Pension Crisis: Is New Jersey the Next Illinois?

Andrew Levine
8 min readMay 12, 2016

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The first thing I would like to point out is that this is not intended to be political. I am not advocating what anyone should do with their vote. This is about what individuals located in New Jersey should keep an eye on so that they can plan accordingly.

*THIS IS NOT INVESTMENT ADVICE

New Jersey legislators have proposed a constitutional amendment that would effectively prioritize the funding of New Jersey public pensions by requiring the government to make regular payments into them. One might be tempted to view this in terms of fairness, as in this is a “fair” thing to do. But this is missing the forest for the trees. America (and in fact the globe) is facing a pension “time bomb” and what we are looking at (“the trees” so to speak) are the symptoms. One must remember why these pensions are “unfunded” in the first place. Effectively an unfunded pension is an agreement to pay someone in the future some amount of money which has no known source. In other words, the State said to these people, “We know you want more money, but we don’t have it now, so we’ll pay you in the future (i.e. when you retire). But, FYI, we have no idea where that money is going to come from, we’re just going to assume that there will be continued long term growth and prosperity in which case money will be falling from the sky and funding your middling pensions will be a trifling matter.” But what happens when you have stagnant economic growth, stagnant wages, a shrinking population (the “demographic cliff”), a shrinking “middle class?” “OK, yeah that’s all bad,” you may be thinking, “but the pension funds invest the money they have, so they can theoretically grow that money by investing wisely.” But what to invest in? Well what you want is safe, steady returns, guaranteed by an entity that can’t possibly go bankrupt like a State. People and institutions (like pension funds) invest in the State by purchasing its bonds and the income those bonds generate is called “interest.” unfortunately interest rates are at historical lows — near zero in fact. That means no income. Add to this the fact that fewer people are paying into the system and more people are retiring (the baby boomers), and what you have is an unsustainable (and unstable) situation. That is the forest. In short, the pensions were built on certain assumptions (most of which boil down to long term economic growth) which have all been proven faulty. Not. Good.

While unfunded pensions are an obviously bad idea, making it a constitutional amendment to fund them is also a very bad idea. The problem is that they are unfunded because they can not be funded. That’s the whole point of unfunded pensions. If you had the money, or you knew you would have it, it would be a funded pension. Making it a constitutional amendment would mean that funding an unfundable thing will have to be given priority over everything else. Of course, this is presumably why the people with unfunded pensions, and the people who represent their interests, are pushing for the amendment. They are worried the money won’t be there and they want to make sure they are prioritized over everyone else. As is their right. Just as it is your right to prioritize your money over theirs. Unfortunately the very logic behind the amendment is unsound. It is effectively, “We (the politicians) are going to FORCE ourselves to fund your pension and THEN figure out how to fund it,” not, “We’re going to figure out how to fund it … and then fund it.” For that you do not need an amendment. The author of one article attempts to allay these concerns by saying effectively, “No worries, as long as revenues increase 3% a year this won’t be a problem.” Assuming that will happen, that there won’t be another recession despite the fact that it has already been eight years since our last (about the average time interval between recessions), AND that lawmakers will stick to their plan is moronic, which explains why the author writes columns for NJ.com :/ In fact, one can refer back to that very same publication in 2014 to find that New Jersey’s economic growth is among the worst in the nation (a nation that has generally hovered around the 3–4 range when not in recession). 46th in fact. Yikes. In 2014 it grew only .4 percent!!! According to NJ.com New Jersey’s average growth rate is on average 1.7%. But no worries, apparently somehow funding its pensions will enable New Jersey to double its growth rate. If it doesn’t (why would it?) then even according to this brain dead journalist these pension funding plans will fail and New Jerseyan’s will wind up paying for the State’s failures. Again, the point isn’t to vote against it, or just to move, but to pay attention. If next year growth is low (it will be), pay attention. If more and more taxes seem to be getting proposed (they will be), pay attention. If legislators demonstrate fiscal incompetence (yes, try to strain your imagination), pay attention.

This is currently what’s going on in Illinois and is bankrupting it. Pensions are a huge drain on that state’s resources and there’s nothing they can do about it because it’s in their constitution. So they have to raise taxes. In 2011 they established a temporary income tax increase that lasted till 2015. Mysteriously this “fix” didn’t solve Chicago’s budgetary woes. This year law makers started proposing bankruptcy in order to solve the problem. That’s what happens when you are constitutionally mandated to pay a bill you can’t afford, you have to go broke. This month a proposal was made to change their tax structure from a flat income tax to a graduated income tax. Note this isn’t about what’s “fair” or not, though I’m sure this is how politicians frame it, this is about them not having enough money to honor their promises. In other words, an institution which failed to honor its promises is promising that by raising taxes they will be able to honor those promises they are not currently capable of honoring. After all, if they were getting enough money from the flat structure, why change it? They need more money and taxes are how they get money. Property and Income taxes are the usual favorites. That New Jersey already has THE highest property taxes in the country should be concerning. Also concerning is that people are seriously considering a tax on retirement income.

