22/5/17: U.S. Public Pensions System: Insolvent to the Core

A truly worrying view of the U.S. public sector pensions deficits has been revealed in a new study by Joshua D. Raugh for Hoover Institution. Titled “Hidden Debt, Hidden Deficits” (see http://www.hoover.org/sites/default/files/research/docs/rauh_debtdeficits_36pp_final_digital_v2revised4-11.pdf) the study opens up with a dire warning we all have been aware of for some years now (emphasis is mine):  “Most state and local governments in the United States offer retirement benefits to their employees in the form of guaranteed pensions. To fund these promises, the governments contribute taxpayer money to public systems. Even under states’ own disclosures and optimistic assumptions about future investment returns, assets in the pension systems will be insufficient to pay for the pensions of current public employees and retirees. Taxpayer resources will eventually have to make up the difference.”

Some details: “most public pension systems across the United States still calculate both their pension costs and liabilities under the assumption that their contributed assets will achieve returns of 7.5–8 percent per year. This practice obscures the true extent of public sector liabilities.” In other words, public pension funds produce outright lies when it comes to the investment returns they promise to generate. This, in turn, generates delayed liabilities that are carried into the future, when realised returns come in at some 3-4 percent per annum, instead of promised 7.5-8 percent.

How big is the hole? “In aggregate, the 564 state and local systems in the United States covered in this study reported $1.191 trillion in unfunded pension liabilities (net pension liabilities) under GASB 67 in FY 2014. This reflects total pension liabilities of $4.798 trillion and total pension assets (or fiduciary net position) of $3.607 trillion.” This accounts for roughly 97% of all public pension funds in the U.S. Taking into the account the pension funds’ penchant for manipulating (in their favor) the discount rates, the unfunded public sector pensions liabilities rise to $4.738 trillion.

“What is in fact going on is that the governments are borrowing from workers and promising to repay that debt when they retire. The accounting standards allow the bulk of this debt to go unreported due to the assumption of high rates of return.”

Actually, what is really going on is that the governments create a binding contract with their employees to loot - at some point in the future - the general taxation funds to cover the shortfalls on these contracts. How much looting is on the pensions liabilities? Take the unfunded liability estimate of $4.738 trillion. And consider that in 2014, total revenues collected by state and local governments stood at $1.487 trillion. Pensions deficits alone amount to 3.2 times the underwriters’ income. In household comparative terms, this is like having a full 100% mortgage on a second home, while still running a full 100% mortgage on primary residence (day-to-day expenses).

Or, put more cogently, the entire system is insolvent. And is getting more insolvent, the longer the local and state governments refuse to use more honest accounting models.

Couple of charts to illustrate

CHART 2: State Contributions: Actual vs Required to Prevent Rise in Unfunded Liability

Now, observe in the above: the distance between the green triangle (required contributions) and the blue dot (actual contributions) is the gap in public pensions funding that has to be extracted to make the contracts whole. This will either have to come from tax hikes or from increased contributions from the public sector workers or from cut in future benefits to these workers. Or from all three.

In a range of the states, e.g. California, New Jersey, Illinois, etc we are already facing draconian levels of taxation, and falling real incomes of private sector workers. In a range of other states, municipal and local taxes are high, while the cost of living increases are swallowing income growth. In other words, there is not a snowball’s chance in hell these gaps can be funded from general taxation in the future.

When all ameliorating assumptions are made (to the upside for public pensions schemes), Raugh concludes that “despite markets that performed well during 2009–2014, state and local government pension systems are still underwater by $3.4 trillion. With relatively poor performance in fiscal years 2015 and the first part of 2016, this figure is likely to be even larger today. Finally, the report reveals the extent to which state and local governments are in fact not running balanced budgets. While they contribute 7.3 percent of their own-generated revenue to pensions, the true annual ex ante, accrual-basis cost of keeping pension liabilities from rising is 17.5 percent of state and local budgets. Even contributions of this magnitude would not begin to pay down the trillions of dollars of unfunded legacy liabilities.”

