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What’s really behind that SEC probe

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Illinois

* Nobody in Illinois really got to the bottom of what was going on with yesterday’s report about an SEC investigation of Illinois pension funds. This was typical…

Gov. Pat Quinn’s administration confirmed Tuesday that the federal Securities and Exchange Commission is conducting an inquiry into statements made by Illinois officials about prospective long-term savings from pension reforms passed last year.

Kelly Kraft, spokeswoman for Quinn’s budget office, said the SEC contacted the state in September regarding a “non-public inquiry” it was conducting regarding the financial effects of the reforms on the pension systems. The inquiry includes “communications relating to the potential savings or reduction in contributions by the state to the Illinois public pension systems,” Kraft said.

“We feel our disclosures are accurate and complete,” Kraft said. “In terms of what the SEC has told us, the non-public inquiry ‘should not be construed as an adverse reflection on any entity or individual involved, nor should it be interpreted as an indication by the Commission or its staff that any violations of the federal securities laws has occurred.’”

* Gov. Pat Quinn was also asked about it yesterday, but he didn’t say much…

“They called, and I think nationwide they are probably looking at everything in light of what happened in New Jersey,” Quinn added. “So, you know, we want to make sure that we answer any and all questions. We’re totally confident that everything we do here is done in the right way and that’s the way it will always be.”

“We’ve never had a problem going into the market and getting plenty of bidders to lend money to Illinois, and I think that’ll be even more so in light of our most recent action,” Quinn said, referring to the income tax increase.

* The New York Times, however, got to the bottom of it…

The S.E.C. contacted Illinois after an article appeared in The New York Times about an unusual actuarial technique the state had been using to save money by shrinking its annual pension contributions.

The method, enacted last year, is based on sharp cuts in benefits for state workers who have not yet been hired. Although the cuts will not produce an appreciable savings until far in the future, Illinois has begun funding its plans as if its current workers were already earning the smaller benefits of the future.

The SEC probe began in September, which is when this story appeared in the NYT…

Earlier this year, Illinois said it had found a way to save billions of dollars. It would slash the pensions of workers it had not yet hired. The real-world savings would not materialize for decades, of course, but thanks to an actuarial trick, the state could start counting the savings this year and use it to help balance its budget.

Gov. Pat Quinn of Illinois approved a plan in April that seemed to help balance the budget, but it may imperil the pension fund.

Actuaries, including some who serve on the profession’s governing boards, got wind of what Illinois was doing and began to look more closely. Many thought Illinois was using an unorthodox maneuver to starve its pension fund of billions of dollars, while papering over a widening gap between what it owed and how much it had. Alarmed, they began looking for a way to discourage Illinois’s method before other states could adopt it.

They are too late. The maneuver, and techniques that have similar effects, are already in use in Rhode Island, Texas, Ohio, Arkansas and a number of other places, allowing those states to harvest savings today by imposing cuts on workers in the future.

* And the Bond Buyer dug even deeper into the state’s latest bond offering for these gut-wrenching nuggets…

More than 20 pages [in the current offering statement] are devoted to pension fund reporting in the $3.7 billion offering statement, more than double the section in past offering statements, including the one for the state’s $3.5 billion sale of GOs to fund its fiscal 2010 pension payments early last year.

The section underscores just how troubled the Illinois pension system remains. The unfunded liability rose to $75.7 billion in fiscal 2010 from $62.4 billion in fiscal 2009. That lowered the state pension system’s funded ratio to 45.4% from a 51% funded ratio that is among the worst in the nation.

Illinois shifted to a five-year smoothing model in fiscal 2009 that limits the impact of near-term investment losses and gains. The unfunded liability would stand at $85.6 [billion], for a funded ratio of just 38.3%, based on the fair market valuation that recognizes gains and losses annually.

