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Home Publications Blogs Beat the Press Public Pension Shortfalls: Don't Forget Braindead Economists

Public Pension Shortfalls: Don't Forget Braindead Economists

Saturday, 07 August 2010 22:19

As noted below, the NYT declared class war against school teachers and custodians, arguing that the public must focus on taking away their pensions. The prior note left out a very important point -- if the economists who make projections of pension returns knew arithmetic, then the pension funds would not be facing these huge shortfalls.

These "experts," all of whom draw high salaries in their working careers and much higher pensions than public employees (think of people like Harvard Professor Martin Feldstein, Boston University Professor Lawrence Kotlikoff, and Steve Goss the Chief Actuary for Social Security), all asserted that stocks would average 7.0 percent real returns even when the market was at its bubble peaks. If the market had performed as they had projected, then these pension funds would be just fine today.

In short, the biggest problem with these pension funds is that they listened to the country's leading economic experts in planning for the future. Unfortunately, the workers and the taxpayers will pay for the incompetence of the experts. The experts themselves are protected.  

Comments (20)Add Comment
written by Peter T, August 08, 2010 2:35
> all asserted that stocks would average 7.0 percent real returns even when the market was at its bubble peaks.
OK, the experts were wrong. The experts, however, have not enough money to refill the public pension funds and, besides, they have no liability for their crappy predictions. Now what? Should we honor the pension obligations and cut public servies to the bone, as also desscribed in the NYT, no libraries in Camden, NJ, no busses around Atlanta airport, rural roads returning to gravel? That would lead to the situation where the rebulicans are suddenly corrrect to say that we pay taxes and don't get anything for it. Or should we reduce the pensions to keep the discretionary public services alive?
written by RebelEconomist, August 08, 2010 4:12
Neither, Peter T. The US should put up its taxes to pay its public servants the compensation that they thought that they were earning when they did the work that the electorate voted to have done. And since the past underpayment of tax accidentally contributed to taxpayers' wealth, and taxes on income and expenditure tend to act as a drag on economic activity, the most appropriate tax to raise is inheritance tax.
Pension plans that invest in stocks and bonds are fine as long as the number of investors at the bottom is increasing.
written by Scott ffolliott, August 08, 2010 7:45
Pension plans that invest in stocks and bonds are fine as long as the number of investors at the bottom is increasing. Since Graham and Dodd we can determine the value of companies and the debt, but rarely do. Rather we have come to view investing as “the bigger sucker theory of value.” Any advisory service that researches value will find that there is no longer a way to find the current net asset value of any company.
It seems then that pensions ought to move their investments to municipal, state, and federal government debt and participating debt. When the public good, which is also the workers good, is taken into account as the principle of underwriting these debt issues, there can be contractual benefits to the issuer and the pensions. Of course these special issues shall not be available for private profit.

We need to think about the public good vs. private profit in every argument so that we can focus on social equality or in a word, democracy.
written by izzatzo, August 08, 2010 8:17
Economic forecasts, especially the private individual versions sold for big bucks behind the broader public versions, are largely "shopped" by major customers for two reasons.

One is the arcane nature of the forecasts themselves, which few beyond the insiders take the trouble to understand, or even could if they wanted due to proprietary restrictions.

The other is to avoid responsibility for bad outcomes. By claiming a credible third party was payed big bucks, they're able to shift downside risks away from themselves while retaining upside gains such as higher bond ratings.

In turn, forecasters avoid long term risks of bad predictions by depending on "who-could-have-known" claims combined with short memories, so short that the next big forecasting contract comes from the same customers burnt by the last one, redone just sufficient to acknowledge obvious mistakes, but not enough to stray too far from what the client wants to hear.

Both parties benefit from the moral hazard umbrella that protects them from downside risk, which they shift onto everyone else to whom they preach are appropriate victims under their ideological framework of "free markets".

The problem that Baker is to them, including academics who don't necessarily sell forecasts directly, is his uncanny ability to hone in on obvious, critical, flawed components of forecasts and hammer away at them.

While they can't run or hide, they know that memories are still short and awareness still willfully ignorant, so ignoring Baker is far more effective than to acknowledge his scathing critique in any way. Like everything else in their business, effective competition from alternative forecasters is barred with protectionism from market entry and just not allowed.
Why do you believe it's "incompetence"?
written by lambert strether, August 08, 2010 9:26
Presumably, many people made a great deal of money "managing" our pensions into the ground, based on public policies driven by the 7% number.

