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Pensions: Left on the Hook will be the Taxpayer

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San_Juan_from_aboveIke Brannon, a visiting fellow at the Cato Institute, explains how the Puerto Rico rescue makes state pensioners the big winner.

Right now, states cannot declare bankruptcy, which is one reason why states have traditionally been able to borrow at such low rates of interest. However, financial markets have come to realize, belatedly, that Illinois (along with other states) is making promises to its lenders that it will have trouble keeping.

Puerto Rico was not supposed to be eligible for bankruptcy either, but the legislation before Congress will allow the territory to reduce its debt, both general-obligation and non-general-obligation debt.

If the bill does become law, the island will promptly cease making payments to its bondholders for the indefinite future: The proposed 2017 Puerto Rican budget — which assumes as much — sets aside no money to pay general obligation bondholders. Since the legislation also stays creditor lawsuits, the island can proceed to use the funds freed up by stiffing the creditors to hire more workers, build infrastructure and put money into its nearly bankrupt pension fund.

Any money that does gets stashed in the pension fund will be well-nigh impossible to disgorge when the stay is lifted. The Puerto Rican government can pull out its pockets and plead poverty and any creditor that lost money during the stay will likely be out of luck.

This is the blueprint Illinois will almost surely follow. It will request that Congress extend it some sort of bankruptcy protection and it will present Congress with a facile choice: Does it want to protect the evil vulture funds from Wall Street that lent it money or the hardworking state employees who just want the pension promised to them? Congress may want to pretend otherwise, but the current legislation before it favors one set of pensioners ahead of other pensioners whose money happens to be invested in Puerto Rican debt.

The safe bet is that before too long, Illinois will be allowed to stiff its creditors at a propitious moment — not before trashing them avaricious or immoral, no doubt — and their pensioners will be held harmless, too.

And before too long, the next state will take its cue from Illinois, and the pattern will be set, if not by law then by custom: State employees on a defined benefit pension will always come before investors who foolishly lent money to their state. And no one will care one whit if that money represents the retirement funds of other U.S. citizens, either.

It wouldn’t be a blow for income inequality; state workers have a higher income and better pensions than most other Americans whose retirements savings will suffer because of this reordering. It’s certainly not a just outcome, given that the states borrowed that money at a low interest rate in no small part because law and custom dictated their payments would supersede other creditors. The new normal will merely represent an ex post reordering of priorities in a way that comports with the allies of the current administration.

And investors will stop treating the muni market as being a safe bet, and the borrowing rates for townships and cities and parks will reflect the new reality of caveat creditor. Left on the hook will be the taxpayer, whose governments will pay sharply higher interest rates going forward.

More on state pensions here.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com