The unfunded actuarially accrued liability “increased between fiscal 2009 and the end of fiscal 2010 primarily as a result of insufficient state contributions as compared to the actuarially required contribution,” or ARC, the state wrote in the offering statement. [Emphasis added]

Oy.

posted by Rich Miller
Wednesday, Jan 26, 11 @ 9:17 am

Comments

Before people start commenting on the “generous” benefits as the cause of all this trouble, remember that those benefits are what allow the state to not pay Social Security payroll taxes. This saves the state a lot of money each year (money that was supposed to fund the pensions).

I also understand that last Spring’s reforms have the Feds looking to see if the state needs to be in Social Security. Those reforms could end up costing a lot more than they saved.

Comment by Pot calling kettle Wednesday, Jan 26, 11 @ 9:27 am
More “smoke and mirrors” budgeting. Perhaps my family member should quit trying to get that state position he’s been trying for. “slash the pensions of [future] workers” is not very encouraging language.

Comment by TimB Wednesday, Jan 26, 11 @ 9:30 am
When reporters let Blago blather on last week about the horrible income tax increase, one of the reporters should’ve asked him about how not funding pensions properly under his regime will create much greater taxpayer obligations than a tax increase would have.

Comment by Jim Wednesday, Jan 26, 11 @ 9:32 am
What sort of punishment could be in store for the Illinois officials who cooked up this methodology if it is found to be wrong?

Comment by Cassiopeia Wednesday, Jan 26, 11 @ 9:32 am
Rich that was simply an outstanding summary of the issues being raised by the SEC investigation. It also shows how desperate the situation has become for funding the state’s pension obligations.

Comment by Rod Wednesday, Jan 26, 11 @ 9:35 am
If an employee is hired today, somewhere the pension system is figuring out how much needs to be contributed this year in order to make sure there will be enough money when that person retires in, say, 45 years.
So why then, can a state that reduces the benefits that person will receive in 45 years, not adjust the pension calculations?
Honest question.
It’s not like Blago math where he’d say this will save 35 billion over the next 40 years, we’re going to recognize 12 of it now and, tah-dah, the budget is balanced.
Oh, as for the smoothing provision to reduce the impact of sudden drops (and gains), that’s exactly what the feds did (with strong bipartisan support) for the private sector pensions they regulate and hope to not have to bailout.

Comment by piling on Wednesday, Jan 26, 11 @ 9:38 am
===The real-world savings would not materialize for decades, of course, but thanks to an actuarial trick, the state could start counting the savings this year and use it to help balance its budget.===

Isn’t this exactly what Enron did, but with future revenues and not future savings?

Comment by Obamarama Wednesday, Jan 26, 11 @ 9:38 am
Let’s get a few facts straight. State employees are in the social security system and have been for decades. Teachers and University employees are not.

Comment by Just the Facts Wednesday, Jan 26, 11 @ 9:40 am
–The real-world savings would not materialize for decades, of course, but thanks to an actuarial trick, the state could start counting the savings this year and use it to help balance its budget–

I don’t think that’s quite right in relation to a fiscal year GRF budget.

I understand how the move allows the governor to claim the unfunded ratio of the pension system is smaller than it is, but I don’t see how it makes any difference in a fiscal year budget deficit.

In the fiscal year, you contribute what you contribute to the pension funds in real money (or no money, as the case may be). That figure doesn’t change, even if you claim that the contribution boosts the pensions’ funded ratio more than it does.

Seriously, what’s the point of this? Are Illinois, Arkansas, Texas, Ohio, trying to pretend state pension funds aren’t in trouble? Would anyone believe that? The subterfuge just makes the inevitable solutions down the road that much worse.

I thought Quinn said he wasn’t going to take any advice from New Jersey, which was the first state the SEC went after for cookng the books on pensions.

Comment by wordslinger Wednesday, Jan 26, 11 @ 9:41 am
We have been broke for many years. Thanks to smoke and mirrors like this we have been reelecting people into office. Yes, this is wrong. It is a lie. But how long were we willing to pretend we were not broke?

The Wizard of Oz was not a mean man. It took two for him to be a wizard. He, and a person willing to not look behind the curtains.

Half the voters knew there was no wizard to save us. The other half was willing to not look behind the curtains and elected the wizard. Illinois has been willfully blind for over a decade. Blagojevich got reelected just four years ago.

