Free fall

Tuesday, September 07, 2010

Just when you thought the state of Illinois' fiscal trajectory couldn't get worse, Springfield has done it again. The major Illinois pension funds are selling off core assets to pay benefits. The biggest fund, Teachers' Retirement System, may have to cut $3 billion from its investment portfolio in the coming year, nearly 10 percent of its total.

This money is supposed to build over time to pay employees who've been promised retirement income at taxpayer expense. State lawmakers have catastrophically underfunded the too-generous pension system — and a forced liquidation of assets makes the outlook even worse: The pension funds are devouring their seed corn.

The effect is doubly insidious. Emergency sales of assets, by reducing the size of the nest egg, undermine investment returns in the short run. The compounding effect of that loss cripples long-term prospects as well.

Let's face it, given how Wall Street and the economy have been going, these funds weren't racking up nearly the investment returns they anticipated even before they started cracking open the piggy bank.

When they calculate their deficit projections, the state's three biggest funds assume an annual investment return of 8.5 percent. In what universe they expect to achieve that fat a return isn't specified.

True, Teachers' has posted a 9.2 percent annual return over the past 25 years — a period that included one of history's biggest bull markets. Hardly anyone in the world of finance expects a repeat of that performance anytime soon. Over the past decade, Teachers' managed a mere 3.7 percent return.

The unsurprising shortfall in its investment results contributes to the Big Lie about just how much the state owes. Bureaucrats with a vested political interest in low-balling hate to admit it, but the real amount of pension underfunding is huge — and rising, unless by some miracle these depleted investment portfolios suddenly grow to the moon. Writing in the Aug. 13 Tribune, public finance professors Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester warned that, "A true financial valuation of unfunded pension liabilities reveals a debt of more than $200 billion for (Illinois) state and local governments." They envision the state's funds empty as early as 2018.

Most public pension systems assume a somewhat less optimistic 8 percent return. And, last week, New York's system cut back to 7.5 percent. Yet even those rates perpetuate a convenient fiction: With 10-year Treasury notes yielding less than 3 percent, investments that could reasonably be expected to produce returns more than twice as lucrative inevitably involve higher risks. The potential downside from investments going sour will be borne, as ever, by the taxpayer — or by retired employees who don't get full benefits from dead pension funds.

Illinois politicians created this mess. Now they need to meet their obligations to the funds — and set realistic pension benefits for current employees. One sure road to further ruin: Gov. Pat Quinn's plan for still more billions in pension debt — borrowing on one credit card to pay down another. These funds have had enough irresponsible stewardship.