By: Mark Glennon*
Governor JB Pritzker’s administration has now made clear it will seriously consider the latest idea to address Illinois’ pension crisis – transferring public assets directly to state pensions. It recently announced the formation of a task force on the subject.
At its core, the concept is exceptionally simple. In practice, however, it’s exceptionally subject to smoke and mirrors and would further obscure a pension system that’s already far too opaque. More importantly, asset transfers do nothing to improve the state’s overall fiscal health.
Just convey ownership of some public assets to the pension, for free, in addition to the cash contributions taxpayers make now. That’s all this is about. Maybe the Illinois Lottery or Illinois Tollway for state pensions. Maybe Midway Airport or its water system for Chicago pensions. Those are examples of assets that have been mentioned that might be handed over.
Illinois state pensions are officially reported to have assets about $130 billion less than what they need to have on hand to pay for pension benefits already earned. Turn over ownership of the tollway and some other assets and, voila, the thinking goes, that shortfall would shrink by whatever the transferred asset is worth.
The first problem should be obvious – the state, as a whole, would be no better off. Whatever assets the state owns – which are your assets as taxpayers – would simply be moved over to the pension funds for the sole purpose of covering benefit obligations. But the pensions are really just a unit of government because Illinois courts have made clear that the sponsoring unit of government is liable directly to pensioners if pension assets ever fall short. So, pensions might be made more secure by an asset transfer, but the government’s overall balance sheet remains the same.
Not true, I’ve heard some proponents of asset transfers say. They claim there are certain public assets where the value of the asset can only be fully unlocked through a transfer to a pension. Just selling or leasing the asset to some third party, they say, wouldn’t work. I’ll believe that when I see an example.
If you’re wondering at this point whether accounting shenanigans might be at play, you’re right to be concerned. Some valuation would have to be placed on the asset transferred in order to understand a pension’s true position. But public assets don’t have clear market values. What’s the Illinois Lottery really worth, for example? Experts will have different opinions, but the temptation will be to inflate the value in order to make pension financial statements look better.
And how on earth will actuaries decide what rate of return to assume on those assets? Currently, Illinois pensions assume about 7% per year. That’s already extremely controversial, with Nobel economists being the harshest critics. This will make heads explode in the actuary world.
Over time, the value of the asset will change. The lottery’s value, for example, will drop markedly if Illinois expands other forms of gambling as rapidly as planned. Does anybody really expect pensions to honestly report that changing value, given their sordid history distorting their position with phony numbers on things like discount rates and mortality projections?
And even if honest valuations are used, another temptation will be to transfer assets that are on the books at lower valuations. That would improve a government’s reported balance sheet when it’s valued fairly in the pension after transfer, but the government’s position wouldn’t really improve at all.
In the private sector, where asset transfers to pensions are sometimes done, that accounting trick is the whole point – take an asset that’s been heavily depreciated to less than fair value and give it to the pension at fair value, which magically improves the consolidated balance sheet. That’s a sensible tactic for a private company to improve its reported position, but for governments, from a taxpayer’s viewpoint, it doesn’t change the economic realities.
What about management and control of a public asset by a pension? Would you really want a pension managing Midway Airport, for example? No, advocates of asset transfers say, the whole transaction would be set up like a triple net lease, where the governmental unit would continue to be in control. Only the cash flow would be diverted to the pension.
But think about that and all kinds of questions are apparent. If the city truly kept control, it would have every incentive to reduce charges for parking, landing and gate fees, which is how airports make money. They’d be sure to cover operational expenses, but nothing would truly be left for the pension, making the whole deal unfeasible. If, on the other hand, the pension could determine those charges, well, heaven forbid that.
The complexity of asset transfers would be mind-boggling for major things like airports, water and sewer systems. They are tied up by layers of mortgages and covenants protecting bondholders. Disentangling them, if that’s possible at all, would be a matter few officeholders or taxpayers would ever understand.
Other questions are endless. Ask them and one thing will come to mind – Chicago’s disastrous parking meter deal. In that case, a public asset was transferred not for pensions but to cover city operating expenses, but the concept is similar, and similar risks of having a bad deal foisted on the public should be apparent.
Our view on this is the same as our view about other ways to throw money at pensions. Don’t do it unless and until the pension system is reformed. Otherwise, Illinoisans will see that their assets are being tossed into a bottomless, corrupt pit. Don’t do it all unless the economic consequences and future reporting will be transparent and certain (which is probably impossible for most assets). Don’t just give away the assets. Demand reform concessions from current workers in Tier 1, who can negotiate collectively, and Tier 1 is where all unfunded liabilities are.
The Pritzker Administration has shown no interest in any of that.
Prepare for smoke and mirrors.
*Mark Glennon is founder of Wirepoints.
UPDATE 2/27/19 : A further issue is impairment of credit quality and increase risk for bondholders. Per The Bond Buyer: “While the state is touting the benefits of leveraging its public assets, a downside is the potential hit existing bondholders could see in the value of their investment. ‘Current and future citizens, not to mention bondholders, that previously may have had a future claim/benefit from the sale/monetization of an asset, would be in diminished position after the transfer,’ MMA wrote.”
A Forbes story by a pension actuary addressing asset transfers and is linked here.