AARP pushes back against proposals to tax retirement income.

The irony of proposing a tax on retirement income to solve a pension crisis is quite staggering. Taxing private retirees to pay for public retirees seems pretty self-defeating. I guess elderly non-public employees are just less important than public ones. It also doesn’t solve the problem economists refer to as “monetary tightening.” Remember after 2008 when the financial crisis caused credit to “dry up” necessitating “quantitative easing” (QE) by the Federal Reserve? That meant the Fed printing money (i.e. monetary) and shoveling it into the banks so that loans (credit) could continue to be made. “Monetary tightening” then can be viewed as any event that has the opposite effect — one which removes capital from the economy. In this case many people, including but not limited to the pensioners themselves, were working under the assumption that pensioners would have trillions of dollars to spend. If that money, which States acknowledge they do not have, does not get paid that is big time monetary tightening. Taking from one group and giving to another doesn’t solve that problem. The money is still gone from the economy, the losses have merely been transmitted to someone else. Someone, presumably, with less political clout. The only solutions to that problem is for investors, savers, and consumers to adjust their behavior by investing less, saving more, and consuming less (a market response), all of which depress the economy OR for the public sector to inject the necessary capital which comes with its own whole set of dangerous side effects that are hotly debated and highly controversial.

This pension issue will likely only continue to be a burden on New Jersey’s system. Even if the amendment didn’t pass that’s by no means the end of the story. These pensions ARE unfunded and either they will get funded through taxes or you will have a whole lot of angry pensioners with a lot less money than they thought they had (and which they won’t be able to spend in New Jersey thus depressing its economy). Of course, if the economy “lifts off” these problems are largely solved. But if, as many believe, we are facing a period of prolonged low growth the problems will only get worse. This pension crisis is likely going to hit everywhere, New Jersey is simply at the top of the list much like Greece is merely at the top of the list of Sovereign Debt Crises poisoning Europe. Advice for New Jersey property owners: keep an eye on this issue and start considering moving your residence to States like Florida and Texas that have healthy pensions and low taxes. Or pray that politicians will fix everything.

Possible Solutions

As a purely intellectual exercise I will now discuss potential solutions to the State pension crisis. If New Jersey controlled its currency it could print the money to pay off the pensioners. This could devalue its currency, but the state would be able to meet its obligations without going bankrupt. Standard of living might go down temporarily, but they could recover. This is actually pretty much the whole point of having a flexible money supply like we have in the US. Though law makers and central bankers don’t like to put it this way, it is orthodox economics to say that what inflation allows you to do is instantaneously and simultaneously lower everyone’s wages without having to do anything about minimum wage laws, or laws generally. It sounds gross, but based on the current structure of the system it is, unfortunately, a necessary feature because the alternative is mass layoffs. But obviously New Jersey doesn’t have a currency so they can’t print money. The Federal Reserve can, so perhaps as part of the next fiscal stimulus they will print money and use it to fund these pensions. There is already a lot of talk both on the fringes and in the mainstream of economic thought that a “QE for the people” (also referred to as “helicopter money”) is going to be needed due to the aforementioned tightening forces, so this might not be as unlikely as people think and admittedly it isn’t the worst idea. Unfortunately it creates a whole new set of questions and problems. If a large print is needed that means that the system is effectively undergoing cardiac arrest. Blood flow (in the case of the economy “capital flow” or “velocity of money”) would be at critically low levels. Quantitative Easing (i.e. money printing) is like using a defibrillator. Like in 2008, it would have to be the case that PRIVATE investment has plummeted (a problem we are still dealing with, hence all the QE talk), effectively causing monetary tightening (removing money from the economy) and so the Federal government would have to act to inject capital into the system or allow the economy to sink into a depression. If the US Federal government had any savings (as some governments do) they could use that, of course, they’re horribly indebted which leaves them with two options: create more debt or simply print money. Creating more debt would make the problem worse. Purely printing money (i.e. no new debt is issued, the Federal Reserve simply taps a keyboard and creates more dollars out of thin air) is probably the best solution, but it’s the “best” solution to very, very bad problems, it is by no means a silver bullet, and likely comes with its own suite of negative side effects.

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Andrew Levine

CEO of Koinos Group, inventors of Koinos, developers of Koinos Pro