Don’t look for Congress to let states declare bankruptcy as a way to deal with their public-pension problems anytime soon. Despite talk in recent months about Congressional legislation to enable it, “there is no political will at this point, because the governors do not want it,” says Robert Novy-Marx, an assistant professor of finance at the University of Rochester Simon Graduate School of Business. Andrew Biggs, resident scholar at the American Enterprise Institute for Public Policy Research, agrees that more time is needed to assess the implications. “The smart money is saying, ‘Let’s sit on it a bit.’ It is unlikely that any states will have a need for that protection in the near future. And the effects of a bankruptcy provision are not well-known,” says Biggs.
While the magnitude of the public pension funding problem makes it a nationwide issue, Biggs says, most of the attention currently is at the state level. “So the role for the federal government is not necessarily clear here,” he says.
Both Biggs and Novy-Marx testified at an April 14 Congressional hearing, “State and Municipal Debt: Tough Choices Ahead,” held by the House Committee on Oversight & Government Reform. While state bankruptcy appears off the table for now, both talked following the hearing about what may come out of Congressional scrutiny of public pensions.
The Public Employee Pension Transparency Act, introduced by Rep. Devin Nunes (R-California) and Sen. Richard Burr (R-North Carolina) in February after Nunes’ original introduction of the legislation in December 2010, remains pending. It would require state and local government pensions to reveal their liabilities based on discounting the liabilities at a Treasury return, Biggs says. It also would prohibit any future public pension bailouts by the federal government.
“In one sense, we would not find out anything that we could not, with some trouble, find out,” Biggs says of disclosure, referring to outsiders calculating the market value of a public plan’s liabilities. “The point of the Transparency Act is to at least disclose what the market value of the liabilities would be. We would have numbers for every state in an apples-to-apples comparison that would tell us what the true liabilities for these plans are.”
“At some level we are aware of how they operate, but there is no reason that it has to be so difficult to figure out what they are doing,” Novy-Marx says. But transparency legislation would not change how these plans operate, he says. “Transparency will just give us a better idea of how bad a shape they are in,” he says. “It will not make them better funded.”
Novy-Marx favors going a step further, with the federal government letting states issue tax-preferred bonds if they use the proceeds to fund their pension systems, for instance. That potentially could come with other incentivizing strings attached, such as also requiring these states to close their existing defined benefit plans to new workers and put new hires in defined contribution plans instead.
“Whether we should preemptively say, ‘We will essentially pay you now to make reforms,’ I do not know,” Biggs says of the bond-issuance idea. He points to another possible federal route: The U.S. Securities and Exchange Commission (SEC) stepping up its scrutiny of disclosures by states issuing bonds, and bringing more action where needed, such as it did with New Jersey in 2010.
If all else fails, Biggs and Novy-Marx say, the markets ultimately will force discipline on public pensions. “My view is that these plans can continue to run as Ponzi schemes for several more years, or many more years,” Novy-Marx says. “But the capital markets will eventually impose more discipline on public pension accounting. I already have heard from hedge funds that are trying to figure out how to bet against the debt of states with the worst public pension funds.”
