02/26/2013 08:48 am ET Updated Apr 28, 2013

Debt and More Debt

The Pension Bomb

The national debt has crested $16 trillion and state and local debts add another $2.8 trillion to the red ink, but there is yet another debt crisis out there -- unfunded pension liabilities of state and local governments, plus private corporations, that add another $2.5 trillion.

Decency requires me to omit mention of the unfunded liability of the biggest pension fund of all -- Social Security -- which is already paying out more than it takes in. Of course, this shortfall is supposedly being covered by the Social Security Trust Fund, but that consists of federal securities which are just more debt. The shortfall is coming out of the general revenues.

Of the 50 states, only Wisconsin's pension funds are fully funded. Nine states are 60 percent or less funded. California alone has $113 billion in unfunded pension liability. Many counties and cities are in even worse shape.

The picture is not much better in the private sector. More than two-thirds of the companies that make up the S&P 500 have defined benefit plans, and as of the last quarter only 18 of them were fully funded. Seven of them had shortfalls of $10 billion or more apiece. The total unfunded benefits for those companies totaled $355 billion, or about 22 percent of all promised benefits.
Many pension fund managers are scrambling to make their liabilities seem smaller. They presume rates of return on their investments to be far above reasonable expectations, a freedom recently expanded by Congress. The amount of pension fund money invested in private equity firms rose from $200 million in 1980 to $200 billion in 2007 -- a thousand fold increase. This money was in fact a major factor in the explosive growth in equity funds, and helped fuel the mortgage bubble. State and local pension funds lost an average of 27.6 percent of their holdings between 2007 and 2009 due to the collapse of the housing bubble -- a bubble they helped create.

Pension funding is the root cause of the economic plight of the U.S. Postal Service which, under a 2006 law, must pay 75 years of pension benefits over 10 years. Pension funding accounts for about 80 percent of the Postal Service's red ink.

The pension crisis is yet another downside of the Fed's quantitative easing that creates a Catch 22 for pension stewards. It makes it difficult if not impossible for pension fund managers to get a decent return by investing in low-risk federal securities. They are increasingly forced into the stock market, helping send stocks higher than they should be, inviting a stiff correction that will come eventually. The bulk of the problem is due to near zero interest rates and excessively easy monetary policy.

Jerry Jasinowski, an economist and author, served as President of the National Association of Manufacturers for 14 years and later The Manufacturing Institute. Jerry is available for speaking engagements.