CEPR - Center for Economic and Policy Research


En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press Public Pensions and Arithmetic Problems at Fox on 15th (a.k.a. The Washington Post)

Public Pensions and Arithmetic Problems at Fox on 15th (a.k.a. The Washington Post)

Saturday, 26 March 2011 07:50

The Post made yet another effort to attack public sector employees today in an editorial (this one is on its editorial page) that criticized the rate of return assumptions used by public pension plans. It tells readers that:

"Eighty-eight of the 126 largest public pension plans assume a rate of return exceeding 8 percent a year, according to the Wall Street Journal. By way of comparison, the S&P 500 achieved a compound average annual growth rate of 5.69 percent over the past 20 years."

Okay, get your calculators out boys and girls. If I look up the value of the S&P 500 for March 1991 I get 375.22. The S&P closed yesterday at 1313.8. This gives a compounded annual rate of return of 6.46 percent. 

But wait, we have to share a little secret with the folks who write editorials for the Washington Post: stocks pay dividends. Dividends are typically paid out quarterly and usually average 3-4 percent of the stock price. If we add in dividend yields, then we would get an average return over the last 20 years in the 9-10 percent range that is assumed by pension funds in their analysis. 

Of course returns going forward will depend on the current ratio of stock prices to corporate earnings. This is around 15 today (measured against trend earnings) compared to about 20 in 1991, suggesting that the prospects going forward over the next 20 years are likely better than they were back in 1991.

It is especially ironic to see these misplaced warnings about excessive stock return assumptions in the Washington Post. This is a paper that for years featured the columns of James K. Glassman, the co-author of Dow 36,000. At the time, it had no room in the paper for those of us who tried to warn of the risks of the stock bubble.

Comments (9)Add Comment
written by skeptonomist, March 26, 2011 9:35
The WaPo is playing its usual games, but some special circumstances are associated with the P/E ratios that Dean gives. During the 1991 recession stock prices remained high instead of going down as they usually do in recessions, so that P/E went high - it went back down again as earnings recovered. Currently P/E is low compared to preceding years because of extremely high earnings - corporate profits are higher as a fraction of GDP than they have been since the early years of WW I. Will earnings remain high or are we already in another bubble of some kind?

Pension funds could consider getting off the stock-market roller coaster. Long-term bond funds have averaged 6-7% returns over the last 10 years and even higher before that. Current stock/bond allocation ratios were influenced by the 1980-2000 bull market - that is not going to happen again from where we are now (P/E was less than 10 at the start of that bull market).
Competition Prevents Crowding Out of Private Jobs by Public Jobs
written by izzatzo, March 26, 2011 10:05
John Boehner is way ahead of Whose Your Nanny Baker on this one, having just announced that once enough public employees are forced into unemployment, they will compete with private sector employees and drive wages low enough to stimulate hiring by the private sector that results in full employment, which of course renders moot the question of public pensions.

That Baker is not capable of grasping the power of free market competition policy under Obama and its ability to create economic recovery from the supply side becomes all the more obvious when hiding behind cutsy financial calculations designed to mask the true drivers of real added value.

Give it up Mr Nanny. Stop trying to save the private sector from working for subsistence wages on par with public employees with a phony
statistical parade of data. As any economist would say, it's better to be approximately right than exactly wrong.

Stupid liberals.
Risk-adjusted rate of return
written by Drive-by commenter, March 26, 2011 1:49
I'd rather see pension funds use a lower assumed rate of return so that employers make more adequate contributions rather than hope to be bailed out by the market.
written by Doyle, March 26, 2011 1:57
"Dividends are typically paid out quarterly and usually average 3-4 percent of the stock price." You may want to check: Is that based on divided-paying stocks only? As far as I can see from a quick search, the S&P500 has generated dividends over 3% in only two of the last 20 years (1991 and 2009). In 2010, the dividend yield was 1.87%. During the ten years 2001-2010, the average yield was about 1.82%.
Right On Doyle
written by Tony, March 26, 2011 7:45
I could not believe what Dean wrote on his blog. When they say that economists don't know markets, his blog confirmed it. I checked the dividend history of the S & P 500 from Robert Shillers web site, and found out, that the last time that the S & P 500 payed a 4% dividend was in October of 1985. And with the exception of November 2008 until April 2009, the S & P 500 has not payed a 3% dividend since October 1992. The average return of the S & P 500, including dividends since January 1st, 2000 is 2.41% per year. Granted, the market will turn around eventually, but who knows when that will be, with all the problems that we have right now. Housing Starts is telling me, that we probably are going back into recession, so that means lower returns on stocks once again. And bonds are only yielding about 4.5% on a 30 government, and about 5.5% on the average high grade corporate mutual bond fund, so how in the world are we going to get 8% returns to fund pensions. The answer is we are not. The returns will be probably be more like 4% per year, and government workers are going to have to work longer with a smaller pension, and that is just the way it is.
Right on Doyle and Tony.
written by AndrewDover, March 27, 2011 8:55
Pension funds and a potential social security investment in the stock market should get the same estimated return, correct?

After all it would be the same stocks, economy, P/E, and dividend rates. So according to Dean's endorsement of pension fund returns of over 8%, Social Security could double its returns by diverting the trust fund from Government bonds to the stock market.

But read how Dean calculated potential SS returns back in 2001 in "Stock Market Returns for Dummies."


"The Social Security trustees project that growth will average 1.5 percent over the next 75 years. If stock prices rise at the same rate, then capital gains will average 1.5 percent a year. Adding this to the dividend yield of 2.0 to 2.4 percent gives a total stock return of 3.5 to 3.9 percent annually."

(That method gives ~3 + ~2 = 5% in 2010.)
(Factually, S&P dividends are under 2% now.)

So Dean switches methods depending on how the stock market returns will be used in a political debate. That is just advocacy.


Dean, please explain why the estimated rate of returns for State Pensions funds don't apply to the Social Security fund.
P/E is low? not according to Hussman and Shiller
written by Steve, March 27, 2011 4:33
Usually love your columns, but I question whether P/(trend)E is 15. As of 24 March 2011,the Shiller P/E (10 year earnings average)stood at 24; according to him, expected total return over the next ten years is roughly 3.5-5% annually. Why the discrepancy between your methodology and that of Shiller? John Hussman's estimates of P/(trend)E are comparable to Shiller's.
written by Don York, March 30, 2011 2:40
Your article is very interesting, thank you!I will bookmark your blog.
Cartier jewelry
written by mens ed hardy shirts, April 09, 2011 5:07
one of the virtually influential new labels that rich person burst on the womens ed hardy shoes scene realise to be the highly fortuitous known tattoo style designs Ed Hardy. conduct you in Ed-Hardy way! The tattoo design of mens ed hardy shirts incessantly leads the fashion trend.

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.


Support this blog, donate
Combined Federal Campaign #79613

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.