Virginia and the Next Global Debt Crisis

Ten years ago the Lehman Brothers debacle precipitated the financial meltdown we associate with the Great Recession, and the financial media are full of retrospectives. A key question is what lessons we learned from the epic failure. The main conclusion drawn, according to Daniel J. Arbess in the Wall Street Journal today, appears to be that the way to dig out of a debt-fueled financial crisis is to pile on more debt. But that doubles down on the original problem, he warns:

In the past decade, total global debt (sovereign, corporate and household) has spiked nearly 75%. This includes a doubling of sovereign debt, from $29 trillion to $60 trillion, according to a recent McKinsey report. Total corporate debt increased by 78% over the same decade, to $66 trillion. Bank loan volumes have been stable, although low-quality “covenant lite” loans have dominated. Bond markets have filled in, with nonfinancial bonds outstanding up 172%, from $4.3 trillion to $11.7 trillion. McKinsey says 40% of U.S. companies are rated one notch above “junk” or lower, and the Bank for International Settlements estimates 10% of legacy companies in the developed world are “zombies,” meaning earnings before interest and taxes don’t cover interest expenses.

This is what zero interest rates and quantitative easing have wrought — more debt and lower credit quality. … Higher rates are coming, possibly heralding a tsunami of credit defaults.

As the Federal Reserve and the European Central Bank slowly dial back quantitative easing, interest rates will rise, stressing debt-laden governments, corporations and households. We are already seeing the effects in Turkey, Venezuela, Argentina and other developing nations as higher U.S. interest rates push the value of the dollar higher. Defaults in developing countries will be transmitted to the developed world in ways foreseeable and unforeseeable. The financial media have remarked upon the massive exposure of Spanish banks to the Turkish economy, for instance, which could prove problematic for the larger Spanish economy, the 13th largest in the world. But global markets are so complex and intertwined that defaults can spread as unpredictably and explosively as the sub-prime mortgage loan crisis in the U.S. did ten years ago via financial innovations that have so far eluded the notice of media and regulators.

What’s it to us? That’s all fine and good for bond traders and hedge fund managers, you say, but what difference does it make to Virginia? It matters because Virginia is part of the global economy and global financial system, and what happens elsewhere will impact us. The policies we pursue at the level of state/local government can make us more vulnerable to, or more resilient in the face of, the next financial crisis.

To be sure, the Commonwealth is nowhere as vulnerable as, say, Puerto Rico was before it declared bankruptcy, or as Illinois and Chicago now are. We have a AAA credit rating, we balance our budget with only a modicum of chiseling, and we pay our bills on time. But the bond rating of the Commonwealth does not tell us anything about the indebtedness of our local governments, our universities, our hospitals, our quasi-government organizations, our economic development authorities, our housing authorities and all the other bond-issuing entities in the state. No one has toted up all those numbers.

We continually discover things we didn’t know before. While Virginia’s $20 billion or so in unfunded pension liabilities are well known, only recently has our attention been drawn to the $3.5 billion in pension liabilities at the Washington Metropolitan Area Transit Authority (WMATA), which operates Northern Virginia’s heavy rail mass transit system and much of its bus system. As the Government Accountability Organization concluded, “Due to their relative size, proportion of retirees compared to active members, and investment decisions, these pension plans pose significant risk to WMATA’s financial operations, yet WMATA has not fully assessed the risks.”

How many other WMATAs are out there?

The Metropolitan Washington Airports Authority (MWAA) comprehensive annual financial report indicates that the authority’s two pension plans were fully funded as of Dec. 21, 2017. The General Employees Retirement Plan was seemingly in great shape with assets amounting to 105% of pension liabilities. Great news! But dig into the assumptions, and we see that the pension plan projects a 7.5% annualized investment rate of return. Many actuaries are saying now that a 7% or 6.5% rate is more realistic.

Similarly, the Ports of Virginia reported an unfunded pension liability of only $8.9 million as of June 30, 2016, an improvement over the previous year. The pension was about 91% funded. The ports assumed a 7% investment rate of return, somewhat more conservative than MWAA’s assumption.

