Jonathan Rochford writes:
The recent blow-up of the Dallas Police and Fire Pension System was entirely predictable. While it is tempting to blame unusual circumstances for the recent freeze of redemptions and likely substantial reductions to pensions for those still in the fund, many other American pension funds are heading down the same road.
The combination of overpriced financial markets, inadequate contributions and overly generous pension promises mean dozens of U.S. local and state government pension plans will end up in the same situation in the coming decade....
The factors that led to Dallas pension fiasco are all too common. Politicians and their administrations often make decisions that are politically beneficial without taking into account financial reality. As financial markets tend to go up the escalator and down the elevator, it is not until a market crash that the unrealistic return assumptions are exposed and the funding ratio collapses.
This is when a second political reality kicks in. In Dallas, there are just under 10,000 participants in the pension plan compared to 1.258 million residents — less than 1% of the population. If Dallas chose to fully fund the pension plan, it would require an enormous increase in taxes. For current politicians, it is far easier to see pensions for a select group cut by half or more than it is to sell a massive tax increase.
It’s tempting to see the generous pension structure and bad investment decisions in Dallas as a special case. Detroit was seen by many as a special case when it went into bankruptcy in 2013, after its population fell by 25% in a decade. This depopulation left a smaller population base trying to fund the debt and pensions obligations incurred when the population was much larger...
Growing debt and pension obligations are signs of what is to come for many local and state governments who have been living beyond their means for decades.
Pew Charitable Trusts research estimates a $1.5 trillion pension funding gap for the states alone, with Kentucky, New Jersey, Illinois, Pennsylvania and California going backwards at a rapid rate. Using a wider range of fiscal health measures, the Mercatus Center has the five worst states as Kentucky, Illinois, New Jersey, Massachusetts and Connecticut...
Among cities, Chicago is likely to be the next Detroit, with the city and its school system both showing signs of financial distress. Chicago is trying to stem the bleeding with a grab bag of tax and other revenue increases, but in the long term this makes the overall position worse.
The problem for Chicago and others trying to pay their debt and pension obligations by raising taxes is that this makes them unattractive destinations for businesses and workers.
Jonathan Rochford is is a portfolio manager at Narrow Road Capital, which specializes in high-yield and distressed credit.