State budget crises: Two wins, one loss

(MoneyWatch) The fact that many states are facing large budget deficits may not be news, but states' responses are now being graded by the markets. Specifically, New York, Illinois and California -- three of the largest offenders -- have seen the markets and ratings agencies react in very different manners based on their actions (or inactions, as the case may be). Let's see how these states have fared.

New York

Standard & Poor's changed its outlook on the general obligation debt of New York to positive from stable while affirming the AA rating on the state. The rating agency cited the passage of a state budget that moves the state toward structural stability. The budgets reflect restrained spending on costly government programs, including Medicaid and school aid. The new Tier VI pension plan for public employees is also credited in part, something the state's large unions overwhelmingly opposed. The state is now faced with a budget gap of $3.5 billion gap for 2013, much smaller than the projected $14 billion gap forecast just a year earlier.

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While the state's actual credit rating hasn't changed, the move provides investors with a bit more confidence in buying general obligation bonds, while likely providing the state with some interest savings. New York's 10-year general obligation bonds are now yielding only about 0.2 percent more than similar AAA-rated bonds. If the fiscal trend continues for at least another two years, Standard & Poor's could raise the rating one notch.

Illinois

Unfortunately, Illinois is another story. Standard & Poor's downgraded the general obligation rating of the state of Illinois to A from A+ and maintained a negative outlook due to budget uncertainty. The news affects $27.5 billion of outstanding general obligation debt.

The downgrade was the result of the legislature's inability to address the states' debt-ridden public employee pension system, which now has an estimated funded rate of 43 percent, or $83 billion. It's estimated that without action that figure will increase to $93 billion by next summer.

The size of the problem is why Illinois has been called "the Greece next door." Unless the legislature is prepared to address the unfunded pension issue, it seems doomed to fall into a death spiral. Illinois residents and businesses are already heavily taxed, and people worry that a massive "temporary" tax increase -- 67 percent on individuals, 46 percent on employers -- scheduled to expire in 2014 may be permanent. The bottom line is that Illinois is now facing the consequences of its actions -- the bill is coming due and it will be unable to continue to kick the can down the road.

The risks of Illinois general obligation bonds are reflected in yields. The state's10-year bonds are yielding almost 1.5 percent more than similar AAA-rated bonds. That's about 0.8 percent higher than even California's bonds. While Illinois bonds are certainly carrying relatively attractive yields, it's worth remembering that it takes an awful lot of interest to make up for unpaid principal. And given that the main role of fixed income is to dampen the risk of the overall portfolio to an acceptable level, it's simply not prudent to invest in the general obligations of the state of Illinois.

California

The news was somewhat better for California. Governor Jerry Brown and state lawmakers recently reached an agreement on some pension reforms for future state and local employees in California. Reforms included capping pension salaries, increasing employee contributions, boosting the retirement age, and creating rules that will limit pension spiking tactics. Unfortunately, a number of important proposals that Brown made earlier this year weren't included in the reform, such as moving new employees to a hybrid defined contribution/defined benefit plan. CalPERS, the agency that manages public pension and other benefits for the state, estimates the savings could be $40 billion to $60 billion over 30 years. Having cleared both the U.S. House and Senate, Brown signed the bill Wednesday.

The yields on California's general obligation bonds look attractive. The 10-year is yielding about 0.7 percent more than similar AAA-rated bonds, much less than the 1.8 percent incremental yield on Illinois bonds with a similar rating. The high tax rate for California residents creates high demand for its obligations. Given the state's inability to completely address its problems, it seems prudent to avoid California general obligation debt, even considering the relatively attractive yields and the tax advantage for residents. However, if you're willing to accept the risks, you should limit the holdings to the short term, say three years or less. You should also limit the amount of holdings to a relatively small portion of your portfolio.

Image courtesy of 401(k) 2012

[Algernon_Moncrief]

WHY HAVE CALIFORNIA PUBLIC SECTOR UNIONS NOT SUPPORTED THE BREACH OF FULLY-VESTED PENSION CONTRACTS LIKE COLORADO PUBLIC SECTOR UNIONS?