Isn't the possibility equally great that the mainstream economists were shilling for them, rather than being "incompetent"?
written by anonymous, August 08, 2010 10:13
RebelEconomist wrote,
And since the past underpayment of tax accidentally contributed to taxpayers' wealth, and taxes on income and expenditure tend to act as a drag on economic activity, the most appropriate tax to raise is inheritance tax.

Yes, it's perhaps true that taxing inheritances won't lead to much "drag" (deadweight loss). But neither will taxes on land, as even Adam Smith realized (writing before Ricardo came up with the theory of rent). And there's a hell of a lot bigger revenue source there than inheritances; perhaps 10% of GDP or more.

Of course, people won't react very well to increasing taxes on land in the aftermath of a burst real estate bubble, given that increasing rates leads to a lower (capitalized) value of land.
written by RebelEconomist, August 08, 2010 10:44
anonymous at August 08, 2010 10:13 AM

I am in complete agreement; a land tax would be even better, especially (here) in the UK, where high house prices represent a continuing economic misalignment. Besides being a minimally distorting way of raising tax revenue, a land tax could also ease obstacles to development and provide an automatic regional redistribution mechanism.
written by diesel, August 08, 2010 11:25
The chief accountant walks into the board meeting and shares the good news with his peers that, based on the pension fund's projected return on investments, future revenue will more than cover the pensions of present and future retirees. Therefore, monthly contributions from employees can be reduced along with matching agency contributions, resulting in more money for everyone and/or lower taxes for the public.

Who wouldn't want to hear this rosy news rather than a dose of realistic projections that acknowledge the inevitability of cyclical contractions. Chocolate cake and ice cream anyone? or would you prefer cod liver oil and vinegar? This feel-good-all-the-time enthusiasm (aka the end of history) adds to the pneumatic pressure that inflates the bubbles that plague our economy (the primary fuel that provides the heat to expand these bubbles is too much money in the hands of too few people).

So the employees, states, counties and cities paid in too little. Taxpayers benefitted because their rates weren't raised to realistic levels or they received more services than they paid for, depending on how you look at it. And now they're all pointing their fingers at one another. Meanwhile, the wars drag on. Defense appropriation bills are rubber stamped (plenty of money there!). Republicans plot their mid-term return. Banks are content. The unemployed stay unemployed. And everyone wonders if the old jobs will ever return. Or is this it? The watershed. It's like the sober cleanup on a rainy day after a big party. "Look here, someone opened all these beers and didn't finish them! They only took one swig and left them. They must have been so drunk they didn't realize what they were doing."
The last man standing ...
written by Benedict@Large, August 08, 2010 11:57
Municipal pension regulation is highly uneven, subject to the whims of local politicians, and so failures will occur even in the best of times. This is a political problem to solve, and economics is limited there to providing commentary.

But let's not kid ourselves. Public defined-benefit pensions are the "last man standing", thanks to the right wing onslaught against unions. For the pension terrorists to now pretend they're really only trying to help is hypocracy unbounded, meant only to distract from their blind-sighted ideological hatred of anything to do with social provision.
Why would anyone want to privatize social security
written by LJM, August 08, 2010 11:59
Aren't these state pension funds the clearest example of why privatized social security is a really bad idea? BTW, for the states that seem to be in good shape, what did they do right?
written by Calgacus, August 08, 2010 3:04
Peter T and RebelEconomist, as the crisis is caused by federal mismanagement, the better solution right now would be for the feds to simply give the money to the states. Sure, raising taxes on the rich bastards, especially the dead ones would be great, but the main thing is to spend in order to help the economy and the people trapped in it.
Moronic Projections, Yes, BUT
written by Nately, August 08, 2010 3:25
but, but, but the public employee unions have also figured out how to rig the pension and compensation systems in many, if certainly not all, localities in the US. Please do study California more thoroughly, for example. The unions here figured out a good 20+ years ago that life is better when you elect your bosses. You have to be blinded by political filters not to see this. In several sub-categories, public sector workers are being paid wildly more than the private sector pays, retiring after 20-25 years, and getting 80-90% of final salary. The $500B+ shortfall in CA public pensions is partially to due to return shortfalls, but MUCH more so to payout schemes that are utterly ridiculous -- comparable to nothing available in the private sector, even at high levels of achievement. The CALPERS system is littered with hundreds of folks like school administrators, prison guards, firefighters and cops who have a PV of $10M-$15M or more in their pension payouts. But you are doing a nice job of hiding behind "janitors and teachers," who seem more sympathetic (and I admit, they are). Please see also the case of Vallejo, CA and the recent case of the $800K Bell city manager as notable recent lowlights, although they are simply a small tip of the iceberg. Go sit in a coffee shop in CA -- even in a liberal bastion like an SF neighborhood or libertarian places like the valley -- public employee packages are the all the talk -- the source of much resentment and rage by more than I would think is possible. And even more liberal-leaning journalists are covering this issue hard, as their pay and benefits look like scraps to the average CA prison guard. Righteous anger is doing its job. Even the unions are smart enough to know that have to lay low in the upcoming elections....

