The Debt Bomb Ticking Near You

Last week Alabama’s Jefferson County filed for bankruptcy. It owes $3 billion on a failed sewer deal. A few weeks ago the capital of Pennsylvania, Harrisburg, filed for bankruptcy. Apparently the only thing its trash incinerator does well is burn through money. Central Falls, RI, is in bankruptcy from the pension promises it couldn’t meet. One pensioner received disability checks while going to law school to become “the heavy hitter” lawyer for injured and disabled workers. Another “disabled” pension recipient from Central Falls runs road races regularly and does quite well. Then there’s Boise, ID, which declared bankruptcy when a federal jury sided with a contractor in a monetary dispute. That’s four bankruptcies so far for this year. The list will grow in coming years, potentially leading to the first state-bankruptcy in history.

On the state level Rhode Island will eventually run out of money when its controversial pension reform comes up short. Unlike the federal government, states can’t print money so they won’t be able to inflate their way out of this hole. Tax increases lead to revolt when taxpayers have to pay more for fewer and fewer services. Rhode Island will find capital markets too expensive to issue new debt as fiscal pressures mount, as witnessed in Greece and Italy. Running out of money is a national pastime. Across the country, the most at-risk states such as Illinois, New Jersey, Connecticut, Oklahoma, Indiana, Louisiana, and West Virginia are on the fast track to insolvency. At current pace they will burn through their pension money within the decade according to economist Joshua Rauh.

Rhode Island’s pension reform shouldn’t be grabbing national attention for its boldness. Nothing is being done about its irresponsible 7.5% expected rate of return. The actual return for the state plan over the last decade through June 2010 was only 2.28%. It should be replaced with a realistic 30-year Treasury bond- yield ranging right now at a low 3%–3.5%. The Mercatus Center calculated the unfunded pension liability numbers using the Treasury yield. The state’s estimates of the unfunded liabilities for the state and local plans were blown out of the water. The unfunded liability for state plans jumped from $6.8 billion to $12 billion and the 36 local plans from $2.4 billion to $6 billion, for a total of $18 billion.

The most at-risk plans in Rhode Island are the 36 locally run plans. All this pension reform talk does nothing to reform the local plans. The funding levels are pathetically low. Local plans use an even higher expected rate of return than the state’s, averaging 7.93%. The actual average five-year rate of return for local plans was, according to the Senate Municipal Pensions Study Committee Final Report, published on February 15, 2011, by the Rhode Island Senate Fiscal Office, only 1.97%.

Providence, the state capital, has $1 for every $5 it owes in pension obligations. It’s almost preposterous to think Providence will do better at avoiding bankruptcy than Harrisburg, PA. The five worst local plans, according to a pension debt to revenue index by the Mercatus study, are: Central Falls, Newport, Cranston, Providence, and Johnston. It’s not all glitz and glamour in Newport. The city council would be wise to bone up on The Fall of the House of Vanderbilt.

Union leaders, the barons of the public sector monopoly, cornered the market through collective bargaining and mandatory dues. They’re flush with cash and have an army of motivated and captive supporters to tilt political will their way. The head of Council 94 in Rhode Island, Michael Downey, brags like a general about the thousands of people he leads. He talks about the performance for the pension plans hitting 9.25% for years. But the time he speaks about has long passed us by. The 20-year secular decline in interest rates is over. Rates are at rock bottom now. The pension plan is still paying for the 20% loss suffered in 2008. Yet he wants the state to keep its promise because municipal workers are contributing 8.75% and teachers 9.5%. But General Treasurer Gina Raimondo has responded to constituents that the “normal” cost for Schedule A employees is approximately 26% of salary for state employees and 30% for teachers, using actual investment returns from the last 10 years. Employees and teachers pay much less than half of the true cost of their benefits.

The debt clock is ticking away not only in Rhode Island but in states, cities, and towns across the country and the world, for that matter. The taxpayers shouldering the burden of overpromising will not shoulder the burden forever. Bankruptcies will be filed. We’re seeing it in four municipalities as we speak. It won’t be long before states will too.

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E.J. Smith - Your Survival Guy

Preparing your investments and family for when disaster strikes.

E.J. Smith is the 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, where he completed course-work in Practical and Defensive Handgun, Conceal Carry Pistol, Shotguns, Precision Scope Rifle and Kidnapping Prevention. E.J. plays a Yamaha Recording Custom drum set with Zilldjian cymbals. 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@youngresearch.com. Sign up here to receive all the best content from Richardcyoung.com each week.