My weekly piece 13 months ago indicated that New York State seized the finances of Nassau County.
The reason: irresponsible financial management.
Despite its inordinate wealth (10th wealthiest county according to Forbes Magazine in 2008), Nassau County is spending 10 percent more than it takes in. By law, this figure cannot exceed 1 percent.
With an annual deficit equal to 10 percent of expenditures and New York State as the financial conservator, Nassau County is continuing down the road toward financial oblivion.
Nassau County, along with other local municipalities in New York State, has decided to increase the unfunded pension liabilities to meet current cash flow requirements. To achieve this, they are making payments to pensioners from pension funds while postponing the commensurate pension contributions.
They hope to receive these contributions sometime in the future.
This methodology increases the debt to equity ratio of the pension fund by increasing future liabilities without increasing assets by the same amount: they are borrowing from the funds that are due beneficiaries.
According to The New York Times, the borrowed amount from New York State pension funds will total $1.75 billion over the next two years.
Currently, Nassau County has borrowed roughly $40 million from the $150 million pension fund. Therefore, the fund liabilities of $190 million ($150 million balance plus $40 million borrowed) exceed the fund assets of $150 million by $40 million.
The $40 million deficit indicates the pension fund is underfunded by more than 20 percent (underfunding = deficit/liabilities = 40/190).
This scenario is a familiar one across the US.
Twenty years ago, I suggested the defined benefit pension system methodology was neither prudent nor sustainable.
The reason:
It typically guaranteed an 8 percent return on investment, ad infinitim, irrespective of the actual return. Any deficiencies would be provided by the government.
For example:
1. Pension fund asset = $1 million
2. Pension fund liability (guarantee benefit to pensioners) = $22 million in 40 years (guaranteed return of 8 percent per
annum)
3. Actual Pension fund assets after 40 years = $5 million (actual return of 4 percent per annum).
4. Underfunded Amount = Deficit = Liability (guaranteed amount) – Assets (actual amount)
= $22 million - $5 million
= $17 million
5. Percentage underfunded = Deficit / Liabilities
= (Liabilities – Assets) / Liabilities
= (22-5) / 22
= 17/22
= 77 percent
6. Percentage funded = Guaranteed Percentage – Actual Percentage
= 100 – 77
= 23
Therefore, this pension fund contains only 23 percent of the guaranteed amount, since the average annual rate of return was half (4 percent) of the guaranteed amount (8 percent).
The 77 percent shortfall of $17 million is guaranteed by the tax payers.
To fund underfunded pensions, municipalities are issuing additional debt and increasing real estate taxes: an ominous sign.
A positive sign:
In some cases, pensioners are beginning to understand the seriousness of this crisis. The pension guarantee system is undermining the ability of economic producers to generate income and tax revenue that fund these pension plans.
Hence, this economic dissonance has led to negotiations that involve smaller pensioner payments.
I hope Nassau County, my hometown, begins to chart a more prudent financial path in the future.
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