution is over transfers,” the study’s authors write. “The current situation is one in which beneficiaries view their benefits as secure promises and taxpayers do not perceive that they will be held accountable for guaranteeing those promises.”

Ultimately, Rauh and Novy-Marx figure taxpayers will have to come up with the money to fill the bulk of the gap that remains regardless of the level of reform that takes place. “If unfunded liabilities continue to grow, the bailouts could be even larger.”

Journalists are supposed to get to the most important stuff first. Not central bankers. And so news of a truly important change in attitude toward asset bubbles was contained in the final paragraphs of two separate speeches made Sunday by Federal Reserve leaders.

(For sticklers, we’re not counting bibliographies and footnotes when describing final paragraphs.)

Fed Chairman Ben Bernanke essentially said that with the greatest of reluctance and if all else failed the Fed might, just might, be willing to raise interest rates to combat an inflating asset price bubble. (Click here for the full text of his speech.)

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“Trees grow.”

That’s successful hedge fund manager (he’ll earn about $2.5 billion this year) David Tepper talking in today’s Wall Street Journal about a simple world view expressed by Professor Allan Meltzer.

The view that economies most naturally push toward growth likely sustained Tepper when he wisely scooped up bargain basement bank stocks early in 2009, making quite a killing in the process, as The Wall Street Journal reports in a front-page article.

To the debate about whether central banks have to be more cognizant about the dangerous impact of inflating asset price bubbles and act precipitously to prick them, add this twist: not all bubbles are alike.

That’s the interesting treatise of a Nov. 10 op-ed piece in The Financial Times by Frederic Mishkin, former Federal Reserve governor and current Columbia University professor.

Mishkin posits that the stock price bubble associated with the tech boom of the late 1990s and the gains that preceded the stock crash in 1987 were benign bubbles in that they didn’t also involve a credit boom. There was no “feedback loop between bank lending and rising equity values.”

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I’ve just come from a chat with the University of Michigan’s president, Mary Sue Coleman, and was tempted to headline this blog “Michigan’s Only Bright Light.” But I decided that would be unfair and inaccurate – in addition to U Mich, there are certainly other things going well there, just not all that many due to the Detroit auto industry’s collapse and wretched unemployment.

As Coleman puts it, the University of Michigan has been in austerity-budget mode for several years; it was fairly obvious shortly after she arrived on the scene, in 2002, that the U.S. auto industry was in decline and public funding for the university was heading downhill. The economic crisis sealed the deal, and along with state money, alumni giving dropped. So did the university’s endowment, which took a 21% hit.

Coleman is dynamism personified, despite a broken hand wrapped in a cast: when she says she actually likes the fund-raising chores that plague college presidents, one believes it. Of course, extracting money from alums’ wallets has been rather difficult since the economy tanked, but Coleman sees signs alumni interest may be picking up.

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