Following A Thread That Connects Paul Payne's Job To Jerome Powell's
The impacts of ending QE and interest rates hikes are now showing up on local pension fund financial statements.
I’m glad folks are calming down
I know that it’s been a long time, but the venom in local #STL politics had been flowing freer than ever before. As such, I have been keeping about as low a profile as possible. While the gaslighting and abusive behavior continues among those directly involved, I get the distinct impression that most people have largely tuned it out. Maybe I’ve insulated my own bubble so much that I can’t see that folks are still just as high strung? I don’t think it’s that, though. I guess we’ll see what happens in the upcoming spring elections. It could all come raging back, complete with all new levels of stupid. It doesn’t feel like that, right now. It’s hard to know what exactly all that means, but I do think this might be a brief window to possibly again engage in meaningful discussions about the city’s financial picture.
While the local political class doesn’t seem to care about even medium term fiscal issues, preferring instead to focus on the distribution of ARPA dollars, those of who pay the taxes should most definitely pay attention to those issues. Really, it’s not surprising that folks are focused on the ARPA monies, because politicians love handing out giant checks. That’s a lot more fun to talk about, compared to long term, structural issue in the city’s finances. Instead, we get overblown talk about “transformative” investment in the city. The truth is that the city’s deferred maintenance issues are so dire that the ARPA money just won’t go nearly as far our local political class has led the public to believe. Sewers alone could eat a massive chunk of the cash. After it gets divvied out, the word transformative will be shown to be little more than the application of the mayor’s political branding to the monies that came down, instead of an actual description of the impact it will have on residents’ lives. Like I said, gaslighting has just become how folks in local political circles communicate. That money also doesn’t plug long term problems in the city’s fiscal picture. This is a discussion of one such thing.
Let’s talk about boring money stuff! 🥳
This brings us to the recently published Market Value Statements from the city’s police pension board. According to these documents, the fund’s value dropped from ~$803M on July 31st to ~$765M on September 30th. That’s roughly a 5% decrease in just a couple months, and the rate of loss increased. While we hope that rate of loss is not continuing to ramp up, it is worth noting that the deterioration in valuation is broad-based. This isn’t a situation where one or two bad bets blew up. Even more concerning is that, if I'm reading things right, the fund balance has already been taking large hits. In the actuarial report, it clearly shows that 2021 was a great year for the fund. Its investments garnered a 16% return in that year, the ending market value of ~$932M. Remember that most current market value report mark the value at ~$765M, which is a significant decline. In fact, that decline appears to have wiped out all of the gains from the previous great year of high returns. That being said, the year before that featured a market valuation increase of more than 20%, so that means there’s quite a bit of unwinding that could still be coming. That means the last couple of months’ decline is actually part of a larger trend of poor fund performance for the past year. Fed monetary tightening has been draining the fund of value. Until it national monetary policy changes, it is very, very unlikely that the fund will see a return to returns anything like the projections given in the document. While rate hikes will eventually stop, it is quite possible that we’re not done with increases, even following yet another 75 basis point increase. If rates are going to stay elevated, it is likely that recent years’ trends of steadily increasing valuations and easy returns won’t return in the near term.
This is important for voters, even if you don’t have a family member who depends on the pension. Why? Because the city’s general fund backfills money into the pension fund. Why? Because, even during years of high, Fed-policy-driven returns, the pension doesn’t have enough assets to meet its obligations. When I say that the past few years were very good, I’m talking about the fund’s most recent actuarial report showed an annual return of roughly 16% in the previous fiscal year. The article does a decent job of explaining how loose monetary policy creates an investment environment where it is very easy to make more money on a whole host of different assets. While the connection between state fiscal policy and pension funds may seem somewhat esoteric, I’ll remind readers that this isn’t just an issue for our local government. Recently, the Bank of England had to step into the bond market, almost entirely because it threatened to make numerous major pension funds. Unlike the UK, there is no central bank entity that can intervene in problems related to our issues. The city doesn’t issue currency. It can’t print money to pay bills. Instead, the city is reliant on revenues from taxes, fees, etc. It is generally recognized that loose monetary policy has inflated asset prices. The Fed’s recent policy moves have explicitly been partially in order to drain this excess valuation in an orderly manner. This is hurting retirement plans, even if we’re just talking about a lot of folks’ 401(k)s and home values. Pension funds’ size, etc. do not grant them immunity from this larger shift in policy environment.
How general revenue ends up covering pension obligations
The easiest way to understand how the city’s budget and pension fund are tied is look in the annual actuarial report. Here’s the most recent one. Go ahead and open that up.
Alrighty, now that you’ve got that opened, you'll see the "employer contribution" chart on page five of the actuarial report. That's how much the city's general fund is backfilling the pension. It is important to note going much below 80% is when a pension fund begins to be seen as in trouble. That’s why they put money in to keep it around that particular level of being funded. As you'll see, prior to 2007, the city didn't have to kick in that much. Even directly afterward, the city's contribution returned to pretty familiar levels, then it started growing.
