In 2013, Detroit went bust to the tune of $18 billion. And earlier this month Puerto Rico filed for bankruptcy restructuring after amassing a staggering $74 billion in debt.
Key to these financial disasters was soaring unfunded pension liabilities.
I’ve talked about the current debacle surrounding U.S. pensions extensively. And the way I see it, it’s only going to get worse.
Consider fiscal year 2015, when U.S. cities, states and governments reported unfunded pension liabilities of $1.4 trillion. While that seems like a staggering shortfall, the latest research says it’s just a drop in the bucket.
In fact, research from the Hoover Institution released earlier this week – Hidden Debt, Hidden Deficits: 2017 Edition – pegged unfunded liabilities owed to U.S. workers based on their current service and salaries at $3.8 trillion.
That’s right: $3.8 trillion in unfunded liabilities! That’s an eye-popping 21% of total U.S. GDP in 2015.
But it gets even worse…
A recent study by the American Legislative Exchange Council estimated unfunded pension liability of states and local governments at $5.6 trillion, which equates to nearly $17,500 for every man, woman and child in America.
Worse yet, credit rating agency Moody’s put the number of unfunded pensions liabilities at $7 trillion.
No matter how you slice it, these shortfalls are terrible. But why the big disparity in size? What’s really going on?
Simple: It’s the way the returns on these pensions are calculated.
For fiscal-year 2015, government agencies used an expected return of 7.6% to make the math work and dress everything up nicely. By using that lofty return goal, pension assets would double in about 9.5 years.
But recalculating the unfunded pension liabilities with the more realistic market rate of 2.8% means it would take roughly 26 years to produce the same results. And it would also make the pension shortfall much larger.
The fact of the matter is that state and local governments use unrealistic investment returns to paper over the true extent of their pension problems.
More astonishing is that despite consistently falling short of these investment objectives, they continue to use these pie-in-the-sky return calculations when figuring their annual budgets. Governments use current worker contributions for funding needs, with “hope” of repayment – aided by higher investment returns – at a later date.
But after all the accounting shenanigans, the sad reality is that underfunded pension liabilities are a massive problem that gets worse by the day. And we could be just a black swan event away from finding out how big a financial disaster it truly is.
And the end-result will be governments going bust, reduced pension benefits for retirees and higher taxes for you and me.
What to do?
I recommend my readers stay away from Treasury securities and diversify their wealth across a wide spectrum of assets. This includes building core positions in precious metals on weakness. I’m also looking for opportunities to buy high-quality blue chip companies during a near-term correction.