Dear Elected Officials,
We keep hearing about cities considering a Wall Street proposal to issue debt to fund supplemental pension contributions to city pension funds. They should not do so.
When cities make pension promises, they and the employees to whom the promises are made are supposed to contribute enough money to pension funds so that, with investment earnings on those contributions, there will be enough money in the funds to satisfy the obligations as they fall due. But often, too little is contributed upfront, which creates a deficit that falls only on the cities because employees have no obligation beyond their upfront contributions. Along comes Wall Street promoting an additional debt obligation, the proceeds of which would be used by the city to make a supplemental contribution to the pension fund in the hope of earning more than the combined costs of the new obligation and the pension obligation. Wall Street falsely labels its product a “Pension Obligation Bond” (“POB”), but no pension obligation is affected, much less reduced. Politicians like these bonds because constituents are falsely led to believe that pension obligations have been reduced, but the only reduction is to an accounting measure known as the “unfunded liability,” which measures the difference between pension assets and pension obligations, and that reduction is offset by an increase in debt accounted for elsewhere. Economically only two things happen: an increase in debt for taxpayers and an increase in fees for Wall Street.
Wall Street argues that now is a good time to borrow at low rates to invest in stocks, bonds and private equity, but should you borrow to invest in the hope of earning more than your mortgage costs you? Even if it made sense to borrow, should you invest the proceeds into a city pension fund, the governance of which favors employees and the performance of which often falls short of other professionally-managed funds? Governments should not borrow to make supplemental pension contributions.*
*Supplemental pension contributions are fine so long as the money to make the contributions isn’t borrowed and budget reserves are not taken below necessary levels. Only when governments have excess reserves should they consider supplemental contributions to pension funds.