Wednesday, September 5, 2012

The Huge Pension Liability Bomb that Will Hit Municipalities in 2014

Anthony Berini emails:

I was reading through the Journal of Accountancy and came across some information I think you'd be interested in. The governmental Accounting Standards Board (GASB) has voted to approve two new GASB standards for local and state governments set to take effect for fiscal years beginning after 6/15/14 relating to governmental pension accounting. These changes move governmental pension accounting more in line with US GAAP (used in business accounting).

First here's the link:

Here are the key parts of the article relating to GASB #68:

"Currently, the pension liability on a government’s balance sheet is based on the difference between the contributions they are required to make to a pension plan in a given year versus what they actually funded. The change reflects the view that pension costs and obligations should be recorded as employees earn them, rather than when the government contributes to a pension plan or when retirees receive benefits."

AB note - This is a big change. Businesses are required to report Net Pension Liability as the difference between the Projected Benefit Obligation (future plan payouts) and the fair value of plan assets. Government's don't need to do that. This is the liability that crushes companies.

“The new GASB standards will benefit users of these financial statements, as well as taxpayers, since state and local governments for the first time will have to report unfunded pension liabilities in their balance sheets, providing a clearer view of pension obligations,” AICPA President and CEO Barry Melancon, CPA, CGMA, said in the release.

"A report by the Pew Center on the States, a national public policy think tank, indicates that the gap between states’ public employee retirement benefit obligations and the funds set aside to pay those benefits was approximately $1.38 trillion in fiscal year 2010."

I assume most people don't bother to read about approved governmental accounting rule changes but I believe this is particularly important given how constrained local and state government budgets already are. Overburdened Balance Sheets are about to be hit with undoubtedly large liability increases relating to the pension accounting change. Taking things a step further, and more importantly, this change could potentially put big upward pressure on municipal bond rates by way of lower credit ratings from the credit agencies due to deteriorating Balance Sheets.

The moral of the story continues to be stay away from municipal bonds.


  1. Writing like this is why I keep coming back to the EPJ. It's like having a time machine in my computer that lets me see into the future.

    It isn't a surprise perhaps that the munis and states have a solvency problem regarding pensions to those who come here, but it will finally expose the chicanery that's been going on for the last 15+ years. It'll be interesting to see how this plays out, or if the rules will be changed before the "extended period" of 2014 Fed speak arrives.

    It'll also be interesting to see what the ratings agencies do about these 'revelations' as the liabilities are brought onto the balance sheets where they always belonged. The upward pressure on rates is going to be enourmous.

  2. This is a huge story which the major media ignoring. State and municipal governments have been using Enron-like accounting to hide the fiscal messes they have. Once more rational accounting standards are in place, how awful and widespread the fiscal mess is will become more clear. California is the tip-of-the-iceberg.

  3. Does anybody know if there are any mutual funds that short muni bonds? 1.4 trillion - just for states. Local pensions are even sweeter than state pensions in my neck of the woods. I've seen a few local cops "retire" here at 49.

    Are muni bonds too big to fail? Who will get the shaft and who will get the bailout?

  4. I don't think it will have the impact you seem to believe. If these entities were a bank or large corp, then yes this is huge. Most government's don't really have balance sheets in the traditional sense since everything is compartmentalize in funds. When creditors judge the credit worthiness of a municipality its based almost entirely on current and future cash flow and not so much accrued liabilities. In other words, the old system of pension accounting is what is relevant to creditors and what will most likely still be used going forward. Liability accruals are really only meaningful when trying to match income to expenses to determine profit. With the exception of enterprise funds, accrual accounting is not very useful for a government entity since there is no value to be obtained from trying to match revenue to expenses. Sorry, but IMO this is really nothing.

    1. I'm no accountant or CPA so I'm basing this on what I've read here. My question is where is the $1.4T shortfall in obligations going to materialize from?

      Do you really believe cash flow is going to remain positive or even at a break even level? It's possible perhaps if property and local taxes are raised massively to cover that shortfall. But at what cost to the local economy and standard of living for the tax payer who is paying for these 'non-issue' obligations acceptable?

    2. I think you're forgetting that state and local governments must release 'government-wide' statements. These statements combine the general and enterprise funds and present them on the accrual basis with a reconciliation back to the fund statements. So while the government wide statements are presented on the accrual basis pensions liability was still recorded as the difference between what the entity was supposed to pay and what it did pay. Seems like this new rule changes that completely.

      I'm not sure I agree with the above commenters analysis that people who evaluate financial positions only look at the fund statements. Then what's the point of GASB 34's government wide statements?

