As we follow the evolving story of collapsing public pensions, one of the trickiest issues is the lack of reliable estimates of future returns on investment. Many of the biggest offenders among pensions assume returns of 8 percent or higher. These numbers may seem reasonable by historical standards, but they’re hopelessly optimistic today. Even plans that have revised their estimates downward still project returns far above what most analysts expect. If these estimates don’t come through, taxpayers will be left holding the bag, and either pension payouts will have to shrink or other services, including education and law enforcement, will have to.
Unions have long claimed that these worries are mere alarmism, but now Wall Street is stepping in to say it, too: pension investment projections are far too high. A new estimate from Moody’s anticipates average pension returns of 5.5 percent rather than the traditional 7 or 8 percent investment projection. The result of this estimate is a tripling of national pension debt, from $766 billion to $2.2 trillion. This is a major increase, but many analysts believe that it is accurate, or at least more accurate than previous estimates. As Public CEO reports:
With a bond-based earnings forecast of 4.1 percent a year, instead of the 7.5 to 8 percent in use at the time, the debt or “unfunded liability” of the three state pension funds increased tenfold, soaring from the reported $55 billion to about $500 billion.
The use of the lower earnings forecast based on U.S. bonds, the Stanford students said, reflected the view of economists such as Novy-Marx and Rauh that risk-free bonds should properly be used to offset risk-free pension debt guaranteed by taxpayers.
As time goes on, the arguments of pension critics are getting more respectful attention. With Wall Street now firmly on their side, it will becoming even harder for pension managers and their union backers to dismiss critics and deny that there is a crisis. The numbers just don’t add up.
The question now is how voters will react. If the recent votes in San Diego and San Jose are any indication, the unions are on much shakier ground than they think.