The City of Houston employee pension disaster

“The whole world is living today off of tomorrow’s money.”

-Old Man Meyer back in the Stone Age, as he got out of the car coming home from work, speaking to a 16 year old Neal Meyer.

 

The words my Old Man said to me long ago were in response to a question I asked him. Namely, I asked my Old Man if he knew anything that day that he could tell me. The Old Man is now gone, but I can still see in my mind’s eye as he got out of the car and eyed the house up as he said them to me. I didn’t really understand what he meant by those words, but I came to recognize over time that he had a kind of gift for (often humorously) making a point about money, politics, sports, or current events with a simple one-line statement. As it was, I suspect he had the house on his mind when I asked him that question. Whether it was the mortgage, repairs, or something else, I’ll never know.

It would not be until I got into my early thirties before I finally did grasp the full weight of what my Old Man said that day. By then, I had been out in the world for a good fifteen years, enough time to have run a few laps around the block. I could see that much of the modern-day world is built around concepts like credit and the borrowing of money. Most people, for example, cannot afford to buy houses or cars straight up with a check. Ergo we take out loans and mortgages in order to buy them and pay for them as we go along.

The same principle often goes with governments. Governments and ruling elites have borrowed money since time immemorial, usually to finance wars and campaigns of conquest. However, with the rise of markets and commercialism came the concept of borrowing money for long-term infrastructure improvements to encourage economic growth. The accrued debt would be paid off over decades, ideally with the infrastructure long outlasting the time horizon needed to pay back  the money borrowed from capital markets.

But the rise of republics and democracies and the expansion of the voting franchise in the 20th century to wider groups of the populace brought new pressures for governments to borrow money. Instead of borrowing money to pay for wars, or to pay for long-term infrastructure, governments at all levels have been borrowing money to pay for welfare-state and retirement programs enacted to take care of groups of people, issues that were for most of human existence the province of families, relatives, churches, or private groups like tradesmen. These programs were first enacted in Europe, but eventually they spread to America. Social Security was enacted in 1935 by Congress, the cornerstone of many such programs at the federal level. Meanwhile at the state level, programs for taking care of government employees spread, most notably the enactment of pension and health care programs for state and local government employees.

All of this sounded reasonable at first, but these programs have since become more contentious as the the burdens to keep them viable have grown. What will be the fate of pensions will be one of the largest issues facing governments in the 21st century.

The noble idea of a defined benefit pension and where it can go wrong

The basic idea behind a defined pension is an entirely reasonable one, and has literally been around for centuries (Simon Schama, in his magisterial A History of Britain television series, visited a manor in Greenwich England that was a hospital during the 18th century for pensioned Royal Navy servicemen). At some point as we age, our human bodies begin to give out on us. We could be beaten down by disease, accidents, or other misfortunes. What do we do for people who have put forth a good faith effort to work during their productive lives, but cannot for some reason work any more? Nobody wants to see 83 year old grandmothers eating cat food, after all!

Pensions are one answer to that problem. The idea is that an employee who has worked for a certain, often lengthy, period of time for an employer will be eligible for payments (usually monthly) for the rest of the employee’s life. In their classic form, a young man or woman gets on with a company in their late teens or sometime in their twenties, and the employer and employee settle into long term steady employment. Forty or so years later, when the employee is in his or her sixties, the employee will retire, having accrued a pension (whose terms are set by the employer) that will replace a fair percentage of their income that they earned during the peak earning years. Such pensions, known as defined benefit pension plans, will be paid out to employees (and sometimes to surviving spouses) for the rest of their lives.

Again, the idea of a defined benefit pension is a noble one, but there are several ways in which such pension schemes can go wrong. One source of problems is the nature of private employment. Private employers will almost always face problems trying to deliver on pension schemes, simply because the idea is contingent on employers staying in business in the first place. The American economy (and the world economy), despite all of the government interference, is highly dynamic. Business professors will tell you that the probability of a new start up company surviving is very low (37-58% survive after only 4 years of existence according to this site, while this LinkedIn article states business start up survival rates as being roughly 30-35% after 10 years). Even huge, powerful, well-respected big name firms get caught up the whirlwinds. I work in IT, an industry which is littered with the names of once-great firms which are no longer — names like Compaq (bought out by HP), Digital Equipment Corporation (DEC – which Compaq had previously bought out), and Sun Microsystems. And, the failure of private employers is not by any means limited to the computing industry. Remember Enron? Literally several hundred small oil and gas companies have gone bust during the latest oil price collapse dating from late 2014.

