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Financial Armageddon Gets Closer

Rick Roeder       May 2011

Earlier this month, our nation has celebrated the death of Osama bin Laden as a definitive victory over the infamous terrorist. While a happy milestone, the bin Laden legacy still casts a dark financial cloud over America. The ensuing wars in Iraq and Afghanistan, triggered by 9/11, have bankrupted the Federal government, produced a greatly devalued American dollar and have had a troubling “trickle down” effect on state and municipal entities.

The weakened American economy has crippled many sectors including the residential real estate sector. Foreclosures again increased in 2010 – exceeding one million -- about a quarter of all houses changing hands. In May, 26% of ongoing mortgage payers are estimated to currently be “under water.”

Earlier this month, Social Security actuaries came out with updated forecasts on Medicare and Social Security. Medicare is now scheduled to go broke in 2024 – five years earlier than the previous forecast. Social Security is now projected to run aground in 2036.

There has been a strong push back against public sector employees since the costs to fund their levels of pensions and retiree health benefits have increased at a staggering pace since 9/11. The financial situation has become so dire that some powerful public safety unions, given such a wide berth after 9/11, are actually receptive to accepting certain “givebacks” that were utterly unthinkable a decade ago.

In March, Wisconsin Governor, Scott Walker, signed a controversial bill that stripped unions of most of their collective bargaining rights. The bill was passed after a total circus took place. Approximately 80,000 protestors descended upon the state Capitol. Democratic legislators fled to Illinois to avoid having a quorum for a key vote (What an unbelievable God send for the public relations’ director of Illinois’ Chamber of Commerce! So, if you are surprised by a “Come visit Joliet in February” ad campaign, you will know the genesis.). Another part of the measure would force public employees to pay a greater share of the cost toward pension and retiree health benefits. Walker estimated that there would be an annual savings of $30 due to bill provisions. His goal is to create 250,000 new private sector jobs in Wisconsin. Hmmmm, that’s going to require a significantly increased appetite for both cheese and Harley-Davidsons.

Wisconsin has received the lion’s share of publicity regarding its union busting activities. However, Michigan’s new Governor, Rick Snyder, has been far more subtle but no less unmistakable in his intent. He has established the power for the state to step in as an “emergency financial manager” for ailing governmental entities. The powers of such manager are broad and include the ability to terminate collectively bargained agreements. Former Detroit Piston great and current Mayor of Detroit, Dave Bing, pleaded and cajoled with members of City Council to take the needed austere measures in the troubled Motor City to keep such emergency manager at bay.

Even in the “liberal” bastion of Massachusetts, legislators passed a bill in which collective bargaining rights were weakened last month regarding health benefits. My recent consulting experiences also indicate that health benefits is a “lightning rod” issue. In many municipalities, the legal status as to vesting is murky, especially for retiree health benefits. This issue is politically explosive since some public sector entities withdrew from Social Security with the related promise to employees that some substitute retiree health coverage would be provided.

Recently, state legislators in Michigan, Missouri and Arkansas are also trying to balance budgets by reducing the maximum number of weeks in which unemployment insurance is payable. Typically, states have provided at least 26 weeks of benefits. This benefit is funded, in no small part, by the Federal government. In aggregate, states have borrowed $44 billion to provide unemployment monies.

The “trickle down” effect of our financial malaise affects individuals on many levels. The amount of households with student debt has risen from 9% to 15% since 1989 as the cost of attending college has far outpaced inflation during such time. The reduced ability to pay for college in a depressed economy, in conjunction with yet more significant tuition hikes, is creating a greater class of “21st century indentured servants” than could have been imagined a generation ago.

Despite the above evidence that Legislators are getting more serious in dealing, rightly or wrongly, with budget issues, there still is an unsettling lack of overall reality. Actuaries are getting ignored by Trustees in a troubling number of situations. Earlier this year, both the California and Maryland statewide retirement systems elected to keep their assumed returns at 7.75% even though their actuaries both recommended reductions in the assumed rate to no greater than 7.5%. The reason is clear: lower assumed rates translate into higher pension contributions that cannot come at a worse time. These are some prime examples of political expediency trumping expert opinion.

To resolve America’s dilemma will require success on numerous fronts. Will an increasingly partisan and divisive political process be able to become more collegial and not pay unfettered allegiance to the monies funding campaigns? Will politicians actually be willing to face reality or will there be futile posturing until a financial D-day when China and other debt holders decide there are other places to invest money? Will Americans have the vision to realize that putting our financial house in order will require significant short-term sacrifice? For public benefits, some compromise will likely be needed. For example, it may well mean the end of one-year final average pay in defined benefit plans and no payment toward retiree medical reimbursements.

Will American voters take more responsibility? In California, the enemy is partly us. Due to the numerous Propositions that annually dot the ballot of the Golden State, voters approved measures such as a $48 billion public works bill in 2006 and a $10 billion dollar bond in 2009 for a bond targeted to a high-speed rail network that is ultimately projected to cost $40+ billion.

If we truly want the satisfaction of bring bin Laden to his due justice to endure, then America will need to have the backbone, vision and acceptance of some austerity to finally put our financial house in order. If not, those still lauding our “victory” over bin Laden are missing the bigger picture.

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