US lawmakers, investors and the Securities and Exchange Commission (SEC) are asking state and local administrations for more transparency about their pension liabilities. All are concerned that these liabilities are increasing the risk level of the $2.9trn (€2.1trn) of municipal bonds issued to balance local public budgets.
To address the problem, House Republicans Devin Nunes and Darrell Issa of California, and Wisconsin’s Paul Ryan, have proposed the Public Employee Pension Transparency Act (PEPTA). It would require the sponsors of state and local government pension plans to report annually to the US Treasury with information about:
• The funding status of the plan;
• The plan sponsor contributions for the year;
• Alternative projections for each of the next 20 years relating to the amount of annual contributions, the fair market value of plan assets, current liability, the funding percentage;
• The actuarial assumptions used for the year;
• The number of retired or active plan members;
• The plan’s investment returns;
• The degree to which unfunded liabilities are expected to be eliminated; and
• The pension obligation bonds outstanding.
The bill would also stipulate that state and local governments are entirely responsible for their pension obligations and the federal government will provide no bailouts. The governments may choose not to comply with the law, but they would become ineligible for issuing bonds exempt from federal taxation.
Apparently there is not sufficient disclosure about unfunded public sector pension liabilities and there are few estimates. According to a study by Northwestern University’s Kellogg School of Management, the combined underfunding of pensions in all the municipalities is at $574bn and states have an estimated $3.3trn in unfunded pension liabilities. Nunes says that 10 states will exhaust their pension assets by 2020, as will all but eight states by 2030. And a non-partisan Government Accountability Office study found that state and local governments face a $10trn fiscal gap over the next few decades. One reason is that public pension funds typically assume an 8% annual return on average, but over the past five years state pension funds with more than $5bn in assets have returned only 4.5%, according to the Wall Street Journal.
The newspaper asked DPC DATA, a specialist in municipal disclosure, for an analysis of disclosure made by public bond issuers, discovering that they “routinely file information about their financial health well beyond the date they promise to bondholders, if at all”. Of 17,000 bond issues studied, more than 56% filed no financial statements in any given year between 2005 and 2009; more than one-third of borrowers skipped three or more years, and the number was 40% in 2009. This means “insufficient ongoing disclosure information for more than $2trn of the $3trn in outstanding bonds”, according to DPC.
Municipal borrowers are unregulated, but they should file the information with the Municipal Securities Rulemaking Board, which posts the documents on a publicly accessible website called EMMA. When they do not warn investors of fiscal problems these problems are often related to their pension systems. The PEPTA would not allow these troubled local governments to issue federal tax exempt bonds if they do not supply details of their pension obligations.
Nine groups representing state and local government employees have protested against the legislation, claiming that it “represents a fundamental lack of understanding regarding the strong accounting rules and strict legal constraints already in place that require open and transparent governmental financial reporting and processes”, according to a press release.
But recent actions by the SEC confirm that transparency is indeed missing in the public sector. Last year, it charged the state of New Jersey with securities fraud, alleging that it had not adequately informed investors of the costs of its pensions in a prospectus for a bond issue. The case was settled last August, but it was only a warning to all other public debt issuers, according to Elaine Greenberg, who runs the municipal-bond unit set up by the SEC in 2010. Then the SEC launched an inquiry into statements by the state of Illinois in the offering document for a sale of $3.7bn of taxable Illinois pension bonds. The SEC wanted to know whether a 2010 reform to the Illinois pension system, which has the lowest funding level among the states, can deliver the savings promised in the prospectus.
No one knows if the Public Employee Pension Transparency Act will pass, but it has behind it a new, vast movement for accountability and restraint in public finances.