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Mark's Market Blog

4-10-10: Public Pensions

By Mark Lawrence

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The markets continue to trend upwards with little conviction. Volume continues to be light as major players stand on the sidelines. There's a growing fear among large investors that this is a topping process, to be followed by a major correction. However, when including everyone, bullish sentiment is raising - which in itself is a bearish observation, as the average Joe is always wrong. I expect the market to continue upwards for a few weeks, nearly to an S&P of 1230. After that, we'll see.

S&P 500 October 5 2009 to April 9 2010

Bulls and Bears - when Bulls get over 50% (currently over 48%), watch out below.

Short term unemployment is down, helped enormously by the Census bureau hiring 40,000+ warm bodies. However, long term unemployment continues to grow - people who have been unemployed for 4 months or more are stuck at a very high level.

Table A-12. Unemployed persons by duration of unemployment Numbers in thousands
Duration Not seasonally adjusted Seasonally adjusted
Less than 5 weeks 3,067 2,607 2,402 3,314 2,774 2,929 3,008 2,748 2,646
5 to 14 weeks 4,523 4,139 3,599 4,032 3,517 3,486 3,362 3,412 3,228
15 weeks and over 6,305 9,245 9,676 5,815 8,976 8,969 8,945 8,829 8,983
15 to 26 weeks 2,971 2,959 2,966 2,574 3,075 2,840 2,632 2,696 2,436
27 weeks and over 3,334 6,286 6,711 3,241 5,901 6,130 6,313 6,133 6,547
Average (mean) duration, in weeks 21.2 29.3 32.1 20.8 28.6 29.1 30.2 29.7 31.2
Median duration, in weeks 13.1 19.6 21.6 11.9 20.2 20.5 19.9 19.4 20.0

Spirit Airlines announced Tuesday that it will charge its customers $20 to $45 for items they place in the overhead bins. Most major air carriers started adding checked-bag fees in 2008. The airlines reported collecting nearly $740 million in baggage fees in the third quarter of 2009, according to U.S. Bureau of Transportation Statistics.

According to a report by the Government Accountability Office, GM will need to add $12.3 billion into its pension fund by 2014. GM says it lost $4B last year. This is very similar to most states; I think GM should apply for statehood. They're certainly not run any worse.

The Greece bailout is turning into a Desperate Housewives on-again off-again drama. It seems it's been decided that the final bailout will be a joint effort by the IMF and several European countries. Germany is holding out for a more punitive bailout. German voters retire at age 67, and don't understand why they should pay extra taxes to help out Greeks who retire at 55. Greece, where employees in hazardous jobs (which includes hairdressers) are allowed by law to retire at 50 to 55, has an average retirement age of 61. This tension between taxpayers and those who retire young is going to prove to be a recurring theme for a couple decades. If this last (current) recession was the story of shedding the unskilled from our workforce, the next recession, which I expect in a couple of years, will be the story of the taxpayers v. public employees.

The Aging Crisis in many countries.

According to research by Jagadeesh Gokhale, an economist at the Cato Institute in Washington, including Greece’s pension obligations show that the government’s debt is in reality equal to 875 percent of its GDP, far above Greece’s official debt level of 113 percent. In France, where the official debt level is 76 percent of economic output, total debt rises to 549 percent once all of its current pension promises are taken into account. And in Germany, the current debt level of 71.9 percent would soar to 418 percent. He estimates that to fully finance future pension obligations, the average European country would need to set aside 8% of its economic output each year. In the US this would mean income taxes go up by a third.

In the US, State budgets continue to look very bad, especially when forecast into the future. Economists are hard at work on state budgets, and getting dire results. A recent calculation of the value of the 50 states’ pension obligations puts the number at $5 trillion, $2 trillion of which is currently funded. In California a controversial independent analysis puts the state's pension shortfall at over $500 billion, nearly $100,000 per California taxpayer. The details of this analysis are actually interesting.

Although private employees all participate in Social Security, many public employees don't. I have long considered this incredibly heinous: social security funds widows, orphans, the disabled; but many government employees don't contribute to this, their pension funds only pay out to themselves. California has several state agencies to manage public employee pensions. Their job is to forecast retirements and life expectancies, and plan to have enough money so that government employees can retire at age 55 or so with 80%+ of their last salary. CHP, the road tax collectors who are some of my least favorite people, make $112,000 per year on average and retire after 25 years, often before age 50. To plan for such retirements you must do a present worth calculation, meaning you have to agree on an effective interest rate your savings will earn. This is the heart of the issue.

The California agencies are planning on making about 8% per year on their money over the next 30 years or so - a rate that implies healthy stock market returns. The Stanford economists who did the new analysis assumed they would make 4.4% - closer to federal treasury bond rate. What is likely to actually happen? California is in trouble and knows it, and has recently ordered their investors to seek higher returns on the stock market to shrink the shortfall. So now we're left with forecasting the stock market for the next 30 years.

Although the stock market does indeed average about 8% per year, this is not at all a consistent thing. As we've seen in previous blogs, the stock market moves in generational trends. Below, we see that in the last 80 years the DOW has gone up from about 1943 to about 1965, then was flat from about 1965 to about 1983, then up from 1983 to 2000, and is currently flat. Many believe we're in the middle of a generational flat period that will last most or all of this coming decade. So one way to analyze things is that if you're heavily invested in the stock market, you should not expect to make anything between now and 2020. Another way to analyze these funds is to ask how they did in the previous decade, and assume they will more or less match that in the coming decade. The answer is that they lost money on their investments from 2000 to 2010. If you analyze for a 0% return, the shortfall in California is over a trillion dollars, more like $200,000 per taxpayer.

Dow Jones Average, 1929 to 2009

Some are casually forecasting that several states will go bankrupt. This is actually not currently an option: bankruptcy law is federal law and applies only to individuals and corporations, not to states. There is no legal mechanism for a state to declare bankruptcy. All a state can do is default on their debt obligations, then watch the jackals and vultures circle in. Some hope for a bailout from Washington, but as we have seen they have their own problems coming up which will almost certainly require a large dose of inflation to repair.

Clearly what's coming across the US and Europe is a whole bunch of taxpayers who work until age 67 to get a social security pension of perhaps $1500 to $2000 per month. They're going to be asked to pay higher taxes to fund the retirements of government employees who have been idle since age 55 and make $5000 to $10,000 per month. This pig will not fly. Alternatively, the retired government union employees will be asked to take sizable cuts in their retirement income, losing perhaps as much as half. This pig also won't fly. Public employee unions have become a parasite that is killing their host. I'm not going to predict the result. I'm only going to note the obvious: there will be a huge fight. Taxes will go up. Benefits will be eroded by inflation and by fiat. People depending on the government to maintain them in relative comfort for the next 30 years definitely need a plan B. Oh, and I think CHP are basically criminals running a protection racket.

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