Friday, January 21, 2011

San Francisco Blockbuster Pension Bonus

Leaving pension decisions to voters may not be any wiser than leaving them to fiduciaries.  San Francisco voters agreed in 2008 to tie increased pension contributions from new hires to an increased payout for current retirees, provided the pension fund performed well.  The fund rocketed higher thanks to the bailouts and stimulus spending that have inflated asset values of late.  The new problem is that SF's pension plan is now massively underfunded in regards to future liabilities:

As San Francisco struggles under ballooning pension and health care costs, the city’s retirees will receive unexpected cost-of-living bonuses totaling $170 million. The city’s anticipated budget deficit for the coming year is $360 million.

Current retirees can thank new hires for this one-time intergenerational transfer of wealth.  Think of it as a reverse inheritance not based on familial ties. 

My fellow residents of The City and I will be paying more in sales taxes to receive fewer municipal services thanks to this budget blowout.  This is the kind of dilemma that has set the stage for municipal bankruptcy warnings, and San Francisco is not immune from the same troubles that sent the city of Vallejo into financial trouble.  Persistent deficit spending and unfunded pension liabilities destroy the status of muni bonds as safe havens for wealth preservation. 

The solution to unintended consequences like this is to take pension formulas out of the ballot box and defined benefit structures out of pension plans.  Investment managers may not be able to predict market returns, but they should be able to match liabilities to returns if they are not hamstrung by arbitrary payout requirements.  If their fund performance can't support a given payout level, then the payout will not occur and retirees will have to live with what their accumulated account can support.  That's what private sector 401(k) investors have to do.  Public sector employees should get the same deal. 

Full disclosure:  I do not own San Francisco municipal bonds.