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California's Pension Crisis

 

How a pension deal went wrong and cost California taxpayers billions.

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  • State Government
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When It Comes To Pensions, Illinois Is California's Ghost Of Christmas Yet To Come

Monday, October 10, 2016 | Sacramento, CA
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401(K) 2012 / Flickr
 

401(K) 2012 / Flickr

Dan Weissmann | WBEZ

As California’s public-employee pension crisis grows—with taxpayers on the hook for hundreds of billions of dollars, and no clear plan for how to pay—other states are facing similar problems, and have lessons to teach.

In some cases, those will be lessons about what not to do.

No state may be better-positioned to offer such lessons than Illinois, where an inability to face up to the problems created by pension debt have created a level of chaos that may produce even more dire problems.

“Illinois is one of the worst-funded states in the country,” says David Draine, a senior researcher at Pew Charitable Trusts and co-author of a new Pew report on the state pension funding gap. Pew pegs that gap, which extends across most of the 50 states, at more than $1 trillion nationally.

The key measure of a pension system’s health is called the “funded ratio.” Expressed as a percentage, a funded ratio compares the assets a pension system currently has to the amount it ought to have, to meet its obligations. A system that’s on-track has a 100 percent funded ratio.

According to the Pew Study, using that yardstick, Illinois sits at the very bottom, tied with Kentucky, at 41 percent.

Several years ago, the extreme nature of Illinois’ problems came home to Laurence Msall, executive director of the Civic Federation, a Chicago-based watchdog organization on local and state finances.

That’s when Mr. Msall served on a national panel about state pensions, convened by the Society of Actuaries. “The thing that struck me immediately,” Msall recalls, “is that other experts from around the country said, ‘Illinois and Kentucky have driven their pension systems so far down, we don’t know if we can save them. We should concentrate on the other 48 states.’”  

The recipe for California to replicate the problems of Illinois, says Mr. Msall, would be to simply take its existing problem and “ignore if for a long time. And when you finally come back to check on it, you find—because of the nature of compound interest— the problem has gotten much, much bigger.”  

Illinois, he says, “has had plenty of chances to fix this over the last three to four decades. But instead the easiest and least-resistant path was the hope that some future revenue growth or some future legislature or governor would magically come up with the ability to pay.”

More recently, Illinois has added a new chapter to the what-not-to-do playbook:  Freaking out and creating a new problem.

By mid-2015, pension obligations threatened to crowd out the state’s ability to maintain services without a significant tax increase. Faced with the choice between dramatic service cuts and higher taxes, Illinois leaders instead decided not to make a decision.

As a result, since June 2015, the state of Illinois hasn’t had a proper balanced budget.

Call it an experiment. “The whole model —to be the only state to operate, among the 50, without a budget— is something that’s never been tried,” says Msall.

(Actually, Pennsylvania tried it for a few months, but elected officials there reached an agreement.)

The person who may be in the best position to describe the result is Leslie Munger. As the Illinois Comptroller, she manages the state’s checkbook.

Her summary: “It's really ridiculous.”

Without a budget, Illinois is actually spending money much faster than it is collecting revenue. And the problem is getting worse.

By the end of August 2016, Ms. Munger’s office had about $8 billion dollars worth of overdue bills to pay—and according to Moody’s Investors Service, that figure was on-track to grow to $14 billion by mid-2017.

The deepening deficit raises an obvious question: How does she choose what to pay first? It is a question for which Ms. Munger has a practiced answer.

“I would ask you: How do you make decisions about which bills to pay in your own house?” she says. “First of all I say, ‘What do I absolutely have to pay?’ You have to pay your mortgage or you lose your house.”

In her role, the equivalent to that home mortgage is payments on state debt like bonds: If those bills aren’t paid on time, the state credit rating—already the lowest among the 50 states—tanks.

Pension payments fall into the same category, and for the same reason: Rating agencies take note when those payments are skipped, especially because skipping them only increases long-term indebtedness.

