The Pensions Stranglehold: Financial Advisors' Daily Digest

By SA Gil Weinreich :

The European Union just slapped Google ( GOOG ) ( GOOGL ) with a $2.7 billion fine. Whether one believes justice lies on Google's side or that of the EU, the wealthy American company can pay a fine like that and survive economically. As could Apple ( AAPL ), Facebook ( FB ) or Amazon ( AMZN ). That would bring us up to $10.8 billion. But from where will governments collect the trillions of dollars they need to restore fiscal balance to their pension systems, let alone other important things like national armies, health care systems and the like?

That's the question that came to my mind as I read an interview with Lawrence McQuillan , an expert on the California economy and the national pensions crisis, in an article by SA contributor Financial Sense.

McQuillan says state and local pension systems are currently $4.7 trillion short of the money they need just to fund current promises to government workers. Worse, the funding gap is increasing such that even with wildly unrealistic annual returns of 19%, their deficits would still increase by 15%, according to a Moody's analysis he cited.

Indeed, the assumption of high annual returns (usually in the 7.5% or 8% range) has been one of the key methods that enabled politicians to underfund government pensions. In a state like California, with pension debt reaching up to $750 billion, government worker unions would routinely put all their financial and political muscle to work on behalf of politicians who would return the favor by lavishing ever more generous pension benefits. The system has been great for politicians and government employees, whose benefits have exceeded those found in the private sector. But the beleaguered taxpayers who have to pay for all this largesse get the additional insult of seeing public services decline as increasingly sizable wedges of the government pie go to pay the folks who no longer work there. Here's how Financial Sense describes this unsavory process in California:

McQuillan offers a number of suggestions, primarily that all government employees be transitioned to the same 401(k) plans that most private sector workers suffice with, as they are not subject to the same politicking that created the mess involving defined benefit plans, in which promises are made but not paid (by those making them).

That's a start. But given the enormity to which the problem has already grown, and the unfavorable demographic and economic headwinds we face (e.g., low birthrate, declining immigration, decelerating growth), it's a little late to "fix" this problem. It seems more reasonable to assume that government pensions will assume a large role in the next crisis, although what that role will be is impossible to say for sure.

Will cities and even states go bankrupt? Will the law permit this? Will taxpayers tolerate funding their public servants when they are receiving a lesser degree of public services? And what of beloved teachers, police and firefighters who put themselves on the line and expect to get what they always understood was due them? What will politicians do at that time? Many will find all sorts of reasons to slap fines on Google, Apple, Facebook and Amazon, in addition to heaping every manner of new tax on ordinary people's purchases, property and income. But if you think entrepreneurs create and sustain businesses for the sake of aging government employees - pick any number of countries that have tried this and see how that's been working. If solving the problem is to have any decent chance of success, the best approach could be to restore the classic if forgotten American approach of slimming down government spending and disempowering politicians. But will voters go for that when so many are hooked on this or that favorite program?

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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