Even the Pension Deals are Big in Texas
There has been a big break in Houston's and Dallas' pension crises over the past week: The Texas Legislature approved reforms that require all sides to pony up big.
In Houston, the changes will cut the city’s $8 billion unfunded liability in half. Municipal and public safety unions agreed to $2.8 billion in benefits cuts. Meanwhile, Houston will issue $1 billion in pension bonds to boost the system’s balance. It will also stick to a payment plan -- that includes capping the city's future pension costs -- to pay off the remaining unfunded liability over 30 years.
Similarly, Dallas’ police and fire workers will shoulder $1.4 billion in benefit cuts over the next 30 years and more than $1 billion in additional contributions from their pay. For its part, the city will be required to significantly boost its annual payments into the fund, starting with more than $150 million next year. Mayor Mike Rawlings will also get to pick six of the 11 trustees on the currently union-dominated pension board, whose poor investments contributed to more than $1 billion in losses.
The Takeaway: The common theme to these reforms is shared sacrifice. While unions and officials are happy to have a plan in place, no one is pleased about what comes next. "This is not a time to high-five," Dallas Police Association Vice President Frederick Frazier told the Dallas Morning News. "This is a time to pull the boots up and get back to work."
Houston Mayor Sylvester Turner last week called the reforms the "first lap" in a longer race. In addition to needing voters to approve the pension obligation bonds, Turner also wants them to lift a revenue cap the city imposed on itself more than 20 years ago. What's more, the Houston Firefighters Relief and Retirement Fund is suing the city over the reforms. The move was expected as Turner was unable to get the firefighters to join the police and municipal employees in endorsing the reforms.
Fitch's Downward Shift
Fitch Ratings announced this week that it is lowering the assumed rate of return it uses to estimate a public pension plan’s total liabilities. Fitch previously assumed pensions would earn an annual 7 percent return on investments; going forward it will assume a 6 percent return.
Fitch cited slower economic growth and a more volatile stock market as reasons for its lowered assumptions. “There is little evidence to suggest the economy will accelerate to previous levels of growth in the near term,” Senior Director Douglas Offerman said in a statement. “Fitch believes that pensions will be hard-pressed to achieve their long-term growth expectations in the current economic context.”
The Takeaway: The lower an assumed rate of return is, the higher a plan’s liabilities are. Fitch said its criteria changes would only have a “limited impact” on ratings because the firm’s current assessments already figure in rising pension burdens. Still, government officials aren't fans of the change since it makes their finances look worse.
More broadly, Fitch’s move is indicative of a growing trend toward more realistic rates of return. And although a fair number of pension plans are stepping down their return assumptions, their average is still north of 7 percent and they aren't doing it fast enough. Earlier this year, Fitch was among the impatient when it noted that this trend was “an exceptionally slow recognition by pension decision-makers that high targeted returns are unlikely to materialize in the current investment environment.”
With the move, Fitch joins Moody’s Investors Service, which has used a lower rate of return for several years.
Swift Punishment for Illinois
Less than a day after Illinois lawmakers closed their third annual session without approving an operating budget, S&P Global Ratings and Moody's Investors Services downgraded the state’s credit rating to BBB-, one step above junk status.
The blistering critique from S&P’s Gabe Petek warned that another downgrade could come as soon as next month if the state’s lawmakers don't find a spending plan for fiscal 2018 designed to reduce the state’s $7 billion structural deficit.
Petek added that the “unrelenting political brinkmanship” has increased the risk that lawmakers might not appropriate enough money for Illinois to make its debt payments. “We now view these payment obligations as having speculative-grade characteristics,” he wrote.
Illinois’ budget deficit now represents nearly 20 percent of its annual expenditures. What's more, its unpaid bills have mushroomed to represent one-third of its general fund spending. The state is also vulnerable to credit swap penalty payments tied to rating downgrades and severely distressed pension funding levels that will require increased payments to solve.
The Takeaway: Typically, multiple downgrades have provided lawmakers with political cover -- or a swift kick -- to make the uncomfortable financial decisions they need to steady the ship. But in Illinois, which is now rated far below the state average of AA, that embarrassment has had no tangible effect.
It’s hard to imagine how much further Illinois will go before things change. But unless the more than two-year budget impasse is miraculously solved within a month’s time, the state risks its bonds being rated at junk -- something that has not happened to any state in the modern era.
*This has been updated.
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