Illinois postponed a $500 million bond offer today after Standard & Poor’s (MHP) lowered the state’s rating to A- last week, with a negative outlook. Pensions are the problem. Illinois is supposed to save money for its state employees. It has not. Not only has it not saved money, it assumed unrealistic investment returns for the money it did save. At the end of 2012, S&P reports, Illinois was almost $100 billion short on what it already owes its employees for retirement, and the state legislature is incapable of even making changes to what the state will owe future employees.
Meanwhile in New York, a state that has been more responsible with its pension program, the state comptroller, city mayors, and investors are arguing over Governor Andrew Cuomo’s plan to allow cities to cash in now on expected savings in the future on pension reforms enacted last year for employees who haven’t been hired yet. “This is a financing plan to get you from today to tomorrow,” Cuomo told Bloomberg News.
One of the many differences between today and tomorrow is that $100 billion in the hand today money is worth more than $100 billion sometime in the future. Economists refer to this as the “time value of money.” Many assumptions about economics have come into question in the last four years. This one stands pretty firm. And it underpins several of the fights America has been having with itself.
In 2009, car companies failed, and the federal government stepped in and had to decide whether to short workers or investors. In 2011, unions swamped state capitols in Wisconsin and Ohio to protest drastic changes to collective bargaining rights. The bargaining, ultimately, was about pensions. Paul Ryan likes to point to a chart with an angry orange triangle showing future growth in government outlays. A “spending problem,” he calls it, but the growth will happen mostly in old-age entitlement programs—Medicare and Social Security. But the United States doesn’t have a car company problem, or a spending problem, or an entitlement problem, or a union problem. America has a problem with the time value of money.
Negotiations with unions and decisions about how to fund entitlement programs come down to the same question: do you want money now or later? For the last half-century, cities, states and companies have held the line at money now—salaries—and instead offered money later—pensions. They did this because money later is worth less than money now. Rather than apply a discounted rate to promises of money in the future, unions accepted those promises at face value. But it’s hard to see, now, how those promises can be redeemed at face value.
Lest we chuckle at unions, we’ve all been conducting the same negotiation with ourselves. When we allow Congress to dip into the Social Security fund to pay for other things, we are admitting that spending $100 now is worth more to us than getting $100 in the future as an entitlement. But we’re still, like the unions, pretending that the money is there, that it can be redeemed at the face value of the promise.
Cuomo helped push through a responsible pension reform in New York State. This is good and needs to happen everywhere. But when he moves to borrow now based on expected savings in the future, he’s doing the exact same thing his predecessors did when they negotiated over-generous pension benefits for future retirees. He’s cashing in now. A promise to fund pensions tomorrow is worth less—to him and the people who elected him—than the value of cash for New York’s cities today.