Why is it so hard to get into our collective brains two basic streams of thought -- that yes, the financial engineers and lords of leverage and gaming the system that is Wall Street are overcompensated, socially damaging, serve little legitimate function in the economy, and have a stranglehold on national policymakers, but also the public employees have taken to declaring war on the taxpayers long ago. The sophomoric liberal-conservative dichotomy prevents us from allowing both thoughts to reside together. After all, rape by the GS overlords as well as your local police union are, in fact, empirically quite possible and probable.

Please, Mr. Baker, don't just be a polemicist and cheerleader for "your team." We have an boatload full of those kind of politico-robots already.
Washington State Board, one of the larger public pensions
written by diesel, August 08, 2010 4:08
Under the old PERS 1 plan, you retired after 30 years regardless of your age. Nice, but still you put in 30, not 20. Under PERS 2, people hired after 1978 or thereabouts have to work until they are 65, regardless of how many years they have put in. You can opt out a little earlier, but the penalties are staggering. I think this is fairly typical of most public pension plans. The rules were revised a while ago. They aren't as outlandish as the worst cases sited above.
written by skeptonomist, August 08, 2010 7:00
I came across a site that has detailed data on individual pensions for state and local workers in New York (which is presumably where Lieber lives):


By using the "greater than" sort facility and comparing the numbers with the total pensioners (342,543), I came up with the following:

The median is a little over $16K/year

7.3% get over $50K

0.4% get over $100K

4 (total) get over $200K (slightly)

I would not consider these pensions overly generous on the whole if I lived in NY (my state is much poorer and I'm sure pensions are smaller). The numbers for California are fairly similar (same median), although there are more with very high pensions:


People who suspect that pension levels might be too high in their state should look for actual data rather than relying on what they hear in coffee shops, or what conservative politicians say, or what they read in the media, which tend to be hostile to unions.
written by AndrewDover, August 08, 2010 9:33
1370 New York pensions over $100,000 per year. (.004 of 342,543 )

"9,111 retired California government workers receive pensions in excess of $100,000 from CalPERS." per

are you kidding?
written by ian, August 08, 2010 11:23
Rebeleconomist - we have public servants here in CA that have pensions up to $450K/yr. Do you think I voted for that? You think my taxes should be raised so that bad investments for pensions like that can be made whole?
written by RebelEconomist, August 09, 2010 1:59
ian at August 08, 2010 11:23 PM

It is rarely a good idea to use particular examples to argue about public policies, because the electoral system is a blunt instrument (although at least California has its proposition votes). But if the person in question was some kind of technical expert in a lucrative profession, such as a lawyer, who was needed for a vital position in local government, and a $450,000 pension was part of the package that was necessary to recruit them from the private sector, it may well be the case that you would be a fool (as in "penny wise, pound foolish") if you did not vote for that.
Pay of public workers
written by AndrewDover, August 09, 2010 6:16
This is a bizarre idea:
"The US should put up its taxes to pay its public servants the compensation that they thought that they were earning ..."
Why not according to what the employer thought they were paying?

It might be sensible to increase the pay package of public sector workers if there many cases of people leaving to join the private sector, but with around 10% unemployment that is not happening.
written by zinc, August 09, 2010 9:15
Many of the current greed problems in the USA, including excess CEO pay, short term business opportunism by the executive class, excess pension payouts, the budget deficit, paying back the social security trust fund, and even, to some extent, the health care can be cured by a steeply progressive income and corporate tax structure on all income, including dividends and capital gains.

It is the best solution, and the one with the least amount of play. The congressional multi-millionare's club in Congress won't hear of such things.
so why aren't you the fed chairman?
written by tinhead, August 10, 2010 8:20
since you are naming names, and you are an honest person (sooooooooooo rare as an economist)

and you've even been correct in forecasts of recession, bubbles etc. that would make you a pariah amongst colleagues.

seriously, you're not a governor or chairman because you're not jewish (or are you?)

now when was a non-jew appointed to the fed last?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.