I have a piece today at Economic Intelligence discussing the significance of recent state and local reforms to pensions and the collective bargaining process. In sum, as the cost of benefits rise relative to budgets, something has to give. Josh Barro finds one the reason the public sector isn't "doing fine." It's the compensation packages and the unaffordable pension and health benefit promises that are now weighing down budgets. He considers San Jose's workforce and finds some interesting workforce trends.
One area I continue to explore is the role of actuarial assumptions. Most notably, the use of risky expected returns to make plan liabilities look small. In this post I run through the reasons why this assumption can hide millions (or billions) and result in insufficient funding. (At the end, there's a great video by Nobel Laureate Bill Sharpe explaining the gulf between actuarial practice and economic thinking). On top of the undervaluing liabilities there are other distortions in pension plan books. Asset smoothing - which recognizes only a fraction of pension plan asset losses (or gains) can make a plan look healthier by inflating asset values.
The result of these accounting distortions is becoming more obvious. Pension plans looked artificially 'inexpensive' to fund and likely led elected officials to make promises that turned out to be more expensive than anticipated. The reforms of the past several weeks (and months) attest to the fact that fiscal reality cannot be avoided (or remain hidden) forever.
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