May 22, 2008

ENRON WAS FOR PIKERS (CONT’D):

The federal government’s long-term financial obligations grew by $2.5 trillion last year, a reflection of the mushrooming cost of Medicare and Social Security benefits as more baby boomers reach retirement.

That’s double the red ink of a year earlier.

Taxpayers are on the hook for a record $57.3 trillion in federal liabilities to cover the lifetime benefits of everyone eligible for Medicare, Social Security and other government programs, a USA TODAY analysis found. That’s nearly $500,000 per household. . . . The reason for the discrepancy: Accounting standards require corporations and state governments to count new financial obligations, even if the payments will be made later. The federal government doesn’t follow that rule.

If it did, it would be harder to promise voters a free lunch! Plus, the actuarial assumptions on which many government pension systems are based are likely bogus. You’d better be saving for your own retirement, because Social Security, etc., isn’t likely to deliver. And that’s just the beginning of the bad news, I’m afraid. Meanwhile, a reader who probably doesn’t want me to use his name emails:

I am GC for a private company with a legacy UK pension plan. Since I joined the company in December 2001 the pension plan has been the number one non-operational issue for the company. This experience has left me absolutely frightened of what is going to happen to municipalities in the US. The most basic concepts relating to pension funding assumptions are likely beyond the grasp of most city council members. Some of these issues:

– Since 2000, the S&P 500 has been essentially flat. If your pension scheme has 50% of its assets in equities (fairly typical) and presumed equities would earn a 10% return (unrealistic, but probably not uncommon for these pension funds) your scheme likely has less than 75% of the assets that were projected in 2000.

– These pension funds likely are using early 1980s mortality tables. If updated to current mortality rates, the liabilities will increase anywhere from 10-20% (recognizing that a 2 year increase in life expectancy is at least a 10% increase in the length of time a person earns a pension).

These two items alone could mean that a pension plan that was thought to be fully funded in 2000 is, at best, 60%-70% funded today. Investments alone will never recover these type of funding deficits. These deficits will disappear only if (i) the municipalities file for bankruptcy, or (ii) there are massive tax increases.

Realistically, I think we’ll see drastic benefit cuts, one way or another.

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