As the federal deficit rises, the US Treasury plans to borrow $329 billion between July and the end of September, and another $440 billion in the last three months of the year. If those numbers hold, the treasury will have increased its borrowing by 63% compared to the same six-month period a year ago.
The Treasury’s Borrowing Advisory Committee said this week that the monthly debt sales will continue to rise as the deficit continues to grow over the next several years, according to Josh Zumbrun and Daniel Kruger of The Wall Street Journal, Fiscal Times online reported.
Yields on treasury debt have been rising as the borrowing binge picks up speed, with the 10-year note touching 3% this week, an increase of three-quarters of a point in a year. The sheer size of US government borrowing is hanging over the bond market, Zumbrun and Kruger write, and many analysts think that increasing rates will lead to higher borrowing costs.
Strong demand for relatively safe US debt has kept those costs in check so far, however, although a stronger economy could reduce that demand significantly, sending interest rates higher.
The US Office of Management and Budget projects trillion-dollar deficits for the next four years, but most analysts expect that trend–and the related borrowing binge–to continue for much longer. The Journal’s Nick Timiraos pointed out that the White House’s projected decrease in the deficit starting in 2023 relies on two key assumptions:
1. 3% economic growth is sustained over many years
2. Congress makes substantial spending cuts starting in 2024.
“If neither of those assumptions hold–and few economists expect them to–we end up with permanent trillion-dollar deficits and a long-term deficit-to-GDP ratio near 5%. Deficits at 5% of GDP have only happened twice in the postwar period,” Timiraos notes, “and both followed periods of 10% unemployment.”
Bernard Baumohl, chief global economist at the Economic Outlook Group, said in a note to clients, “We’re applauding strong growth—yet have no choice but to borrow the largest amount of money since the financial crisis a decade ago. And that’s just the start, the US will be running trillion dollar deficits as far as the eye can see.”
$5 Trillion Pension Hole
Financially strapped cities and states in the US can’t afford the retirement payouts they made to public workers years ago and WSJ reports that by one estimate they are short $5 trillion, an amount that is roughly equal to the output of Japan, the world’s third-largest economy.
Many retirement funds could face insolvency unless governments increase taxes, divert funds or persuade workers to relinquish money they are owed, the Journal warned.
“Uncertainty over public pensions is one reason some Americans are reaching retirement age on shaky financial ground. For this group, median incomes, including social security and retirement fund receipts, haven’t risen in years. They have high average debt, and are often using savings for their children’s education and to care for their elderly parents,” WSJ explained.
Cost-Sharing Mechanism
“State and local pensions lost roughly $35 billion in assets between 2008 and 2009, according to Pew. Liabilities, meanwhile, ballooned by more than $100 billion a year, widening the difference between the amount owed to retirees and assets on hand. Not even a nine-year bull market in stocks could close that gap.”
Meanwhile, Maine has adopted a risk-sharing plan for municipal employees that participate in the system starting the fiscal year that began July 1. Under the plan, the risks of investment gains and losses aren’t just assumed by taxpayers, but shared between local governments, their employees and retirees.
Most US public pensions were fully funded as recently as 2000, but the collapse of the internet bubble and the Great Recession caused by the financial crisis of 2008—combined in some cases with years of contribution shortfalls and unfunded benefit increases—resulted in pension debt exceeding $1 trillion, Bloomberg reported.
Between 2003 and 2013 the cost of making required pension payments almost doubled, according to a 2017 report from the Pew Charitable Trusts.
In response, some pensions have adopted formal cost-sharing mechanisms, adjusting contributions or benefits, instead of making unplanned benefit cuts or contribution increases. Almost 30 defined benefit pension plans in 17 states use cost-sharing mechanisms to manage risk, according to the Pew report.
Changing Retiree Benefits
Some states, such as Illinois and New York, have constitutional or statutory prohibitions on changing retiree benefits.
Maine capped contribution rates by municipalities at 12.5% and 9% for employees, giving both parties certainty about how high costs would go to make up for investment losses. If pension losses exceed the capped contribution rates, retiree cost of living adjustments are reduced. Maine’s local governments and employees share in investment gains and losses at a 55% to 45% split.
Had Maine’s plan been in effect after the financial crisis, contribution rates would have increased to 12.5% and 9% and held there for five years. Retirees would have had a 30% annual reduction in cost of living adjustment for seven years, according to Gene Kalwarski, chief executive officer at Cheiron, a McLean, Virginia-based actuarial and financial consultancy.
When the markets rebound and investment gains exceed the assumed investment return, the COLA would increase until reaching a cap of 2.5%. Further gains would allow employers and employees to reduce contributions for services performed by current members when the plan is fully-funded, to a minimum of about 14%, 7.7% for employers and 6.2% for employees.
