Analyzing the News: Handling Michigan’s financial crisis
Unfunded pension liabilities have been in the news as of late, as have tales of bankrupted cities and cash-strapped states. The debate has been over which caused the other.
In an article published in October 2012 by the Lincoln Institute of Land Policy, a research center located in Massachusetts, authors Richard F. Dye and Tracy M. Gordon write how, “state and local pension fund equity holdings lost nearly half of their value,” in the financial crisis. From a peak of $2.3 trillion in Sept. 2007, pension fund equity dropped to $1.2 trillion in March 2009.
Since 2007, the start of the financial crisis, until now, there have been over 10 municipal bankruptcies. Two of which, as specified by Dye and Gordon, were caused by defaults on pension obligations (Vallejo, Calif., and Central Falls, R.I.).
“In Illinois the main reason that there has been a problem is that the state government has not been contributing to the pension and that has led to a shortfall,” said professor Darren Lubotsky of the University of Illinois’s Department of Economics in an interview.
The Securities and Exchange Commission accused the state of Illinois of securities fraud in March as reported by The New York Times. Official complaints from the SEC claim Illinois misled investors about the financial health of its public pension fund in the late 2000s.
Like many other states, Illinois has repeatedly failed to make the full annual contributions to its public pension fund. In 1994, as noted in the Times report, the state passed a law which allowed itself to contribute less to the public pension fund than was previously required.
In “Michigan’s Pension Changes Serve as Model,” by Chris Christoff of Bloomberg News writes in October 2011 that because of reforms enacted in 1997 the state of Michigan is better off than many other states like Illinois or California.
“Michigan’s ‘radical reform’ 14 years ago to rescue its retirement system by placing newly hired workers in a 401(k),” saved the state a lot of trouble said the article. Essentially, the state ceased to offer new employees a defined-benefit plan and switched to a defined-contribution plan.
A defined-benefit plan is a pension plan where the amount an employee is awarded by their employer after retirement is based on a calculation of salary and duration of employment. Defined-contribution plans rely on mutual investment by both employee and employer into a retirement account. Many companies match between 20 and 100 percent of employee contributions.
Despite Michigan’s reforms, in “Widening the Gap,” a series by the Pew Research Center, it was noted that there is serious concern over the management of the state’s public pension system.
As of 2010, the data in the report shows Michigan failed to pay its full annual pension contribution four times since 2005. In 2010, the system was 72 percent funded, even after state lawmakers cut benefits, raised the retirement age from 55 to 60 and eliminated cost-of-living increases.
The problems of the state, however, are overshadowed by the financial shortfall Detroit suffers. Kevyn Orr, the city’s emergency manager, says that the city’s pension fund has $3.5 billion in unfunded liabilities. The costs have forced the city into bankruptcy.