The Capital of ‘Budget Gimmickry’ Updated X1

Add comment February 29th, 2008

The New York Times editorial page recently took note of New Jersey’s fiscal crisis, and in doing so issued this warning to other states:

It is hard to remember when any governor used the sort of desperate language that New Jersey Gov. Jon Corzine chose this week to describe his state’s fiscal crisis. His words should be a sober warning to other states to get their fiscal houses in order before they face a crisis of Trenton’s magnitude.

The editorial went on to describe what it called a “self-destructive gimmick”:

… the state seriously underfunded its pension plan and used the money to pay for current spending programs.

And it concluded:

The Garden State’s woes should serve as a warning to other states, whose lawmakers might be inclined to use budget gimmickry to deal with shortfalls in revenue and get through immediate fiscal troubles. As New Jerseyans are learning the hard way, that is likely to lead to much bigger trouble in the years ahead.

Illinois should take note. As far as I can tell, this state is the capital of “budget gimmickry.”

Illinois for decades blew off its public pension systems, and future taxpayers will pay — big time. Believe it or not, state leaders didn’t even have a long-term plan for paying down pension debt until 1995, when they finally got around to instituting one.

No longer would the state take a “pay as you go” approach to financing public pensions — putting aside just enough each year to cover annual pension and benefit payments to retirees. Instead, the state would, once and for all, start putting aside enough money each year to cover long-term pension liability.

And by putting more money away into its public pension funds, those funds would ultimately earn enough interest — dollars going back into the funds — that the state’s annual obligation would become minimal.

Or at least that was the idea behind the 1995 plan, which established in Illinois law a formula under which the state would get its pension systems 90 percent funded by 2045 — over 50 years.

But state leaders just can’t help themselves from putting off those payments each year in order to free up cash for all their favorite projects. In 2005, they took their policy of procrastination all the way by wholesale restructuring the 50-year plan. Rod and the gang called their move a “pension holiday.”

Then there was that clever pension maneuver during Rod’s first year in office, 2003. The state borrowed $10 billion to bolster the pension systems. But rather than dumping the entire $10 billion straight into the pension funds, the state skimmed more than $2 billion off the top and used those dollars to offset the state’s mandatory annual pension contribution.

In doing so, Rod and the gang freed up more than $2 billion they could spend on other stuff.

How cool is that! Pretty cool if you’re Rod, and you’re eager to spend some taxpayer money. Not so cool, if you’re a future taxpayer.

As I explained at the time, in a previous job:

Imagine getting a home equity loan for $100,000, spending $27,000 of it on a new car and investing the rest — then counting on the interest earned to cover the interest paid, as well as the cost of the car. That’s the essence of Gov. Rod Blagojevich’s $10 billion pension bonding plan, which became law in April.

This isn’t a new idea. Buying and selling in separate financial markets in order to profit from the difference in rates is called an arbitrage. It’s commonly used by banks, which invest their customers’ money for a higher rate of return than they pay on, say, checking or savings accounts. …

But counting on the performance of any investment is risky. When the market slumps, as it did during the last two years, an arbitrage can fail; there’s a chance the rate of return on the investment could be less than the cost of the loan. Pension bonding plans can put governments on the hook for additional, unforeseen contributions to their systems — while they continue to pay the debt service on the bonds.

This state’s pension bonding plan, which doubles the state’s total bonded indebtedness and constitutes the largest such scheme to date, is no exception to the rule. And there’s an additional twist that heightens the risk. Rather than realize gains as they occur, the administration is realizing, and spending, the projected 30-year gain in the first year of the plan. Like the homeowner who spent 27 percent of an equity loan for a car, the plan dictates that some 27 percent of the bond proceeds be spent immediately.

What’s the bottom line? The state is in lousy shape financially, particularly with regard to pensions. As the state comptroller noted in a recent report:

The funding level of the state’s five retirement
systems remains among the nation’s lowest.
The five state systems — the State Employees’
Retirement System (SERS), the State Universities
Retirement System (SURS), the Teachers’ Retirement
System (for teachers outside of Chicago –
TRS), Judges’ Retirement System (JRS), and General
Assembly Retirement System (GARS) – were
funded at a 62.6% ratio at the end of fiscal year
2007 (assets vs. liabilities). Even with the infusion
of the $10 billion pension funding bond proceeds
into the system in July 2003, the funded
ratio has failed to reach the highs seen prior to the
last recession, where the systems’ funded ratio
reached 74.7%.

UPDATE 1

The Legislature’s fiscal forecasting agency has compiled a chart showing the state’s future pension liability and how it changes based on the payments made each year. I posted it here.