Pension-Bond Warnings Go Unheeded by Kansas Leaders: Muni Credit

Sam Brownback, governor of Kansas, speaks during a Bloomberg Television interview inside the Bloomberg Link during the Republican National Convention in Tampa, Florida, U.S., on Tuesday Aug. 28, 2012.

Photographer: David Paul Morris/Bloomberg

Kansas and Kentucky may borrow billions to invest in cash-strapped pension funds, undeterred by warnings the practice risks driving up taxpayers’ bills to retirees.

The states’ lawmakers are considering following a strategy used more than a decade ago by Illinois and New Jersey, which sold bonds to bolster retirement systems that have since fallen further behind. In January, with stocks close to record highs, a group of state and local-government officials advised against speculating with borrowed money, saying it may backfire if investments sour.

“There’s an exception to every rule,” said Beau Barnes, general counsel for the Kentucky Teachers’ Retirement System, which is backing a $3.3 billion bond to help close a $14 billion shortfall. “If we don’t do something really soon, this problem gets much, much worse.”

U.S. state and local governments have $1.3 trillion less than needed to cover pension benefits owed in the decades ahead, even after the Standard & Poor’s 500 Index tripled over the last six years, according to the Federal Reserve. Governments are under pressure to put more tax money aside to close the gap.

Speculative Wager

Selling bonds is a way to inject cash into retirement plans, with public officials speculating that they can earn more from investments than they will pay to borrow. With interest rates in the municipal market hovering above a half-century low, top-rated, 30-year taxable munis yield 3.65 percent, according to data compiled by Bloomberg. Pension funds typically assume they can earn more than twice that amount.

In Pennsylvania, Representative Glen Grell, a Republican, said he plans to introduce a bill next month that would authorize borrowing $9 billion as part of a pension-system overhaul aimed at cutting costs. Hamden, Connecticut, with a population of about 61,000 about six miles (10 kilometers) north of New Haven, on Tuesday is set to sell $125 million of the securities.

This year, governments have sold at least $340 million of pension bonds, compared with $368 million in all of 2014, Bloomberg data show.

Whether the strategy pays off depends on timing, according to a July study by the Center for Retirement Research at Boston College. While most pension bonds have been profitable because of stock gains since the recession, those sold after the late 1990s rally or before the 2008 crash lost money, the study found. Detroit’s pension-fund borrowing in 2005 and 2006 helped push it into the biggest municipal bankruptcy in U.S. history.

Questionable Timing

Sean Carney, head of muni strategy at New York-based BlackRock Inc., which oversees $116 billion in local debt, said now isn’t a good time for such deals.

“You’re doing it at a time when equity markets have hit all-time highs, which hasn’t proven to be a good strategy in the past,” he said.

In January, the Chicago-based Government Finance Officers Association, which advises its more than 16,000 members, recommended that state and city officials avoid such deals. The group said they pose “significant risks.” The Schaumburg, Illinois-based Society of Actuaries issued a similar recommendation last year.

Kansas Plan

Kansas Governor Sam Brownback, a Republican struggling to balance the budget after cutting taxes, has proposed borrowing $1.5 billion for the state’s retirement fund, which has a $7.4 billion shortfall. He’s seeking to cut Kansas’s pension contribution by $41 million to help close a deficit projected for the year ending in June.

Eileen Hawley, a spokeswoman for Brownback, referred questions to the Kansas Public Employees Retirement System. A spokeswoman for the pension, Kristen Basso, said the system profited from a $500 million pension bond sold in 2004. She said it earned 7.45 percent a year by investing the proceeds, more than the 5.39 percent it cost to borrow.

State Representative Ed Trimmer, Democrat from Winfield, 43 miles southeast of Wichita, has doubts.

“It’s a huge risk,” said Trimmer, who sits on a committee overseeing pensions. It “creates a bond payment that has to be made.”

Benefits Seen

Proponents disagree. The 2004 sale has saved Kansas more than $200 million, said state Senator Jeff King, a Republican from Independence who supports Brownback’s plan. He said he hadn’t read the government finance officers’ recommendations.

“We are using pension-obligation bonds as a tried-and-true way to manage that debt in the best way possible,” King said. “We are not using them to create new debt.”

As for Kentucky, Standard & Poor’s said in a January report that it may lower the state’s AA- credit rating, the fourth-highest rank, if the finances of the teachers’ pension plan don’t improve. The bond plan, sponsored by House of Representatives Speaker Greg Stumbo, a Democrat, would infuse cash into the system and give the state eight years to make its full annual pension contribution, said Barnes, the counsel for the teachers fund.

“We don’t have a lot of options,” said Barnes, who was aware of the advice of the finance-officer group. “Doing nothing is not an option.”

House Approval

The House approved the pension-bond bill on Monday, sending it to the Republican-led Senate.

Kentucky Governor Steve Beshear, a Democrat, said he wants to reach an agreement with legislative leaders that would strengthen the pension fund. He said he’s open to issuing bonds, though it may limit Kentucky’s ability to borrow for other projects.

“I do think we need to do something, so I’m kind of open in terms of what approach we take,” Beshear said in an interview in Washington, where he was attending a meeting of the National Governors Association.

Hamden, the Connecticut town, has no other choice, said Scott Jackson, the city’s mayor. With only 10 percent of the money it needs to cover future benefits, the city has little to invest to meet those bills. Without the new cash, Jackson said the pension might run out of money, which would mean paying retirement checks with the city’s general tax revenue.

“Nobody likes pension bonds,” he said. “It’s an indication something has gone horribly wrong.”

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