    3. I knew this would be confusing especially for those not in the profession. I apologize for not being clear. Accrual accounting is a concept that tries to match revenue with the expenses required to generate that revenue. Its a timing concept to be able to determine accurate profitability numbers. There is no such requirement with a governmental entity. This requirement is simply informational. I suppose taxpayers may be freaked out by the amount, but then again no one seems to care about the massive number released by the GAO each year on the underfunding on an accrual basis of the Medicare and SS trust funds. We are talking $33Trillion. Not even the politicians talk about this.

      If it were a for profit firm this kind of change could throw their entire capital structure into a tail spin due to credit, bond and preferred share covenants. Actually something like this happened about 25 years ago. If you remember IBM had to book a massive loss related to pension catch up accounting. With a government, it would be a non-cash loss so who cares?

      One thing that would be material would be if they would require actuaries to report the funding based on both projected and worst case future returns on pension assets. Right now most pensions are using 7 - 9 percent which masks the real underfunding when the long term returns may be closer to 2-3%. I doubt the government would be in favor of that since the numbers would be very dramatic and the unions would probably lose it.

      Lastly, a balance sheet for a governmental entity beyond the current (liquid) assets and liabilities is not all that meaningful. I'm not a governmental auditor so perhaps someone that does that kind of work can chime in here. My point is that this is really no big deal. Do you honestly believe that any of this is going to be news to the bond rating agencies? Do you really think they overlooked the fact that they were no reporting their current accruals?

      This is mostly going to have political ramifications if they are required to show it on an individual basis like they already show payroll for government workers. People may find out that the average pay for a cop or FF is more than double what they believe today. Same goes for teachers and admin workers, but maybe 1.5x what they believe the average is today.

    4. @anon 6:05:

      I don't think this is news to anyone since its been reported all over the place for quite some time that pensions have been underfunded. I agree that there will (hopefully) be a political backlash from the public when they see the real costs of the government.

      Regarding the ratings agency, of course they know this information. If I know the off balance sheet pension shortfalls, they better know. But more importantly is the recognition of these liabilities. The ratings agencies, as government granted monopolies, are political animals and distort the truth to serve their masters. Do you really believe that US Government debt is AAA? Or even AA+?

      Recognizing the liabilities will force an honest assessment of muni finances that the ratings agencies cannot ignore any longer. Even if its just the perception of danger it will push rates up to entice buyers that are not the Fed.

  5. What happens if you're in the belly of the beast? Should pensioners take lump sums now before some strange reorganization that resembles default?

    1. Based on many of the expections of Wenzel and others who are part of the Austrian tradition, inflation is likely to accelerate and take a huge toll on fixed income.

      A lump sum would allow the pensioner to buy hard assets such as gold, oil, real estate or whatever real assets you want. These purchases would help protect you from the inflation.

      Personally, I contribute nothing to 401k's, IRAs or other such instruments because I think the currency crisis is going to make those instruments liabilities through gov't intervention.

    2. I am going to tell you the "hard" truth. You will not like it. Many who read this will say that I am doing you a diservice, and that I should keep my big mouth shut. I'll give it to you in three words: "Run Forrest, Run!!!"

      All of us are "in the belly of the beast". Understand, pensions, Social Security, Medicare/Medicaid exist only on paper, backed by paper, backed in turn - by nothing. There is no great store of wealth somewhere - no vault full of gold, or silver, or food, or anything else of value. It exists as a bunch of 1's an 0's on a mainframe, and it will only exist as long as the shell game can be continued. That is why you are looking at, and trying to make sense of the total insanity swirling around you. You have been moved to ask your question because you suspect the game is over. You are correct.

      Each one of us must make some very difficult personal choices and then live (or die) based on what is about to transpire. More and more very savvy and successful investors who aren't selling newsletters or trying to pick you pocket, are advising to get out of any form of paper ie: fiat currency, stocks, bonds, and instead buy real goods - anything you can hold in your hand, live in, or grow food on. Keep only enough cash for three months of expenses, and enough cash, food, and water when the system shuts down.

      Now, I'm going to go put on my tin foil hat while the rest of you choose up sides.

      Peace brothers.

    3. Great points both of you. Thanks, Anon @ 1:17 and 1:21. I am in line with both of your assessments. I'd heard that other countries had changed the law on pensions. I was a school teacher. Couldn't stand it. Too many forced rules on EVERYTHING and EVERYBODY. Horrible. I had to get out. After reading in a few cases where governments either taxed, put a hold on, or confiscated half or more of pensions, I thought that at least taking a lump sum that I could walk with something. But I can't do it this year--want to avoid added tax from added income. By taking a lump sum I will lose 20% plus fees and taxes. Losing 20% on top of that means that in my late 50s I will be competing in all markets with youngsters who have a natural antipathy toward oldsters. Unpropertied, unmarried, some Au, out of debt for now. Thanks for your input.

    4. Anonymous @ 1:21PM wrote, "trying to make sense of the total insanity swirling around you."

      There's something there... do you see it too?

      Make sense of insanity, ha!