MWAA and the Ports of Virginia are two of the largest quasi-governmental business entities in Virginia, and it is reassuring to see that they have their pensions under reasonably good control. But there are dozens if not hundreds of other bond-issuing entities in the Commonwealth. After the Petersburg fiscal meltdown, the General Assembly began watching for early warning signs in Virginia’s local governments, but there are dozens if not hundreds of other entities that issue bonds and borrow money. The federal government conducts “stress” tests on too-big-to-fail banks to see how they would hold up under adverse economic circumstances. Is anyone conducting stress tests for Virginia’s public and quasi-public entities? Not very likely.

The bottom line: Another global debt crisis is inevitable, the only questions are when it happens and how the damage ricochets throughout the global economy. How vulnerable is Virginia? We really don’t know. To be forewarned, as the saying goes, is to be forearmed. We are neither.

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12 responses to “Virginia and the Next Global Debt Crisis

  1. so I have a really dumb question but I suspect others don’t know either and I don’t think I’ve ever seen it explained here.

    What does it mean if it is said that a pension is fully funded?

    What does it mean if it is not?

    okay, 2 or more questions.

    so if a pension is NOT fully funded does it mean they cannot pay 100% of pensions currently being paid out?

    does it mean they can pay it but in some number of years they cannot unless they pay more into the fund between now and then?

    How close is Virginia in it’s debt and liabilities ..say compared to Greece or Venezuela

    I think it’s important to understand this BEFORE we go talking about govt and pensions going broke…

    OH … by the way whatever happened to the GOP and Conservatives Balanced Budget initiative? Seems like it has totally disappeared from their lexicon!!!!

  2. WMATA does not operate Northern Virginia’s commuter rail.

    Virginia Railway Express (VRE) is managed by Northern Virginia Transportation Commission (NVTC) and Potomac and Rappahannock Transportation Commission (PRTC).

  3. If and when they can’t honor the pension obligations, they won’t. And nobody depending on those pensions has any reason to hope the taxpayers will happily pony up more in a massive inter-generational transfer of wealth.

    • I wouldn’t be too sure. While the taxpayers might not “happily” bail them out they might not have any choice as NoVa’s increasingly liberal state legislators agree to a special regional tax to bail out WMATA pensioners. Anybody following the campaign of Jennifer Wexton can see the shift from Progressivism to socialism in NoVa.

  4. If we don’t fully fund pensions – we already know how that plays out because Social Security has told us how that would work.

    You still get your pension – but you get less than promised.

    It’s not rocket science.

    Before we blame govt – three things:

    1. – there are hundreds of companies that failed to fully fund their pensions and the big bad incompetent Govt bailed them out.

    2. – We could do a law/regulation for all pensions like the one done for the Postal Service …

    3. – The big bad incompetent govt actually allows all of us to put money in a retirement account without paying taxes on it – at a cost to the budget – and people do not take advantage of it – and often end up relying primarily on their Social Security which many Conservative types over the years who either want to kill it outright or allow people put that money into their own personal accounts – which we already know less than half will do.

    Finally if we want to talk about inter-generational transfer of money – nothing is more massive and unsustainable than Medicare since we’ve added Medicare Advantage to it and now the Govt subsidizes 100% coverage with no co-pay instead of the original Medicare which has a 20% co-pay.

    I seldom hear on these tomes – what we should do to fix them problem other than kill Social Security or pay less generous pensions… which, if you think about it, are mutually-opposing actions..

    The real thing that is killing retirement and leading to intergenerational transfers is our health care system which is by far the most-costly system in the civilized world … while we call those other countries “socialist” and watch our own folks – refuse to fully fund their own 401Ks and expect the govt to “help” them in retirement.

    We could fix these things… without the current blame game sans any whacko extreme Conservative “solutions”,but we don’t.. we seem to actually prefer the never-ending blame game..

    • You’re arguing with yourself again Larry. You start by saying we know how under-funded pensions work because of Social Security. Then you cite government bailouts of under-funded pensions at private companies. Which is it? the government will bail out Social Security in order to keep benefits at the advertised level or government will stop bailing out pensions?

      I’m guessing that the pending reduction in Social Security benefits will be at least partially offset by higher taxes on working Americans. One can hear teary eyed liberals like Elizabeth Warren and Bernie Saunders citing specific cases of people on Social Security forced to eat dog food based on the reduction in benefits. Pravda on the Potomac will happily join in with editorial after editorial decrying the vast unfairness of it all.