The point being made here is that the prospect for private employers to provide defined benefit pensions is a very uncertain one when even famous, well respected, big name employers can go poof overnight. The possibility of creating defined benefit pensions for private sector employees perhaps has a better chance in the long run with multi-employer pension schemes, where workers (often unionized) go from job to job, albeit pension contributions are paid into single pension programs. Yet even multi-employer plans have come under pressure in recent years, and will likely need reforms to keep going. In their place have come 401-k type defined contribution programs, where the onus for saving for old age has been transferred from the employer to the employee.

The rise of government employee pensions

This brings us back around to the issue at hand, that of government pensions, specifically the issue of municipal pensions. Unlike private employers, governments (at all levels) are seemingly ideal employers for offering defined benefit pension schemes. Namely, many people who are employed by governments tend to stay for long periods of time, and there’s the not-so-small issue that governments tend to stick around for long periods of time too. The state of Texas and the City of Houston were both founded in 1836, and it doesn’t look like either entity will be going away any time soon. Furthermore, there’s the fact that government employees often are protected under various civil service laws and rules from termination, which greatly enhances their prospects for long-term employment. Given the long-term prospects that governments and their employees are going to be around, then the stage is set for defined benefit pension schemes.

And so it is. Yet one big wrench that has been thrown into this idealized world is precisely that government employee pension schemes are funded out of taxpayer monies, and hence are subject to political considerations. Among them? The issue that government employee unions across America were negotiating with Democrat-dominated city mayors and city councils, which means there was nobody there to say, “Gee whiz. Are we sure these plans will generate 7.5 percent returns every single year from now until the end of time — because taxpayers are going to be on the hook otherwise!” Then there are concerns that pension monies have been used for political purposes, such as socially responsible investing. So, if your municipal pension funds are short a few hundred million (or a few billion) dollars of the promises made to employees, would they make a decision to invest in oil and gas companies whose stocks might skyrocket in value if the price of crude oil or natural gas goes through a spike? Or, would they take the opportunity of investing in such firms if the price of crude oil were to fall to snap up some cheap stocks? Well, not if your pension plans are being controlled by politicians (or board members) whose political support depends on hard-core environmentalists or others who don’t like the oil and gas industry. This City Journal article describes how CalPERS (the state of California public employee retirement system), which controls over $200+ billion in investment funds, went off the rails in part from socially responsible investing and from investment in favored real estate vehicles that went bad. Bad real estate investments seem to be a big factor in the City of Dallas pension disaster up I-45. The City Journal article points to whiffs of corruption stemming from political campaign contributions given to favored politicians, as well as self-dealing from board members.

One telling aspect of the City of Houston pension debacle is that – as far as I know – there hasn’t been an investigation done by any journalists or local media into what investments have been made over the past 15 years that have helped put the City of Houston in the same perilous state that so many other cities find themselves in.

The perilous, unsustainable state of City of Houston pensions

Current City of Houston mayor Sylvester Turner was elected to office in December 2015, outlasting a crowded field and defeating Houston businessman and Houston Chronicle columnist Bill King in a runoff. Government employee pensions, which were not even an issue anywhere in America twenty years ago, emerged front and center as a political issue, thanks in large part to the efforts of Mr. King. Mayor Turner, who seemingly spent much of the election pretending as though the tension between pension promises and fiscal reality didn’t exist, quickly snapped up support from City of Houston employee groups. I found my Facebook feed filled during the runup to the election with photographs of City employees block walking for Mr. Turner.

But having gotten elected to the office, Mayor Turner quickly ran into the reality of the scale of the pension underfunding. Estimates vary, but various outlets have estimated that the City of Houston is some $4-$10 billion in arrears, with estimates of $7-8 billion in pension shortfalls being reasonable. The City of Houston’s own official audit, which was just released, indicates that the City’s pension shortfalls have grown from $3.9 billion in 2014, to $5.6 billion in 2015, and now stand at $7.7 billion at the end of 2016.

After a year of hemming and hawing about the matter, Turner came out saying that he intends to hold on to a defined benefit scheme for City employees, ruling out any transition to a 401-k type plan for the future. Turner’s plan includes a billion dollars in taxpayer-footed pension obligation bonds, along with a rather vague promise that the City’s three pension plan boards have agreed to $2.5 billion in concession cuts. The City’s contributions to the pension funds are to take up a whopping 32-37% of the City’s payroll. Then, the plan is to reduce this problem gradually over the next thirty years. The issue goes to Austin starting in a few weeks with the upcoming 85th Texas Legislature.