Wake up. Our Yellow Brick Road was not yellow or brick. Worse, it seems to be leading to a 3000 foot cliff. The tax hike may not be enough to keep our government credible after the SEC is through with it.

Comment by VanillaMan Wednesday, Jan 26, 11 @ 9:52 am
It sounds a bit like the Mark to Market stuff Rod had tried back in the past.

http://htsblog.blogspot.com/2005/05/best-metaphor-about-some-blaog-budget.html

Comment by OneMan Wednesday, Jan 26, 11 @ 10:00 am
==reporters should’ve asked him about how not funding pensions properly under his regime will create much greater taxpayer obligations==

They should also ask Ryan, Edger, Thompson, and Walker,

Comment by Bigtwich Wednesday, Jan 26, 11 @ 10:00 am
Remember that 38.3% (which I dug out last night also) is the number as of June 30, 2010. Since then we have made no pension contributions to the funds as far as I know. Also, in FY10, we had 9ish% gains on investment but still dropped our funding ratio. With the non-funding continuing, our funded ratio is even lower than that 38% even assuming a good rate of return on the dwindling assets we still have.

Comment by John Bambenek Wednesday, Jan 26, 11 @ 10:04 am
If you assume an 8.5% return on your investment, you would need to contribute about $57.5 million today to have $1 billion in 35 years. That means chopping $1 billion in expenses in 35 years reduces your current contribution requirement by $57.5 million. If you change the rate of return to 9%, the savings drops to just under $50 million (because you need a smaller investment to earn the $1 billion with the higher rate of return). This should give a flavor of how easy it is to manipulate the computations, which are way more complicated because they involve multiple-year savings, rather than savings at a single point in time, and trying to predict actual savings that far down the road is not easy.

Comment by Pat Robertson Wednesday, Jan 26, 11 @ 10:06 am
Oh, two other factors. The funding ratio probably takes into account the very pension savings the SEC is looking into. Those savings are compromised by the rate of hiring before Dec 31st bring people into the old system while there was still time.

Comment by John Bambenek Wednesday, Jan 26, 11 @ 10:07 am
Wow, with a 6/30/10 funded ratio of 38.3%, and as John Bambenek pointing out, likely lower now, does everyone still dismiss Josh Rauh’s (Kellogg School of Management) report that Illinois’ pension fund will be empty by 2018 and have to rely on general revenue funds? He even points out, in his update, that reforms for future employees don’t extend the date of reckoning because the cash impact of those savings wouldn’t start until 2045 or so. For people thinking Illinois is out of the woods with this temporary tax increase (I don’t know that there are many), you’re mistaken. There are still huge reforms and decisions that have to be made now.

Comment by South Side Mike Wednesday, Jan 26, 11 @ 10:15 am
Perhaps I’m missing something (I often do), but why should reducing future benefits have an impact on current obligations? Isn’t the entire point of the actuarial calculations an attempt to assign a present value to future payment obligations? If the amount of the future payment obligations decreases, shouldn’t that have a corresponding effect on the present value of those obligations? That doesn’t seem like an actuarial “trick” so much as an actuarial fact.

Comment by Duck Duck Goose Wednesday, Jan 26, 11 @ 10:17 am
Capt fx
the simple answer is that since the SEC missed all aspects of the crooked deals that destroyed the economy via the housing/mortgage market /meltdown/shakedown they are now at work to prevent a double dip via the muni-meltdown some traders are promoting.
Of course promoting the SEC “probe” helps elavate the instability angle
Hope that helps.
BTW stick with Bond Buyer and Reuters if you want to understand the muni issues

Comment by CircularFiringSquad Wednesday, Jan 26, 11 @ 10:23 am
Pot Calling Kettle’s comment should be considered more often. and there are clear rules on the receiving end of money if you are also eligible for Social Security, not allowing Social Security in addition to the pension.

Comment by amalia Wednesday, Jan 26, 11 @ 10:27 am
Illinois Supreme Court - 4 justices are all that is needed to end the budget issue.

