May 11, 2016
The New York Times had a piece on Puerto Rico’s financial problems which argued that they are a harbinger for the problems facing many state and local governments. In the process it managed to mix many different stories in a way that does not make much sense.
For example, it reported on the problems of deteriorating infrastructure in many cities and states, specifically citing the case of the troubled Metro transit system in Washington, DC. Infrastructure has historically been an area in which the federal government took substantial responsibility. Unfortunately, it has chosen not to step up its efforts in the last decade, even as the economy has been well below its full employment level of output. The decision by the federal government not to spend money cost the country hundreds of billions of dollars in lost output and needlessly kept millions of people from working. It also means that cities and states will face expensive repair bills and lost economic output in the future due to problems with infrastructure.
The piece also quoted former lieutenant governor Richard Ravitch saying, “New York City has $85 billion of retiree health obligations all by itself.” To put this in context, the city’s annual output is over $600 billion. Since this obligation will have to be met over the next three or four decades, Ravitch is referring to a commitment that is equal to roughly 0.5 percent of future income. This is hardly trivial, but not obviously an impossible burden.
The piece then refers to public pension funds in states like New Jersey and Illinois that are badly underfunded. In this context, it notes a warning from the Illinois Supreme Court from 1917 that the pension funds might run into trouble. The origins of these states’ current funding problem date to the stock bubble of the 1990s. They opted to put little or nothing into their pension funds as the stock market soared to record highs. Effectively, the rise in the market was making the contributions for them.
When the market crashed in 2000–2002, the pensions were suddenly much more poorly funded. However, the economy was also in a recession and state and local governments were squeezed for cash. Some, like Illinois and New Jersey, chose to forego part of their required contribution, perhaps in the hope that the stock bubble would return. It didn’t.
In any case, given the recent origins of the severe pension shortfalls in Illinois, New Jersey, and a few other states, it is probably fair to say that the 1917 warnings were wrong, unless the Court somehow foresaw the stock bubble and crash and its impact on pension funds.
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