Yes, the entire system of public pensions is insolvent. No surprise there. And there is not enough fiscal space to recover from that insolvency without cutting benefits, raising taxes and hiking employee contributions. No surprise there either. Finally, although Raugh does not say so himself, it is pretty clear that there is zero will on either side of the Washington’s political divide to do anything tangible to address the problem.


Note: you can read a series of previous posts covering various sides of household debt in the following threads: Total Household Debt http://trueeconomics.blogspot.com/2017/05/19517-us-household-debt-things-are-much.html; U.S. Social Security Insolvency  http://trueeconomics.blogspot.com/2017/05/19517-reminder-social-security-is-only.html, and Student Loans Explosion http://trueeconomics.blogspot.com/2017/05/21517-student-loans-debt-bubble-is.html).

19/5/17: A Reminder: Social Security is Only Getting More Insolvent...

On foot of my earlier post on U.S. household debt, it is worth mentioning another, much-overlooked in the media, fact concerning U.S. real economic debt crisis. This fact is a staggering one, even though it has been published a year ago, back in April 2016.

Based on the 2016 OASDI Trustees Report, officially called "The 2016 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds" (see link here: https://www.ssa.gov/oact/TR/2016/index.html).

• U.S. Social Security's total income will exceed total cost of Social Security payouts through 2019. However, beyond 2019, interest income and money taken out of reserves will have to cover the funds required to offset Social Security's annual deficits until 2034.
• Assuming the U.S. Presidential Administrations and the Congress continue business as usual approach to Social Security, the federal government payroll taxes will only be able to cover roughly 75% of scheduled retirement benefits until 2090
• As the result, the Social Security Administration now projects that unfunded obligations will reach USD 11.4 trillion by 2090 or some $700 billion higher than the USD 10.7 trillion shortfall projected a year ago
• Worse:  on an "infinite horizon" basis (netting Social Security expected future liabilities from forecast revenues) Social Security will face a USD 32.1 trillion in unfunded liabilities by 2090, or staggering USD 6.3 trillion more than 2015 projection

Chart below plots forecast Social Security unfunded liabilities corresponding to each forecast year:

The above clearly shows that the Social Security 'stabilisation' achieved in 2014-2015 is now not only erased, but is set back to what appears to be a rapid acceleration in liabilities back to 2008-2014 trend.

Yes, Social Security is a system in which people pay in taxes for an 'allegedly' ringfenced program that is supposed to supplement retirement. No, Social Security is not a program that is actually contractually ringfenced to provide anything whatsoever to those who pay into it. Which, really, means that the default on Social Security is looming large for the millennials and subsequent generations. And this raises the issue of what will happen to pensions provision across the entire U.S. Currently, even public sector pensions (across states and municipalities) are facing severe uncertainty and, in an increasing number of cases, actual cuts. Which raises public reliance on Social Security just at the time that the Social Security system is facing higher threats of insolvency. 

Meanwhile, household debt situation is getting from bad to awful (see this post: http://trueeconomics.blogspot.com/2017/05/19517-us-household-debt-things-are-much.html). 

The status quo is a prescription for a social, economic and political disaster. No medals for guessing what the Congress is doing about it all.

10/2/17: Sovereign Debt Bubble: Methane Emissions from the Debt Dump

Because global pile of debt growth has been outpacing global economic growth for quite some time now, the sovereign debt bubble is getting wobblier by the day.

As Fitch Ratings noted yesterday: "The number of Fitch-rated sovereigns with 'AAA' ratings is at its lowest level since 2003 and is expected to remain unchanged over the next two years". In other words, non-junk is getting smaller and smaller, even as Central Banks continue to hold more of the prime stuff.

Currently, only eleven countries have 'AAA' status with Fitch, compared with an all-time high of 16 during 2004 to 2009, "reflecting the longer term impact of the global financial crisis." Personally, I don't think this reflects the impact of the GFC alone. Instead, it reflects the fact that majority of Governments around the world have gone on a debt-piling binge post-GFC in the absence of real productivity and economic growth.