      Government is bad and incompetent. The original Social Security was meant to be a “patch on the pants” for retired people. However, over time, politicians saw that could buy votes by endlessly expanding the program. So, expand it they did. Reagan and O’Neill saw that there was a crisis and got a stop-gap measure (the trust fund) through Congress and onto The Gipper’s desk. Decades later nothing has been done about the mathematically certain drop off in benefits. That’s the epitome of incompetence.

      • Well no.. not actually arguing with myself. I’m relating what I’ve heard from others…

        AND I’m pointing out that ANY actuarial system is subject to things like people living longer and ANYONE who “believes” that those realities won’t affect pensions – public or private is living in LA LA Land. Blaming the govt for being subjected to the same actuarial forces that affect other pensions is not an intelligent thing.

        And making this issue about Liberal and Conservatives is equally dumderhead.

        It’s like the Conservatives want to blame the Liberals for actuarial realities and at the same time the Conservatives have no real “fixes” to the problem – only affixing blame …. to “liberal policies” – as if this is not a fairly universal problem … to start with – and again – no solutions.. just blaming .

        FINALLY – don’t be blaming the govt for your own inability and refusal to set aside your own retirement – no matter what the govt does or does not do AND DEPENDING on the govt to make your retirement secure by giving you health insurance ! What REAL Conservative would actually support the govt subsidizing your health care? Yet they do….not only Medicare but employer-provided.

        All I say is that let’s deal with the truth on these issues and not your favorite left or right fairy tale..

        how about it?

  5. Fix the problem. First start by eliminating all defined benefit pension plans for government employees not retired or vested. Move to defined contribution plans or hybrid plans like the federal FERS plan and VRS.

    Second, adopt qualification requirements that use the rule of 90 (age plus years of employment must equal 90 before one can retire). Change plans that base pensions on an employee’s top three years to his/her top five years’ earnings.

    Third require higher employee contributions to defined benefit or hybrid plans that are comparable to what private sector employees contribute.

    Eliminate, except for first responders, all supplemental pension plans that pay a retiree the equivalent of Social Security until he/she is eligible for Social Security benefits. Partially liquidate existing plans and give vested employees a credit to their main pension plan. Pay benefits to existing retirees but only until they are 62.

    These changes won’t fix all the problems but they will surely stop them from getting bigger.

  6. Are we actually agreeing on what the problem is? I’m not seeing data that says it’s a Federal employee problem . Do we know what the status is of the Federal employee pension system?

    Also – the standard for Fed employees now is the FERS which is a hybrid.

    I think I might LIKE your second proposal.. at least it’s one of the more reasonable ones I’ve heard lately.

    On the third – I’m not convinced that public sector pensions are worse than private sector… perhaps there is data to show this?

    On your last point – you have a point that we agree on in general for any occupation where you can retire with full pension – AND health care long before age 65. This is especially true of folks that serve in the Armed Forces – retire after 20 years and go to work for public safety organizations.

    It’s totally true that they have served their country – twice – and they need to be treated fairly and kept whole. On the other hand – I don’t think most folks realize on a public sector basis – just how big law enforcement and public safety is compared to education and transit not only with respect to pensions but OPEB, i.e. health insurance

    We need to better explore and understand these issues – beyond the current round-robin whack-a-mole on selected favorite targets.

    And the 600lb gorilla in the fiscal realm is Medicare Advantage (as opposed to original Medicare).

    Original Medicare – Part A (that we pay for when we work via FICA taxes) and Part B which we pay for at the princely sum of $134 a month. That Medicare covers 80% and you have a 20% co-pay whereas Medicare Advantage – heavily subsidized – often covers 100% AND provides optical, dental and hearing (that Medicare does not cover at all).

    Most people would not save near enough for retirement if we did not have Medicare. Most folks who retire – if they did not have Medicare – their savings would be wiped out by common aged-related health problems

    That’s the core of the issue. Our current pension system is totally predicated on Medicare coming online when someone gets to age 65.

    You said fix Social Security according to age + work years. Why not Medicare in a similar way so that while you’re entitled to get Medicare – you pay the premium required to keep it from being subsidized and that would be more like what we pay for health insurance before Medicare?

    I don’t think that public sector employees are “THE” problem. I think it’s a bigger thing than that – that involves most workers…

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