California, America’s largest and possibly brokest state, just received another big piece of bad news: The U.S.’s two largest pension funds, CalPERS and CalSTRS, posted returns of 1 percent and 1.8 percent, respectively, over the past fiscal year, both missing their benchmarks (1.7 percent and 3.3 percent). As at least one of the immediate results makes clear, their investment managers aren’t accorded the job security of all other public employees: The CIO of CalSTRS “told the board that two of eight managers in the $3 billion corporate governance class would be terminated because of poor performance.”
But there’s a more important number that’s very far off from their 1 percent gains: 7.5 percent, which is what the plans are supposed to return every year in order to pay out compensation, and the discount rate they use to calculate their, and the state’s, unfunded liabilities. (Admittedly, the plans did beat that number in 2011 — bravo!)
Underscoring just how fanciful these assumptions are, given the outlook for the U.S. and global economy, the ratings service Moody’s has announced that it is lowering the discount rate they use when assessing the funding level of pension funds and the creditworthiness of their owners. The firm will go from assuming a return between 7.25 and 8.5 percent to a rate of 5.5 percent. This would have huge effects on the expected contributions state governments will have to make: Pensions & Investments explains that, for instance, this would increase Illinois’s state plans’ unfunded liabilities from $83 billion to $135 billion.
Profligate politicians, no doubt, will lambast this as Wall Street stealing from hard-working pensioners, but it’s probably the right call. Back in May, Kevin Williamson praised another hopeful development when the independent organization establishing public-accounting standards began requiring governments to report their unfunded liabilities as part of their balance sheets. Moody’s decision, coming from the private sector and the financial markets, is another helpful development. One place we’re definitely not going to get better rules: the government itself. At the beginning of July, a bipartisan majority of U.S. congressmen proudly paid for low student-loan rates by letting corporations increase their pension-account discount rates, allowing them to underfund their pensions, report higher profits, and pay more in taxes.