I have never been able to read the tea-leaves… but it seems to me within about 15 years there are going to be MAJOR election battles to the Illinois Supreme Court with the “litmus test” being ones position on whether current employee pensions can be reduced on a go-forward constitutionally.

Elect four justices who see it as being constitutional and the problem is over. The Civic Committee types would be at the ready to fund that I would think.

Meanwhile, the band plays on as the middle and lower classes battle themselves… “Yes, the problem is too high a minimum wage! It’s too high of pensions! Retirment before death is unfair! We must lower wages!” and on and on.

Capital and capitalists will always seek the lowest point, the proverbial race to the bottom. We can lower wages, but until it is at a point where the standard of living is equal to our competitors + shipping costs to get here, it will never be low enough. That’s a fact Jack.

I dont have the solution, but that seems to be the problem.

… and hey, I dont love the fact that four elected supreme court justices can take my pension (the only reason I came into state employ - a pay cut but a calculation that long term I would be ahead of my 401(k) brethern), but such is life.

Comment by Peter Snarker Wednesday, Jan 26, 11 @ 10:29 am
@ Just the Facts

=Let’s get a few facts straight. State employees are in the social security system and have been for decades. Teachers and University employees are not.=

I worked for the state for 28 years. Never paid a dime to SS. Wasn’t a teacher or a university employee.

Comment by Leave a light on George Wednesday, Jan 26, 11 @ 10:38 am
“within about 15 years there are going to be MAJOR election battles to the Illinois Supreme Court with the “litmus test” being ones position on whether current employee pensions can be reduced on a go-forward (basis)constitutionally.”

In other words, public pensions will become to the SCOT-IL what abortion and gun control are to the SCOTUS. I wouldn’t be surprised if public pensions and the possibility of “state bankruptcy” or some other kind of financial oversight also end up becoming a litmus test issue for the SCOTUS.

Comment by Secret Square Wednesday, Jan 26, 11 @ 10:48 am
All-

The problem with thinking of the pensions as only guaranteed by the State Constitution is that it’s not true. The pensions are also FEDERALL guaranteed by the Contracts Clause in the US Constitution. Prior to 1970, that was not the case. However, since then, federal courts have viewed pensions as an enforceable contract and thus prohibited from being “impaired” by Art 1 Sec 10 of the US Constitution.

You could have a brand new state court and you’d still have to deal with the feds. And it’s not likely they’ll simply roll on the pensioneers without “consequences” all around.

Comment by John Bambenek Wednesday, Jan 26, 11 @ 10:52 am
SS @ 10:48

Predicting the future is a fools errand and a lot wiser people than I post on Rich’s blog, but it seems to me if 4 supreme court justices can be elected that agree with Msall’s Civic Committee legal opinion, you can fast-forward from 2045 to as soon as you get those 4 elected to start “realizing savings”.

I am not an accountant, but if you get those 4 justices (and I believe that IL Supreme Court is elected by appellate district - meaning it would be tough to get an anti-pensioner type elected in the first district and the fourth (I believe that is Chicago and Springfield) but the others?

Not so tough.

You get those 4 elected and nothing else matters, someone cuts current pension benefits, AFSCME sues but 4 IL supremes disagree it’s over except the whining.

Remember life isnt fair.

Comment by Peter Snarker Wednesday, Jan 26, 11 @ 10:55 am
State employees who started before a certain date did not participate in SS (I don’t know the date). Those who originally started with the state sometime in the late 70s/early 80s (or thereabouts!) were required to participate in SS and there was a group in the interim there that got a choice. That’s why these two groups also have different pension formulas; the old state formula compensates for the fact that they don’t have SS.

Comment by Katiedid Wednesday, Jan 26, 11 @ 10:57 am
–However, since then, federal courts have viewed pensions as an enforceable contract and thus prohibited from being “impaired” by Art 1 Sec 10 of the US Constitution.–

JB, that section refers to “Powers Prohibited by States.” What if federal law allowed state bankruptcy?

I’m against that, of course. But who knows how the U.S. Supremes would see it? They come down 5-4 on everything big, and a roomful of judges here can’t agree on whether Emanuel can run for mayor.

