Intergenerational War
Save Pensions, Burden the Young

Puerto Rico, our very own Greece, got another credit downgrade from Moody’s this week, despite the government’s presenting a new budget which features $674 million in spending cuts, as well the efforts of the territory’s governor to pass a bill with a stiff sales tax increase. The reforms are meant to lay the groundwork for a hedge-fund backed $3 billion bond sale, which would see the territory through another year. Moody’s, however, doesn’t believe the cuts, if and when they pass, will be deep enough for the bond sale to happen.

Illinois, take note. Moody’s, which downgraded Chicago last week, did so in response to the Illinois state supreme court’s ruling a pension reform bill unconstitutional. Puerto Rico’s pensions are also grossly underfunded (at only around 5 percent), and are a large part of the territory’s problems.

As the FT noted earlier this week, Moody’s changed its internal methodology for rating states in 2013 by giving pension plan solvency higher prominence. And, the article reports, a slew of accounting rules are just now coming into effect that will make municipalities’ pension obligations more transparent for investors. The end result: higher borrowing costs are just around the corner for many of the poorly-administered blue municipalities around the country.

In most cases, however, this doesn’t necessarily mean we are headed for dozens more “Detroit” scenarios:

“The most likely scenario is rather than triggering defaults or insolvency, pensions will squeeze out other spending, such as infrastructure investment, educational spending and social services,” Mr [Matt] Fabian [managing director at Municipal Market Advisors] says. “It is not a great scenario, but different than default or bankruptcy.”

People need to understand the stakes here: favoring pensioners seems like a nice idea, and in many ways it is. But if it raises the cost of municipal borrowing, it basically means slashing services for the young to pay off the old. There is no other magical way out of problems of this scale.

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