All in, less than 10 percent of the global sovereign debt issuers are now rated AAA. And only 40 percent of global sovereign debt volumes fall under AAA rating (much of this sitting in the Central Banks' vaults), "down from 48% a decade ago".

Source: Fitch Ratings

17/1/17: Government Debt in the Age of Austerity

The fact that the world is awash with debt is hard to dispute (see data here and here), but it is quite commonly argued that the aggressive re-leveraging happening in the corporate and household sectors runs contrary to the austerity trends in the public debt segment of the total economic debt. The paradox of the austerity arguments is, of course, that whilst debt is rising, public investment is falling and public consumption remains either stagnant of rising slowly. This should see public debt either declining or remaining static. Of course, banks bailouts in a number of advanced economies would have resulted in an uplift in public debt during the early years of the Global Financial Crisis and the Great Recession, but these years behind us, we should have witnessed the austerity translating into moderating debt levels in the global economy when it comes to public debt.

Alas, this is not the case, as illustrated in the chart below:

Here's a tricky bit:

• In the 5 years 2012-2016 (post-onset of the recovery) Government debt around the world rose 11.4% in level terms (USD), and 14.51 percentage points as a share of GDP per capita. During the crisis years of 2007-2011, Government debt rose 72.7% in dollar terms and was down 4.39 percentage points as a share of GDP.
• In the advanced economies, Government debt rose 67.6% in dollar terms in 2007-2011 period, up 4.7 percentage points, before rising 5.44% in dollar terms over subsequent 5 years (up 26.65 percentage points in terms of debt to GDP ratio). 
• In the euro area, Government debt was up 57.4% in dollar terms and up 0.51 percentage points in GDP ratio terms over the period of 2007-2011, before falling 6.9 percent in dollar terms but rising 24.8 percentage points relative to GDP in 2012-2016 period.
• And so on...

As the above chart shows, globally, total volume of Government debt was estimated to be USD63.2 trillion at the end of 2016, up USD6.46 trillion on the end of 2011. That is almost 84.1% of the world GDP today, as opposed to 78% of GDP at the end of 2011. More than half of this increase (USD3.91 trillion) came from the Emerging and Developing Economies, and USD2.3 trillion came from G7 economies. Meanwhile, euro area Government Debt levels declined USD815 billion, all of which was due solely to changes in the exchange rate and the rollover of some debt into multinational organisations' (e.g. ESM) and quasi-governmental (e.g. promissory notes) debt. Worse, over the said period of time, only one euro area country saw reduction in the levels of debt: Greece (down EUR34.46 billion due to restructuring of debt). In fact, in Euro terms, total euro area government debt rose some EUR1.36 trillion over the span of the 2011-2016 period.

All in, global pile of Government debt is now USD27.84 trillion (or 78.7%) up on where it was at the end of 2007 and the start of the Global Financial Crisis.

So may be, just may be, the real economy woe is that most of the new debt accumulated by the Governments in recent years has flown into waste (supporting banks, financial markets valuations, doling out subsidies to politically favoured sectors etc), instead of going to fund productive public investments, including education, skills training, apprenticeships and so on. Who knows?..

4/5/16: Canaries of Growth are Off to Disneyland of Debt

Kids and kiddies, the train has arrived. Next stop: that Disneyland of Financialized Growth Model where debt is free and debt is never too high…

Courtesy of Fitch:

Source: @soberlook

The above in the week when ECB’s balancehseet reached EUR3 trillion marker and the buying is still going on. And in the month when estimates for Japan’s debt/GDP ratio will hit 249.3% of GDP by year end

Source: IMF

And now we have big investors panicking about debt: http://www.businessinsider.com/druckenmiller-thinks-fed-is-setting-world-up-for-disaster-2016-5. So Stanley Druckenmiller, head of Duquesne Capital, thinks that “leverage is far too high, saying that central banks and China have allowed for these excesses to continue and it's setting us up for danger.”

