All three have pumped billions of dollars into their states’ pension systems to stabilize programs amid unpredictable market swings. And all three are widely believed to be exploring presidential elections in the future.
“There will be acute fiscal pain and pressure the more you ignore costs,” said Leonard Gilroy, a senior director of the Reason Foundation’s Pension Integrity Project, which advises state governments on retirement plans. “If you don’t pay for it, you chase it.”
For all three governors, the moves of many of their predecessors have put them in the unfortunate position of giving chase.
“When we got to the scene, New Jersey’s retirement system had been ignored or underfunded for more than 20 years by the administrations on both sides of the aisle,” Murphy said in a statement to POLITICO. He is “fully committed” to paying the state’s entire obligation to his pension system in 2023 for the third time in as many years, he said.
Prolonged periods of sluggish economic growth and weak markets can deter what pension systems expect to generate from their investment plans – meaning taxpayers and officials must shoulder a larger share of the cost. As a result, states ultimately have less money to spend on schools, social programs and basic infrastructure — a problem likely to be exacerbated by falling tax revenues and the scrapping of billions of dollars in federal Covid aid.
Those challenges become even more difficult when investment portfolios fail to reach their goal. States don’t budget their retirement payments based on a single year’s returns — those projections are smoothed so they’re less prone to booms and busts. But it only takes a few years of underperformance to “pull the system’s finances out of whack,” Gilroy said.
And 2022 was pretty bleak. The combination of rising interest rates and sharp stock market declines created an unforgiving investment climate.
The California Public Employees’ Retirement System, the nation’s largest public pension, lost nearly $30 billion in the recession. Pensions in New Jersey and Illinois also ended their fiscal years in the red – just like almost every other state and local pension system.
Many investors don’t expect much better in the near term.
Marcie Frost, CEO of CalPERS, sees “a challenging road ahead as major economies around the world continue to slow and market volatility increases,” a statement to POLITICO said. “We understand that these low-yield environments can put pressure on our employer partners and local government budgets.”
Raising pension payments with spending cuts or new taxes could make politics difficult, said Alex Navarro-McKay, a longtime Democratic adviser and the outgoing chief of the BerlinRosen campaign team. This is especially true in an economy that has avoided recession despite a pervasive sense of fear in financial markets.
“When the real economy is in recession, voters understand that policymakers have to make tough choices; and policymakers who honestly deliver difficult news can skate through difficult times,” he said. “If the real economy avoids a recession, it’s harder for voters to understand why their state or local government is cutting spending or raising taxes.”
Underfunded pensions in states like California, New Jersey, Illinois and elsewhere have troubled the political leaders of both parties for decades.
Many states have gone years without making full payments through a combination of poor planning, budget shortfalls or political play with powerful public sector unions. Changes that lowered the retirement age and promised higher employee benefits drove up costs. So did cost-of-living adjustments, complicated loan arrangements, and short-sighted decisions to cut employer contributions.
The problem became even more acute during the global financial crisis and its aftermath.
As markets collapsed, the investment income that covered some of the states’ obligations to their retirees disappeared, leaving an even deeper hole that elected officials, union leaders and financial advisers have spent years trying to fill. Total unfunded liabilities hover around $1 trillion nationally — though estimates vary — and could run higher if returns repeatedly fall short of expectations.
“There are probably going to be some very tough choices,” said tax watchdog Laurence Msall, who heads the Chicago-based tax policy research group and government Civic Federation. “The financial pressure is not going away.”
That said, Msall and other pension experts said state leaders have started taking meaningful steps to stabilize their pension systems by funneling more money away at a time when the state coffers have been tied with federal Covid aid and rising tax revenues. In mid-2021, barely a year after a sharp pandemic triggered a brief recession, Pew Charitable Trusts researchers reported that the country’s pension systems were on their strongest foot since the global financial crisis.
“States and localities recovered quickly and strongly through policy action,” Brian Deese, director of the White House National Economic Council, said in an interview. “That provides tailwinds for some of the challenges or risks that may arise.”
Pritzker spokesman Alex Gough said the last two budgets include full pension payments as well as an additional $500 million allocation that will put the state in a better position to manage future market declines.
Murphy, a former Goldman Sachs partner who led the bank’s asset management division, said New Jersey is slowly winding down its return expectations — in addition to paying down bond debt and meeting its retirement payments — in anticipation of a slower investment climate.
“This more conservative assumption has better positioned us to absorb any volatility in future returns,” he said.
In California, Newsom continues the reforms introduced by former Democratic governor Jerry Brown, who made a review of the state’s benefits program a priority after the global recession. Newsom’s budgets included extra deposits for CalPERS and the state’s teacher retirement system, and money was diverted to a rainy day fund for periods of economic stress.
Those budgets benefited from a strong economy and multibillion-dollar revenue surpluses. Utilities, analysts warn trouble lies aheadespecially as California’s technology industry struggles to cope with a market downturn that has led to thousands of layoffs.
“In every single budget, Gov. Newsom has prioritized strengthening California’s retirement systems and planning ahead of an economic downturn to ensure people get the benefits they worked for. The state has prepared for this,” said spokesman Alex Stack.