i initially posted this article from bloomberg.com in a response to one of ben's comments on my last post. now, having read it, i realize that it is more than just mildly pertinent to the corporate bond issue; it may, in fact, be the next leg of the financial meltdown. public pension funds in the united states are $1 trillion below their obligations, and that isn't a side effect of the past few months. these funds have been underwater for more than a decade, and it looks like they've been doing their best to sink even faster by taking extremely dangerous stop-gap measures. what is the chief among these? bond issuances.
as an bit of political economy, i think this fiasco is particularly enlightening. public pension funds, as we all know, are meant to manage the retirement funds of public employees. most came into being after the second world war, during america's brief flirtation with, you know, helping people. along those (gasp!) socialist lines, it was written into law that public pensions were not allowed to fail. if there was ever a shortfall in available funds, state legislatures were to make up for it. those same legislatures, however, for reasons no doubt specific to time and place, yet somehow generally consistent, have consistently denied public funds to pensions.
short-changed and yet unable to bottom out, these pensions turned to the easiest ways to plug the holes in their balance sheets. as we've seen in private sector, the solution which everyone seems to have picked was bonds. they then issued those bonds at 6% interest, and promised beneficiaries, and the state, that they would make 8% returns on the new capital. 8% is generous by anyone's standards, and it was particularly generous given the history of these funds: california's public employees' pension, for instance, has averaged 3.3% a year for the last twenty years. what bonds did let pensions do was coast through another fiscal year. unfortunately, they coasted right into an even deeper hole the next.
at this point, that hole is very, very deep, and it is common to even the most successful of plans--new jersey, a poster child for sound fiscal management in the 90's, is now in the hole by nearly 20%. new jersey doesn't even look that bad next to other states: chicago's CTA is underfunded by 62 percent, and puerto rico's got cash in hand for only 19% of its promises to public employees. all of this money is going to have be made up by states, which means that all of it will come from the federal government. now, none of this will be instantaneous, but it will become more urgent now that credit is tight and states are reeling. adding $1 trillion to washington's obligations is not good, not with all of the other things we're going to have to pay for.
what this article really does for me is highlight the urgency what's happening with corporate bonds. while they can, with proper planning, work out spectaculary, bond issuances can also be a substitute for good business. i'm almost positive that when the next quarterly earnings reports are out, bond markets are going to be sent reeling, and the result is going to be the disappearance of capital from an already squeezed capital market. the same just isn't true of government securities. money put into t-bills goes almost directly into the goverment's purse, which means that it will go into much-needed fiscal stimulus. by contrast, with corporations still on a spending freeze (look here for more on that), the money being raised isn't producing any economic benefits, and there simply aren't any investments to put the new cash in that would cover interest payments with profit. 1929, you got nothing on the two double-oh's.
as an bit of political economy, i think this fiasco is particularly enlightening. public pension funds, as we all know, are meant to manage the retirement funds of public employees. most came into being after the second world war, during america's brief flirtation with, you know, helping people. along those (gasp!) socialist lines, it was written into law that public pensions were not allowed to fail. if there was ever a shortfall in available funds, state legislatures were to make up for it. those same legislatures, however, for reasons no doubt specific to time and place, yet somehow generally consistent, have consistently denied public funds to pensions.
short-changed and yet unable to bottom out, these pensions turned to the easiest ways to plug the holes in their balance sheets. as we've seen in private sector, the solution which everyone seems to have picked was bonds. they then issued those bonds at 6% interest, and promised beneficiaries, and the state, that they would make 8% returns on the new capital. 8% is generous by anyone's standards, and it was particularly generous given the history of these funds: california's public employees' pension, for instance, has averaged 3.3% a year for the last twenty years. what bonds did let pensions do was coast through another fiscal year. unfortunately, they coasted right into an even deeper hole the next.
at this point, that hole is very, very deep, and it is common to even the most successful of plans--new jersey, a poster child for sound fiscal management in the 90's, is now in the hole by nearly 20%. new jersey doesn't even look that bad next to other states: chicago's CTA is underfunded by 62 percent, and puerto rico's got cash in hand for only 19% of its promises to public employees. all of this money is going to have be made up by states, which means that all of it will come from the federal government. now, none of this will be instantaneous, but it will become more urgent now that credit is tight and states are reeling. adding $1 trillion to washington's obligations is not good, not with all of the other things we're going to have to pay for.
what this article really does for me is highlight the urgency what's happening with corporate bonds. while they can, with proper planning, work out spectaculary, bond issuances can also be a substitute for good business. i'm almost positive that when the next quarterly earnings reports are out, bond markets are going to be sent reeling, and the result is going to be the disappearance of capital from an already squeezed capital market. the same just isn't true of government securities. money put into t-bills goes almost directly into the goverment's purse, which means that it will go into much-needed fiscal stimulus. by contrast, with corporations still on a spending freeze (look here for more on that), the money being raised isn't producing any economic benefits, and there simply aren't any investments to put the new cash in that would cover interest payments with profit. 1929, you got nothing on the two double-oh's.
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