What all of the above really is missing is one simple catalyst to tie it all together. That catalysts is the realisation that not only the Central Banks are to be blamed for ‘allowing the excesses of leverage’ to run amok, but that the entire economic policy space in the advanced economies - from the central banks to fiscal policy to financial regulation - has been one-track pony hell-bent on actively increasing leverage, not just allowing it.

Take Europe. In the EU, predominant source of funding for companies and entrepreneurs is debt - especially banks debt. And predominant source of funding for Government deficits is the banking and investment system. And in the EU everyone pays lip service to the need for less debt-fuelled growth. But, in the end, it is not the words, but the deeds that matter. So take EU’s Capital Markets Union - an idea that is centred on… debt. Here we have it: a policy directive that says ‘capital markets’ in the title and literally predominantly occupies itself with how the system of banks and bond markets can issue more debt and securitise more debt to issue yet more debt.

That Europe and the U.S. are not Japan is a legacy of past policies and institutions and a matter of the proverbial ‘yet’, given the path we are taking today.

So it’s Disneyland of Debt next, folks, where in a classic junkie-style we can get more loans and more assets and more loans backed by assets to buy more assets. Public, private, financial, financialised, instrumented, digitalised, intellectual, physical, dumb, smart, new economy, old economy, new normal, old normal etc etc etc. And in this world, stashing more cash into safes (as Japanese ‘investors’ are doing increasingly) or into banks vaults (as Munich Re and other insurers and pension funds have been doing increasingly) is now the latest form of insurance against the coming debt markets Disneyland-styled ‘investments’.

3/12/15: Of Debt, Central Banks and History Repeats

Couple of facts via Goldman Sachs' recent research note:

1. Since the start of 2008, U.S. corporate debt has doubled and the interest burden rose 40 percent. Even as a share of EBITDA, debt servicing costs are up 30 percent, so U.S. corporations’ ability to service debt has declined despite the average interest rate paid by the U.S. corporate currently stands at around 4 percent, as opposed to 6 percent in 2008.
2. Much of this debt mountain has gone not to productive activities, but into shares buybacks and M&As. Per Goldman’s note: “…the changing nature of corporate balance sheets does raise the question, again, about the lack of organic growth and reinvestment post the crisis.”

And the net conclusion? “…the spectre of rising rates, potential global disinflation, declining operating profits and wider credit spreads continues to create near-term consternation for weak balance sheet stocks.”

Source: Business Insider

Oh dear… paging the Fed…

• Meanwhile, per IMF September 2015 Fiscal Monitor, Emerging Markets’ corporate debt rose from USD4 trillion in 2004 to USD18 trillion in 2014. Much of this debt is directly or indirectly linked to the U.S. dollar and, thus, Fed policy.

Oh dear… paging the Fed again…

And just in case you think these risks don’t matter, a quick reminder of what Jaime Caruana, head of the Bank for International Settlements, said back in July 2014 (emphasis mine):

• "Markets seem to be considering only a very narrow spectrum of potential outcomes. They have become convinced that monetary conditions will remain easy for a very long time, and may be taking more assurance than central banks wish to give… If we were concerned by excessive leverage in 2007, we cannot be more relaxed today… It may be the case that the debt is better distributed because some highly-indebted countries have deleveraged, like the private sector in the US or Spain, and banks are better capitalized. But there is also now more sensitivity to interest rate movements."

All of which translates, in his own words into

• "Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally."

And as per current QE policies?

• "There is something strange about fighting debt by incentivizing more debt."

Which, of course, is the entire point of all QE and, thus, brings us to yet another ‘paging Fed moment’:

• "Policy does not lean against the booms but eases aggressively and persistently during busts. This induces a downward bias in interest rates and an upward bias in debt levels, which in turn makes it hard to raise rates without damaging the economy – a debt trap. …Systemic financial crises do not become less frequent or intense, private and public debts continue to grow, the economy fails to climb onto a stronger sustainable path, and monetary and fiscal policies run out of ammunition. Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent."

Now, take a look at the lengths to which ECB has played the Russian roulette with monetary policy so far: http://trueeconomics.blogspot.ie/2015/12/31215-85-v-52-of-duration-of-risk.html