Fast forward to today, and it has stabilized with the city contributing roughly 3x what it used to, back in the fiscally halcyon days of the "aughts". On the next page of the report, you'll see the headcount. You can clearly see that the department's headcount has been declining, which matches with what you read in the paper. That means less active contributors to the fund, making it more dependent on market returns and, when those aren’t sufficient, general fund contributions. The following page shows you the city's projected contributions with the fund's assumed baseline annual return of 7%. With that assumption, the city would already have been on the hook for something around $35M. If you go down to page 11, you'll see the "pessimistic" projection, which would be for a 5.5% annual returns. Even under that model, general fund contributions would be projected to fall, though eventually they would again start heading upward. There is also an "optimistic" model, but its assumption are not really plausible at this time. Basically, if the fund ends the year with a growth rate of 2%, all the models in the actuarial report will have been too rosy. In defense of the report’s authors, it is very hard to foresee when a recession will hit. At the time of it’s drafting, these numbers would’ve seemed quite doable, especially in light of the previous two years’ double digit gains.
I’d also note that if you then go back and reference the chart for the "pessimistic" model, you’ll see the green line that is their market value projection. It is wildly divergent from today's market value, due to the declines we’ve already seen set in. We could already be in the 75% funded liability zone or lower. That would mean the city’s general fund could have to contribute significantly more in the upcoming year’s budget. That’s not the end of the potential issues with these projections, as there doesn’t seem to be any account of increased inflation in the projections. That being said, it is unclear to me what exactly that means. The recently released Cost Of Living Adjustment (COLA) report shows that there is a 3% annual cap on how fast payment can increase, with excess increases in COLA being “banked” for years with lower price increases. This would essentially smooth out increases. That said, if annual inflation stays over 3% for an extended period of time, this will equate to a meaningful reduction in SLMPD retirees’ purchasing power and quality of life.
The best laid plans, yadda yadda.
What happens next?
I have no idea what the world economy will do, but I think it is fair to say that there’s a consensus that it will take at least a little while for inflation to return to the Fed’s 2% target, which means that the need to increase general fund contributions to the pension system is likely to be with us for at least a couple budgets. It could be more, though. Also, will the widely-expected recession (which is again linked to Fed monetary policy) put an end to the consumer spending spree that began during COVID? It’s hard to know, but there are signs that we might be getting there. If that happens, the city will likely see a reduction in sales taxes and other revenue streams. If this drop in revenue happens concurrently with a greater need to fund the pensions, which is what happened in the aftermath of the last financial crisis, the city will need to either use ARPA money to backfill holes in the city budget or make cuts. The county has already used millons in ARPA funding to plug budget holes, so the idea that much of this “transformative” investment could go to fund mundane city functions isn’t too far fetched.
I also don’t really know what is going on with the other city employee pension funds. The firefighters have two separate funds, which complicates things. The other city employee pension funds also simply aren’t as transparent. The SLMPD pension system regularly makes new documents public and accessible in an easy-to-find place. This cannot be said for either firefighter or the general employees pension systems. As such, there is less public visibility into their health and potential need for general fund support.
Anyway, it is likely that folks will soon have to start talking about this. Budget season is fast arriving, and it is likely that they won’t be able to ignore this issue. Like many things in our now post-loose-monetary-supply economy, easy money is no longer around to paper over significant issues. Whether it’s companies that can no longer sell bonds to finance money-losing operations or local governments who will have to again grapple with long term municipal employee pension problems, economic gravity has been turned back on. The hope is that things come back to earth in a relatively orderly manner. Otherwise, we’ll get another “bubble popping” moment in the economy. Nobody wants that.
Thanks for stopping by!
I don’t think that I’ll be writing these notes with any regularity. To generate the amount of analysis that I used to would entail spending time engaging with politicos. There’s a snowflake’s chance in hell of that happening. Life’s better on the outside. It allows you to have more genuine relationships with other people. I think that’s something we desperately need more of, as a society. We need a politics that understands that the very real need to build non-transactional relationships. Remember after #Ferguson, when folks were talking about building a political movement based on love? I’m still down for that. Give me a call when that kind of politics come back around.
Another unfortunate reality is that there is virtually no political coverage in the city, these days. This then creates a second order effect: there are virtually no high information voters. People are fed a lot of surface level stuff and narrative, but there given very, very little actual information. That isn’t to say that there isn’t content. It’s just that said content is mainly “infotainment”. I know that there are always lots of stories about the soap opera stuff, but there is rarely analysis that goes much deeper. There are some stories on important issues, but there are so few reporters left in the city that surface stuff is about that can be covered with the limited journalistic bandwidth available. This means that the electorate can’t really make informed decisions, even if you read every puff piece and bit of narrative spin. You can learn more about the things driving that particular issue in this article. If you want more and better political coverage, take your fight to Big Tech. Like many issues in today’s America, there isn’t really a local solution to problems that are driven by larger, more powerful systems.
Anyway, we’re coming off the fiscal sugar high of COVID era stimulus and loose monetary policy. With that, we’re entering into a period of increased uncertainty. I’ll try and flag things that seem to be of significant concern.