Public Pensions: Are They Doomed?
The Dynamic Wealth Report
February 3, 2011
by Jay Chernoff, Editor
A very popular – and heated – topic these days is the fate of public
pensions. Most developed countries have some form of public retirement
plans for their elderly citizens. And a huge number of government
employees in the US and elsewhere rely on state and local pensions for
their retirement.
Very few topics get people’s blood boiling like this one. Of course,
possibly not being able to afford your retirement is a big deal. And
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Public retirement plans are extremely popular. There’s simply no
denying the facts. These plans have dramatically reduced poverty levels
among the elderly wherever they’ve been in place. And they’ve been doing
so for over 50 years.
So what’s the problem?
Basically, the global debt crisis has forced public pension issues into
the spotlight.
There are several potential reasons why public pensions are in trouble.
For one, the baby boomer population is reaching retirement age. Basically, a lot more people will be receiving money from the government
than contributing to it. It’s just a matter of simple math. If cash
outflows are greater than inflows for any significant period… there’s a
big problem brewing.
But there’s more…
In theory, the government should be able to cover the gap between
pension inflows and outflows through pension investment returns or
budget surpluses. Unfortunately, neither of those are reliable sources
of cash flow right now.
You see, pension investments tend to be safer, cash flow generating
instruments such as government bonds. Those types of investments are
heavily dependent on interest rates. And with interest rates so low,
returns are also miniscule.
The fact is interest rates are at historically low levels… and they
could stay low for a while longer.
What’s more, budget surpluses seem to be a thing of the past. With all
the debt being taken on by governments across the country – and overseas
– there just isn’t enough cash to go around.
Look at what’s happening in Europe…
According to the European Commission, Spain and Belgium are projected to
spend 15% of GDP on public pensions. Ireland is expected to spend 11% of
GDP on their public pension. And Greece… they’re tabbed for a robust 25%
of GDP.
Clearly, public pensions are a large and growing burden for many
countries. But solving this problem isn’t an easy task.
Remember when the Greek government raised the retirement age and cut
benefits? There were riots in the streets! Think this is an emotional
topic for folks?
In the US, the situation with state and local pensions is looking more
dire every day.
Some estimates have the gap between current pension assets and future
obligations as high as $3 trillion. That’s just crazy. Even conservative
estimates have the gap at $1 trillion. One thing is clear… there’s a
serious problem.
But what can be done? Are public pensions a hopeless case?
Fortunately, there’s hope. But it isn’t going to be easy.
First of all, an improving economy will help in many ways. If good
economic conditions push up interest rates, pension investments will
earn higher returns.
What’s more, a hot economy will do wonders for government budget
shortfalls. (Unless we’re talking about the US government’s budget…
that one may take a few hundred years to reach a surplus.)
Another way pensions can improve their returns is by investing in
riskier assets.
More risk means potentially greater returns. Of course, more risk is
more risk, but Treasury bonds aren’t going to solve the pension crisis.
Then there’s the more painful road…
Just like in Greece, it’s very possible the US must raise the
retirement age, decrease pension benefits, or both. Of course, nobody
wants to consider those options. But then, I doubt anyone wants their
government to go bankrupt.
Look, it isn’t going to be easy. Drastic measures may need to occur in
order to make sure public pensions are funded in the coming years.
There’s a silver lining though… robust economic growth will make
everything easier.
If you’re worried about your pension, you can start pinching pennies
now. But the better bet might be spending those pennies to support the
economy. Very few things will alleviate the pension crisis like a red
hot economy.
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