Comment by wordslinger Wednesday, Jan 26, 11 @ 10:59 am
John B. -

I am probably one of the few people who posts who typically finds myself agreeing with you - and thank you for raising that point about fed protections - something I wont pretend to know about or pretend that I considered with my original post.

- however, in some future “red state” environment (as far as elected federal positions go) I could see a willingness to accept the “consequences” on behalf of California, Illinois, etc. I dont think in such an environment there would be a lot of pity.

Finally, as far as “consequences”… look, that is what this is all about. Someone, somewhere, at sometime is indeed going to face consequences here. I can still hear my father saying to me as a child “Actions have consequences”.

I think the “consequences” are assured at this point - the only question is who will they be visited upon…

… the options as I see it are:

(1) current pensioners
(2) current employees
(3) taxpayers (whether federal or state)
(4) some combination of the above

I guess I just assume (1) and (2) will eventually take the brunt b/c there are more (3)’s (taxpayers) voting than there are (1) and (2) voting. That’s my simple arithmatic.

As for the law or constitution - it’s elastic, like it or not, and will react to the body politic and future realities.

I dont know accounting, but I assure you, I do know judges.

Comment by Peter Snarker Wednesday, Jan 26, 11 @ 11:06 am
As is customary, good job by Yvette

Comment by steve schnorf Wednesday, Jan 26, 11 @ 11:07 am
As far as bankruptcy, if federal law allowed it, then it would allow the federal government the power to impair a state contract, so it would be an “out” on the contracts clause. But it isn’t going to happen because the 40-45 other states won’t sign up to take the large bond rating reduction just to let a few of the other states slide.

As far as a judge ruling on the contracts clause, there is a “supreme public necessity” doctrine that will allow states to impair contracts. There’s always an “out” in the law. The consequences would more likely be borne by the taxpayers, as while there is “more of them”, the federal courts don’t have to worry about voting. But that’s speculation.

If I were a lawyer representing pensioners, my argument would be, “Your honor, my clients faithfully worked for the state and faithfully paid their contribution. Why should they bear the cost of the state who through it’s nonfeasance at best or malfeasance at worst, failed to live up to its promises? The state and its elected officials created this problem by knowing what they needed to put in and yet failed to do it.”

(1) and (2) will get a haircut, sure. But (3) will bear the largest chunk of the costs.

Comment by John Bambenek Wednesday, Jan 26, 11 @ 11:24 am
The SEC inquiry is just one more coffin nail into the government employee pension fiasco. Please do not refer to these deals as enforceable promises or contracts in a legal sense. These boondoggles were agreed to by elected officials, presumably owing a fiduciary obligation to all the citizenry that elected them, but nevertheless they accepted money, favors and campaign workers from the government employees and their unions with whom they “bargained.” In the real world, that’s fraud and collusion. If your selling your home, would you be happy to learn that your real estate agent was cutting side deals with the buyer which were anatagonistic to your interests? The SEC is looking into sub-standard and often non-existent and usually surrealistic financial info provided by most government units when they push their paper into the market. Some less than scrupulous dealers pass this paper on to seniors with the misrep that it’s next to a T-Bill for safety, which is a lot of bovine excrement. Hopefully, the SEC inquiry will add 50 or a 100 basis points to the state’s upcoming pension bond sale and wake some people up that municipal bonds are as risky as junk bonds. just one of the numerous and unreal aspects of these pension plans that they provide 3% cost of living adjustments, regardless of inflation. This year there will be no COLA for Social Security or Veterans Pensions because there is no inflation, supposedly. But for you more mathematically advanced, giving a 3% bump every year on a $45,000 a year pension to someone who retired at 55 turns into what say twenty years out? The ominous sound getting louder and louder is arithmatic.

Comment by Cook County Commoner Wednesday, Jan 26, 11 @ 12:36 pm
Only $75 Billion? Jeesh, I would have thought it was much worse.

Comment by Yellow Dog Democrat Wednesday, Jan 26, 11 @ 4:32 pm