Pensions, Manhattan Style
New York Times reporter Mary Walsh and Michael Cooper offer a grim assessment of New York City's pension finances in their August 20, 2006 article entitled "New York Gets Sobering Look at Its Pensions". Their research suggests a funding gap as large as $49 billion or "nearly the size of the city's entire annual budget and the equivalent of the city's publicly disclosed outstanding debt."
A key point of contention is how to properly measure the true economic value of the city's pension obligations. According to the article, New York City employs a unique method that sets the pension shortfall to zero. By doing so, it is never clear whether the plan is in deficit and to what extent. Apparently the method started at a time of bounty, with the aim of preventing a raid by officials.
As this author has repeatedly said, you must be able to properly measure the pension liability. Otherwise, how can one identify what corrective action to take, if any, to set the plan right? (Written for private plans, the same commentary applies in concept to public plans. Good information is everything. Click here to read "Will the Real Pension Deficit Please Stand Up?")
The NYT article talks about valuing the pension liability using the appropriate municipal bond yield. Because this rate is lower than the current GASB-mandated rate, the liability balloons.But municipal bond yields are low because they are tax exempt. I'd make the case for the same-risk corporate bond yield. (If NYC has Aa credit, use the Aa corporate bond yield.) This approach would reflect the risk of the pension liability, but not the tax shield. Since pension distributions are subject to taxation, the tax-exempt municipal yield is inappropriate from the pensioner perspective. Some might argue that the pension obligations are close-to-un-violatable and should be valued at a risk free rate. If so, I'd argue that it should be a Treasury rate, not a Aaa muni rate.