Wednesday, December 11, 2013

Nobel Prize Winner: Illinois In *much* worse shape than people think

There's been lots of crowing - and complaining - about the recently passed (and signed) Pension "Reform" legislation by the Illinois General Assembly.   There were plenty of folks who said that the bill doesn't go far enough and compared it to putting a 'band-aid on a bullet hole'.  

Everyday, we learn more and that analogy might end up being appropriate.  And that the 'reform' that passed was a step in the right direction - but clearly was NOT enough.  

First, it was the news that the State income tax hike - passed in 2009 - as a "temporary" income tax hike appears to be headed to being a permanent 67% increase.  

Now, news is coming out that we weren't getting the full story on the breath of the pension problem.  

Everybody is an expert these days, but some are a bit smarter than others.  Chicago Magazine recently sat down with University of Chicago "Market Maven" and Nobel Prize winner Eugene Fama where they talked about Illinois and the state of bonds.

More bad news for Illinois as Dr. Fama 'lifts the kimono' a bit in talking about how Illinois discounts liabilities and what the implications are for Illinois' pensions problem:
How do you feel about buying Illinois bonds?Well, in the short term, they’re OK. In the long term, I wouldn’t touch them. The [state’s] pension liability is much worse than [the reported $100 billion that] people think. 
How so?States discount their liabilities—I think Illinois uses a discount of 7.5 percent [it’s between 7 and 8]—arguing that’s the expected [annual] return on their portfolio. But the expected return on a portfolio is totally irrelevant. What counts is, How risky are the claims that you have to meet? You’ve made a promise to your employees that you’ll pay them a certain fraction of their income that is usually indexed. Which means it’s a risk-free real outcome. What’s the risk-free real rate? Is it anywhere near 7.5 percent? It isn’t. Historically, it’s like 2 percent. A 2 percent discount rate would approximately triple Illinois’s pension liabilities.
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