Since the Great Recession in 2008, warnings of an impending pension crisis have been splashed across the business pages of newspapers across the country. Despite these boisterous decrees, America’s public pension funds are stable. We explore the roots behind the false pension crisis narrative and examine the facts.
Credit ratings agencies are powerful players in the United States financial system. The big three ratings agencies -Moody’s, Fitch, and Standard & Poor’s- rate thousands of bonds and other financial products all around the world. Cities, states, and nations value the bond ratings they receive from these agencies as an indicator of their creditworthiness. One factor these agencies consider when rating bonds issued by cities and states is pension obligations. Recently these agencies, especially Moody’s, have taken some hostile positions toward public pensions.
As we’ve been discussing on the blog, Minnesota unanimously passed bipartisan pension legislation this year that will reduce the unfunded liability in its public pension plans by more than $3.4 billion and shore up the system for years to come. After the passage of this legislation that was universally hailed as a major success, Moody’s stated in a report that the changes are “far from a cure-all.” Moody’s acknowledged that the pension legislation was a positive step toward reducing the overall unfunded liability, but thinks more should be done. Fitch and Standard & Poor’s offered similar assessments of the Minnesota pension legislation.
It’s not just in Minnesota that the credit ratings agencies are offering critical views of public pensions. In June 2018, Moody’s released a report on pension plans for school employees. They focused on states where the state government picks up part of the cost of funding teacher pensions, rather than forcing local school districts to bear all of the cost. The report focused primarily on states that pension critics love to criticize, including Illinois, Kentucky, and New Jersey. The issues in these states are well-known and there is widespread acknowledgement that the pension challenges in these states are the result of failures by governors and state legislatures of both parties over decades. Criticizing these states for their high unfunded liabilities offers nothing new to the discussion regarding public pensions and merely serves to perpetuate the pension crisis myth.
When commenting on public pensions, credit ratings agencies are limited by the scope of the work they do. They do not look at the full picture of public pensions and why cities and states offer pensions to their public employees. When the credit ratings agencies issue their reports, they do not discuss the unfunded liability represented by the lack of retirement savings among workers without access to a pension. They do not analyze what would happen in twenty or thirty years when workers are ready to retire if they lose access to a public pension plan today. The credit ratings agencies are only looking at the unfunded liabilities and the amount of money cities and state governments are contributing each year to fund pensions. Keep in mind that the majority of revenue for public pension funds -upwards of two-thirds of revenue- comes from investment earnings, not employer contributions.
In their analysis of public pension liabilities, the credit ratings agencies seem to be guided by the financial economics view of anti-pension ideologues like Stanford professor Joshua Rauh. Rauh and his allies are known for promoting the view that public pension plans should dramatically and dangerously slash their assumed rate of return to the rate of U.S. Treasury bonds. This could cut the assumed rate of return from 7.5 percent to 2.5 percent, which would seriously overinflate the unfunded liabilities in pension plans. An unnecessary and harmful move like this would make public pension plans appear to be in much worse shape than they actually are. While not taking as extreme a stance as Rauh, the credit ratings agencies have also argued for a continued lowering of the assumed rate of return, a move that would immediately increase costs to public employees and taxpayers.
The analyses done by the credit ratings agencies should also be taken with a big grain of salt. The ratings agencies contributed to the 2007-2008 financial crisis by giving strong credit ratings to dangerous financial products, such as mortgage-backed securities. According to the Financial Crisis Inquiry Report, 73 percent of the mortgage-backed securities Moody’s had rated triple-A in 2006 were downgraded to junk by 2010. In January 2017, Moody’s agreed to pay nearly $864 million to settle with the Department of Justice, other state authorities, and Washington over its role in the financial crisis. No one should assume that the credit ratings agencies are reliable, trustworthy, and objective groups offering fair and reliable ratings. These agencies can be very wrong in their assessments of creditworthiness.
The credit ratings agencies have an important role to play in the U.S. financial system, but their recent actions seem to indicate an agenda hostile to public pensions. Following the U.S. Supreme Court’s recent Janus decision that bars public sector unions from collecting fair share fees, Bloomberg quoted Moody’s analyst Emily Raimes as saying, “We expect the Supreme Court decision may lower public union revenues, membership, and bargaining power in the 22 states that can no longer allow mandatory fees. These developments could change how state and local governments set employee wages and pensions, resulting in a positive long-term impact on government finances.” Credit ratings agencies should not be playing a political role, advocating for the elimination of public pensions. If these agencies hope to regain the respect they lost during the financial crisis, they should stay out of politics and stick with analysis.