PROOF THAT COLORADO'S GOVERNMENT LIES: COLORADO PERA'S ATTEMPT TO TAKE CONTRACTED RETIREE BENEFITS.

When I was young I held the belief that public service in the United States is honorable, that the United States of America was exceptional in the world, that governments in the United States, while flawed, deserved the respect of citizens.

Now that I am old, I see that I was naive . . . that governmental entities in the United States will intentionally deceive to achieve their goals, and that over two centuries our soldiers have died for a country that will countenance, and even celebrate, base behavior on the part of its public sector instrumentalities. It saddens me, but if this state of affairs persists in the United States . . . Honor is dead.

Some background . . .

You may know that an entity of Colorado state government, Colorado PERA, is attempting to breach its public pension contracts with its retirees. Colorado PERA is attempting a retroactive taking, a "clawback" of accrued, fully-vested pension benefits that were earned by retired PERA members over decades.

Colorado PERA public pension benefits include a "base benefit" that is set at retirement and a "COLA benefit" that adjusts pensions annually to compensate for inflation. The "base benefit" and the "COLA benefit" are set forth in Colorado statutes with identical force of law and legal status.

In its attempt to breach retiree contracts Colorado PERA has created a contrivance. The contrivance that Colorado PERA is using is that somehow the "base benefit" is a contractual obligation, but the "COLA benefit" is not a contractual obligation, in spite of the fact that both pension benefits are set forth in law in an identical manner. What this boils down to is attempted, unabashed, theft by government.

Whether or not Colorado PERA's attempt to take fully-vested public pension benefits from PERA retirees is ultimately successful in the courts, one fact has been incontrovertibly established . . . Colorado PERA, as an instrumentality of the State of Colorado, is an organization that will lie to achieve its policy goals.

This is a sad fact for the many employees of Colorado PERA, for the trustees that have served on the Colorado PERA Board of Trustees over 80 years, and for the thousands of PERA members and retirees.

And now, the proof of the deceit . . .

Colorado PERA has told us, in writing, that the PERA COLA benefit IS a contractual obligation of PERA . . . and then, after initiating their attempt to breach contracts, Colorado PERA has told us, in writing, that the PERA COLA benefit IS NOT a contractual obligation of PERA. Both of these statements cannot be true.

Colorado PERA in a written document, to the Colorado General Assembly's Joint Budget Committee on December 16, 2009 states that the PERA COLA benefit IS a contractual obligation of PERA:

"The General Assembly cannot decrease the COLA (absent actuarial necessity) because it is part of the contractual obligations that accrue under a pension plan protected under the Colorado Constitution Article II, Section 11 and the United States Constitution Article 1, Section 10 for vested contractual rights."

Link:

http://www.kentlambert.com/Files/PERA_JBC_Hearing_Responses-12-16-2009_Final.pdf

Colorado PERA on page 23 of its May 6, 2011 "Reply Brief" in the pension case Justus v. State states that the PERA COLA benefit IS NOT a contractual obligation of PERA:

"Plaintiffs seek to create a contract right that has never existed—an unchangeable COLA for life triggered (inconsistently) by either the date of their retirement or 'full vesting.'"

Link:

http://saveperacola.files.wordpress.com/2011/06/2011-05-06-pera-defendants_-reply-in-support-of-summary-judgment.pdf

That is simply unbelievable.

In one document PERA writes "the contract right has never existed." In the other they write that the COLA benefit is a contractual obligation protected under the Colorado and US constitutions.

When PERA writes that they need "actuarial necessity" to take the COLA benefit, they are not denying that it is a contractual obligation, in fact, it is an admission of the contractual nature of the COLA benefit.

For further information regarding Colorado PERA's attempt to take fully-vested pension benefits from retirees visit saveperacola.com or Friend Save Pera Cola on Facebook.