Strapped Governments Revive Pension Bonds
Proceeds Would Go to Retirement Funds

By Michael McDonald and Adam L. Cataldo
Bloomberg News
Sunday, May 4, 2008

Pension bonds are making a comeback, as states and cities from Alaska to Philadelphia bet they can use the proceeds to help fill deficits in their retirement funds and still generate a higher return than what they pay in interest.

Officials may sell a record $35 billion of the securities this year after offerings have declined since 2003, according to data compiled by Bloomberg. Connecticut issued $2.2 billion of pension debt last month, paying an average rate of 5.88 percent on money that state officials projected would earn 8.5 percent when invested.

With the economy slowing and states facing budget deficits that Standard & Poor's said would top $30 billion next year, officials are turning to the quick fix of borrowing even though the $50 billion worth of pension bonds that were sold produced mixed results for taxpayers. New Jersey sold $2.8 billion of the debt in 1997, and its pension gap has since ballooned to 10 times that amount.

"It's the dumbest idea I ever heard," said New Jersey Gov. Jon S. Corzine (D), a former chairman of investment bank Goldman Sachs. "It's speculating the way I would have speculated in my bond position at Goldman Sachs." He became governor in 2006.

There are more than 100 public retirement systems in the United States managing a combined $2.3 trillion. The amount is $380 billion short of the funds needed to pay pensions over the next 30 years, according to the National Association of State Retirement Administrators in Baton Rouge, La.

While the systems earned on average 11.9 percent a year from 2003 to 2006, many of them failed to make the contributions required to keep pace with the benefits they promised, the Pew Center on the States, a nonprofit public policy research group, said in a December report. New Jersey's seven retirement funds have a combined deficit of $28.3 billion, up 14 percent from last year, according to state actuarial reports.

"It's politically expedient to go out and borrow money," said Robert Smith, president of Austin-based Sage Advisory Services, which oversees $5 billion in assets. "It's like taking a second mortgage on a house you haven't paid for yet."

Alaska Gov. Sarah Palin (R) approved legislation last month authorizing the sale of as much as $5 billion in pension bonds. Wisconsin Gov. Jim Doyle (D) signed a law in March permitting Milwaukee County to borrow money to close a $406 million deficit. Puerto Rico issued $1.58 billion in debt in January and said it plans to sell an additional $5.4 billion over the balance of the year.

Public officials first turned to the bonds to close pension deficits when Los Angeles County borrowed $461 million in 1986. Sales peaked at $17.8 billion in 2003 when Illinois sold $10 billion of the securities, data from Thomson Reuters show.

Then-Gov. Christine Todd Whitman (R) of New Jersey sold $2.8 billion of the debt to help close a $4.2 billion deficit in the state's pension fund in 1997, the year she ran for reelection. The state later increased benefits by 9 percent for some public employees after market gains closed the gap.

The strategy collapsed when stocks tumbled in 2001 and the economy slipped into a recession. Pension fund returns fell below the interest rate on New Jersey's bonds, and the state, faced with budget deficits, stopped making the annual contributions required to keep pace with rising costs.

"New Jersey is an extreme example, but it is highly illustrative of how critical consistent contributions can be to a state's pension system," Susan Urahn, managing director of the Pew Center on the States, wrote in December.

Philadelphia fell into a similar trap when then-Mayor Edward G. Rendell (D), now Pennsylvania's governor, sold $1.29 billion in pension bonds in 1999. Rendell's successor did not make full contributions to the fund as he tried to balance the budget.

Current Mayor Michael A. Nutter (D) said he wants to borrow as much as $4.5 billion to close the deficit, promising that this time the city would make the necessary annual contributions.

"We're going to be committed to making sure the fund stays well-funded," said Rob Dubow, Philadelphia's finance director.

Illinois Gov. Rod Blagojevich (D) is making similar promises four years after selling $10 billion in pension bonds. The state still faces a $42 billion deficit and the governor asked the legislature to approve $16 billion more of the securities.

A study released last month by consulting firm Greenwich Associates in Greenwich, Conn., found that public pension managers expect to outperform market benchmarks by 1.46 percentage points over the next five years, an outcome it said was "probably not" realistic.

Jeremy R. Cooke contributed to this report.

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