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Public Pension “Smoothies” Will Cost $2 Trillion

Posted by Larry Doyle on January 5, 2010 11:11 AM |

Life will get increasingly expensive in America 2010.

Just because the calendar changed does not mean the smoke and mirrors disguising massive losses in banks, insurance companies, and federal and municipal operations have undergone some massive purging. If anything, the policies and programs developed in 2009 have likely only exacerbated the losses across a wide cross section of our economic landscape.

Our federal deficit obviously dwarfs all public and private deficits combined. That said, the obfuscation in other financial corners of our economic landscape are egregious. This obfuscation is often accomplished via an accounting practice known as smoothing. While this practice is not necessarily an indication of improper – if not illegal – financial chicanery, very often the two go hand in hand. Which financial institutions most seriously violated generally accepted accounting practices via smoothing? Hello Freddie. Hello Fannie. And we will pay.

Where else will American taxpayers pay? Public pensions. How much will the smoothie cost at the public pension Dairy Queen? How does $2 trillion sound, or a full four to five times the currently projected cost?

The Financial Times today provides a chilling, sobering, and smooth review of this story in writing, U.S. Public Pensions Face $2 Trillion Deficit:

The US public pension system faces a higher-than-expected shortfall of more than $2,000bn that will increase pressure on many states’ strained finances and crimp economic growth, according to the chairman of New Jersey’s pension fund.

The estimate by Orin Kramer will fuel investors’ concerns over the deteriorating financial health of US states after the recession. “State and local governments are correctly perceived to be in serious difficulty,” Mr Kramer told the Financial Times.

“If you factor in the reality of these unfunded promises, their deficits will rise exponentially.”

Estimates of aggregate funding requirement of the US pension system have ranged between $400bn and $500bn, but Mr Kramer’s analysis concluded that public funds would need to find more than $2,000bn to meet future pension obligations.

A shortfall of that size could force state governments to take unpalatable decisions such as pouring more public money into their funds or reducing pension benefits. State and local governments have already cut spending to close budget deficits.

Mr Kramer, chairman of New Jersey’s investment council and also a senior partner at the hedge fund Boston Provident, warned that outdated accounting models and unrealistic expectations of future returns had led states to underestimate their pension requirements.

Public pension funds do not use mark-to-market accounting, relying instead on actuarial numbers that average out value of assets and liabilities over a number of years – a process known as “smoothing”. Mr Kramer’s analysis used the market value of the assets and liabilities of the top 25 public pension funds at the end of the year.

What are the ramifications of this reality? Ongoing cuts in services. Ongoing layoffs in municipal payrolls. Increased taxes. Could a state or municipality default? The chances are not zero that a municipality will not default.

What other lesson should we learn from this story? When you see the term smoothing used for financial accounting purposes, get nervous and look deeper. Smoothies do not typically come in kiddie size.

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  • Taxpayers Unite


    These smoothies aren’t going to be so sweet. I’m thinking the flavor in these drinks will be more like a heavy dose of strychnine.

  • Mike

    What will dry up first, pension funds or unemployment benefits? Probably not unemployment benefits…

  • Sid

    Hope you will explain in a future articl
    e how you came up with the $2 B deficit
    figure…in fact hope you will provide a state
    state by state breakdown. It dosen’t seem
    to compute. CalPERS, the largest pension loss was
    about $125B ? All others states losses would
    be smaller. Also what about financial chicanery
    by state governors & fund managers ?

    • Larry Doyle


      The $2 trillion figure is the projected deficit by Orin Kramer, the head of the New Jersey pension fund. Kramer is assessing the future liabilities (likely far greater than currently thought) and the future asset valuations (likely far less than currently thought). Pols typically sell future giveaways to garner votes and support. The asset valuations are subject to the market. Those values have gone down a lot in the last two to three years.

      Hope this clarifies.

  • Joe Golowski

    I have watched Orin Kramer’s involvement in NJ’s Public Pension since 2002. Orin is a very smart person with a lot of investment savvy. However, Orin has a tendency to “exaggerate” and likes to preform for the Press that he is all knowledgeable.

    When in 2002, he and then State Treasurer John McCormack wanted to use “private managers” to invest the assets of the NJ Public Pension, Orin repeated to any who would heed including the State Legislature that NJ had loss over $700 million on NJ’s investment Sun Micro Systems over the last few years. It was proved by the members of a CWA local who worked in NJ’s Division of Investment, Sun had provided a $900 million profit for the Division. This was a swing of over $1.6 billion from what Kramer had said.

    When confronted with the actual figures Orin said he was miss quoted and we would had a “draw down” of $700 million if we sold earlier (records show he wanted the DOI to sell stock it had not even owned as of the date he used.).

    7 years later he makes a statement that “Public pensions are underfunded as much as $2 Trillion dollars ($2,000,000,000,000.00)”. However, NORTH CAROLINA STATE UNIVERSITY (/ recent study advises the Public Pensions maybe under funded by only $550, billion or 1/4th as what Orin Kramer states.

    I have seen Orin use statistics as little as a 3 year average to question a 35 year average pension when it is in his favor and then complain that 3 years is not enough time to judge the “alternative asset class” (hedge funds private equity, sub-prime mortgages)which caused horrors in the financial world.

    Orin Kramer is also a national political opportunist, who likes to collect money for politicians. If the $100 million in fees NJ pays to the limited “private managers” in the NJ Public Pension Funds, somehow end up in much smaller amounts to candidates for the US Senate races in other states or to the National Democratic Party so much better for Orin.

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