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For several years now, various commentators have warned that state and local government pension funds are significantly underfunded.  In fact, the issue is no longer “whether” but “by how much?”  Estimates are that aggregate underfunding is at least $700 billion and could be as high as $3 trillion.


The funding shortfall varies from state to state.  California and Illinois, and their cities, are at the top of the underfunding list.  Not surprisingly, therefore, one city in each state has been the focus of recent news reports highlighting the issue.


Chicago newspapers have reported on the quandary facing Mayor Rahm Emanuel. That city’s pension plans for teachers, safety workers and other municipal employees is underfunded by $24 billion.  The city is obligated, pursuant to court orders, to begin funding the shortfall.  If the city were to try to use property taxes to do so, it would need to raise levels by 150%.  Obviously, tax increases of that magnitude are unrealistic.  Recent efforts to begin reining in the costs have failed.  In March of this year, the Chicago police sergeants’ union rejected a deal to reduce pension benefits in exchange for a 9% pay raise over four years.  Other unions have signaled equal recalcitrance.  And looking to the State to help is not an option for Chicago.  The SEC recently settled civil fraud charges against Illinois regarding its misrepresentation of the actual funding (or lack thereof) of its pension system.


Things are equally bad on the West Coast, where California and several of its cities face enormous fundingobligations.  Stockton, which was recently authorized to remain in bankruptcy, owes almost $900 million to the California Public Employees Retirement System for pension obligations.  A significant (if not critical) issue in its bankruptcy is whether is can restructure its bond debt without reducing its pension obligations.  If Stockton’s bondholders successfully argue that bondholders and pension claimants must be treated similarly – “share the pain” equally – the resulting precedent could embolden bondholders around the country to force pension reductions.


The implication of the aggregate state and municipal pension shortfalls, the obstinance of public employee unions and the precedent in the Stockton case is that, both practicably and legally, pension obligations of cities and states may not be sustainable.  State and municipalities will either, on the one hand, need to raise taxes and/or cut services to meet their pension obligations or, on the other hand, reduce those obligations.  Retirees and current employees may find (as their private sector counterparts have) that “guaranteed” pensions are only as good as the guarantor.