Of course there are several big issues with Mayor Turner’s solution. First, who on earth runs a firm where retirement payments are 32-37% of payroll? Next, under current state law, Houstonians won’t get to vote on whether we agree to the added pension debt, albeit State Senator Paul Bettencourt has filed a bill (SB 151) that would require a public vote before pension obligation bonds could be issued. Then, Houstonians would be stuck paying this whole scheme off over the next 30 years, which would mean that the entire next generation of Houstonians will be on the hook for paying for pension promises made to City employees back around the turn of the 21st century. What was it that my Old Man said about living today off of tomorrow’s money?

Turner’s whole plan smacks of pothole-plan thinking, of temporary fixes to an issue that without some radical reform will continue to hover over Houston like a cloud for the entire next generation. “Give me a billion now, and I’ll put the rest on the credit card over the next 30 years!” An awful lot can happen over the next 30 years; all we have to do is look at what has happened over the past 2 years to see that pension liabilities have grown by nearly $4 billion! Bill King sent out a note a few weeks ago that the City of Houston’s police retirement plan lost 3% on its investments from 2015 – 2016, and the fund will be $476 million short of what the fund’s estimated value would need to be at the end of 2016 just to keep pace. Again, is anybody in Houston journalism doing any investigative work on what monies are in the pension pot, and how the monies are being invested? Moody’s and the other financial ratings bureaus will continue to dog Houston’s political classes for the entire next generation.

Pensions can serve a purpose, but they have been transformed from the days of yore where the Royal Navy pensioners of the 18th century who retired to the Greenwich hospital were unlikely to live past the age of 45-50. Even when Social Security was passed in 1935, the average life expectancy of Americans was 57-58 years, while the age of eligibility to collect payments was set at 65. What has happened over the past decades is that, thanks to the wonders of 20th century medicine and improved sanitation, life expectancy has increased to roughly 80 years. However, the eligibility ages set for collecting pensions has not been increased in tandem with our greatly increased life expectancies. Instead, the age of retirement at which prospective pensioners can become eligible to draw pensions has often been lowered, increasing the time horizon which pensioners can draw (often highly increased) benefits without having to do productive work anymore. In the case of City of Houston employees in 2014, 74 City firefighters retired, at an average age of 54. They received an average of an $813,000 lump sum payment upon retirement, along with a lifetime pension starting at nearly $60,000 per year — a figure that is scheduled to be indexed for inflation. Their spouses are also eligible to continue to collect pension payments should the retiree pass away.

A recipe for fiscal disaster

This is a recipe for fiscal disaster. The implication is that City firefighters and police officers, if they live to be 80 years old, will be spending some 25 years in retirement collecting a sizable pension, which is nearly as much time they spent working. It implies that every time one or two police officers or firefighters retire, you can pretty much kiss an entire street reconstruction project goodbye, because every retirement is now a $2.5 million proposition. No city or country, no matter how wealthy, can afford to have that many people getting paid that well while not working.

So, what’s next? Mayor Turner, the City Council, and the City employees should not be patting themselves on the back just yet. News just came out this past week that CalPERS, for the first time in its 85 year history, has cut pension payments to some retired California government employees by as much as sixty percent. Meanwhile, Don Hooper over at Big Jolly Politics covered how the City of Dallas mayor, Mike Rawlings, filed a lawsuit to stop City of Dallas employees from pulling any monies out of the Dallas retirement system to prevent the total collapse of the Dallas pension fund. City employees had pulled over $500 million in funds out since August 2016, and now the City of Houston is flirting with the same bank run dynamics on our City employee pension funds, as over 100 police officers have filed papers to retire. New police chief Art Acevedo has stated he feared that 600+ police officers could retire over the next year over the pension issue. In short, events driven by City employees who are reading the writing on the wall may force matters to a head no matter how much shouting goes on over the issue, or how many laws, statutes, or audits get passed.

However this turns out, I’m not putting up with what the City employees and Mayor Turner want without a fight. I will be traveling to Austin to help push Senator Paul Bettencourt’s bill, as I’m not in any mood to have to pay off $1 billion in borrowing for something the Democratic Party dumped on Houston. Nor am I interested in seeing my taxes go up. The City has provided nothing in the way of additional value to me that would justify me having to cough up a huge increase in property taxes to bail out this employee pension debacle. I also agree with Brian Phillips in that the City, under the influence of many different interest and pressure groups, has gotten itself into way too many different issues and concerns that are far beyond the scope of protecting liberty or rights. I would prefer not to move, but if the plunderers down at City Hall get everything they want and I am forced to pay up, then I may well decide to throw in the towel, pull up stakes and go somewhere more taxpayer friendly. There was never any reason for this to have ever happened to begin with.