Everyone else—including Medicaid providers, state-funded social service agencies, even state legislators looking for their paychecks—simply gets in line. On average, it currently takes more than three months to get to the front of that line, and get paid.

However, some in that line—like non-profits that provide Medicaid services—can’t wait that long.

Ms. Munger expects—even encourages—such agencies to call her. “They’ll say: ‘You owe us X amount of dollars, and we can’t meet our payroll,’” she says. “So we go back to the back of the line somewhere,” to find invoices from the group that has called, and make an expedited payment.

“We manage that on an ad-hoc basis,” she says.

Records from her office show this to be more or less an every-day occurrence.

“This,” says Ms. Munger, “is no way to run a state.”

For the first year of the state’s experiment in doing without a balanced budget, there were hundreds of social-service agencies she couldn’t pay at all. Similarly, state universities and community colleges went a full year without state funds.  And they’re still playing catch-up.  

For Northeastern Illinois University in Chicago, that meant enduring a year with more than a quarter of its usual revenue simply gone.

Northeastern’s example provides a parable about how the state’s pension-based budget problems have started to metastasize into new problems.

Meet Angela Sweigart-Gallagher, now of Canton, New York.

Until very, very recently, Ms. Sweigart-Gallagher was a resident of Chicago, teaching theater at Northeastern, where she had just been awarded tenure.

Tenure, of course, represents something of a holy grail for university professors. Ms. Sweigart-Gallagher—and her family—had traveled a hard road to get there.

Before arriving at Northeastern, she had worked overtime, in a temporary job, six hours away from her husband, while pregnant. “I was living in an apartment all by myself in this tiny little town,” she recalls, “and spent most of my pregnancy sleeping on this blow-up mattress.”

The job at Northeastern had been like hitting the jackpot, she says, and her family settled in. “We had landed,” she says. “We were really building our life there.”

Then, at a faculty meeting this spring, the bomb dropped.

“We’re having a faculty meeting,” she recalls, “and they say, ‘We’re going to begin mandatory furloughs. Your pay is going to be cut 20 percent. Details to follow.’  And I started to cry.”

As it happened, she had an out; another job offer.

However, accepting that offer would mean giving things up, and not just her family’s life in Chicago. The new job didn’t come with tenure.

She took the job anyway. Compared to the financial turmoil of Illinois, it seemed like a safer bet.

In addition to her own job prospects, she and her husband considered the uncertain funding picture for Chicago’s public schools—their financial fate tied to the state’s—where her daughter was scheduled to start kindergarten this fall.

Overall, things turned out well. She says she likes her new department very much.

However, when she talks about a celebration for her newly-tenured colleagues at her new university, her voice breaks. “I had earned that same honor,” she says, pausing to collect herself, “And gave it up.”

As she will admit, this is a first-world problem.

And it is the first-world nature of her dilemma that makes her parable so dire for the state of Illinois.

Beyond the prospect of tax increases and excruciating service cuts that hurt a state’s most-vulnerable residents, problems like the ones Illinois has created threaten to drive out residents who have more choices including the option to leave.  

Angela Sweigart-Gallagher is not alone. Other state universities in Illinois have reported significant difficulties in retaining and recruiting faculty this year.

Nor is the phenomenon limited to college professors, or to individuals, according to Laurence Msall, director of the budget-watchdog group the Civic Federation.

“We have had conversations with companies that basically have decided not to make an investment,” says Mr. Msall, whose board is stocked with corporate and financial-services leaders. “We know companies that are not able to invest in Illinois because they can’t predict what the tax policy will be in the state of Illinois.”

That is, even a significant tax increase would be preferable, from a business perspective, to the current uncertainty.  “It’s not the potential increase in the rate,” he says. “It’s the fear and anxiety of not knowing how big the increase could be.”

The longer Illinois waits, the higher the price will be. That’s a lesson any state can learn from.


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