Defined Benefit Pension Plans are, almost by definition, a ponzi scheme. Current assets are used to pay current claims in full in spite of insufficient funding to pay future liabilities: classic Ponzi. But unlike wall street and corporate ponzi schemes no one goes to jail here because the establishment is complicit. Everyone from government officials to union bosses are incentivized to maintain the status quo - public employees get to sleep better at night thinking they have a "retirement plan," public legislators get to be re-elected by union membership while pretending their states are solvent and union bosses get to keep their jobs while hiding the truth from employees.

We even published a note several weeks ago titled "Establishment Tries To Suppress "Dissident Actuaries" Explosive Report On Public Pensions," which pointed out that the American Academy of Actuaries and the Society of Actuaries killed a report that would have warned about the implications of lowering long-term expected returns on pension assets. Apparently the truth was just too scary.

Similarly, Janus' Bill Gross has been warning of the unintended consequences of low interest rates for years, and reiterated his concerns to Bloomberg recently:

Fund managers that have been counting on returns of 7 percent to 8 percent may need to adjust that to around 4 percent, Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, said during an Aug. 5 interview on Bloomberg TV. Public pensions, including the California Public Employees’ Retirement System, the largest in the U.S., are reporting gains of less than 1 percent for the fiscal year ended June 30.

Two weeks ago, we decided to take a look at what would happen if all federal, state and local pension plans decided to heed the advice of Mr. Gross. As one might suspect, the results were abysmal. We conservatively assume that public pensions are currently $2.0 trillion underfunded ($4.5 trillion of assets for $6.5 trillion of liabilities) even though we've seen estimates that suggest $3.5 trillion or more might be more appropriate. We then adjusted the return on asset assumption down from the 7.5% used by most pensions to the 4.0% suggested by Mr. Gross and found that true public pension underfunding could be closer to $5.5 trillion, or over 2.5x more than current estimates. Others have suggested that returns should be closer to risk-free rates which would imply an even more draconian $8.4 trillion underfunding.

The result which we dubbed an "Unsolvable Math Problem", is the reason why so few pension funds have dared to address this issue face on.

However, to our surprise perhaps because they realize just how near to the end really is or for other unknown reason, certain pension funds are finally taking notice, and action. In early August, Richard Ingram of Illinois's largest pension fund announced that he would be taking another look at long-term return expectations noting that "anybody that doesn’t consider revisiting what their assumed rate of return is would be ignoring reality." Ingram's Illinois Teachers' Retirement System is only 41.5% funded and currently assumes annual returns of 7.5%, down from 8% in 2014.

And right here we get an example of precisely why US pensions are a legal ponzi, because the moment one person is willing to do the right thing, and evaluate the situation soberly, someone else promptly steps in, realizing that if just one card is removed from the house of cards, the whole thing collapses.

Enter Illinois governor Bruce Rauner, who warned that should his state's largest public pension fund do what it should have done long ago, it would put a big dent in the state's already fragile finances and lead to "crippling" pension payment hikes, Reuters reported today.



Bruce Rauner and his wife Diana

According to a Monday memo from a top Rauner aide, the Teachers' Retirement System (TRS) board could (or rather, should) decide at its meeting this week to lower the assumed investment return rate, warning that this move "would automatically boost Illinois' annual pension payment."

"If the (TRS) board were to approve a lower assumed rate of return taxpayers will be automatically and immediately on the hook for potentially hundreds of millions of dollars in higher taxes or reduced services," Michael Mahoney, Rauner's senior advisor for revenue and pensions, wrote to the governor’s chief of staff, Richard Goldberg.

As a reminder, the TRS already lowered its assumed rate of return once, back in 2014, and as a result of the even bigger underfunding hole created by the lower assumed rate of return, the state's pension payment increased by more than $200 million, according to the memo.

It is about to do it again, only this time it would have to cut the discount rate far lower, if it wishes to be even remotely realistic: recall Gross' suggestion is to lower the expected return to 4% (or even lower). However, as we reported two weeks ago, the TRS hole is already gargantuan and about to get even bigger. Illinois' fiscal 2017 pension payment to its five retirement systems was estimated at $7.9 billion, up from $7.617 billion in fiscal 2016 and $6.9 billion in fiscal 2015, according to a March report by a bipartisan legislative commission. The country's fifth-largest state's unfunded pension liability stood at $111 billion at the end of fiscal 2015, with TRS accounting for more than 55 percent of that gap. The funded ratio remains just under 42%, implying that any rate reductions will push the already frigthfully low funding ratio even lower.

And this is where the politicians come in.

An impasse between the Republican governor and Democrats who control the legislature left Illinois as the only state without a complete 2016 budget, however a six-month fiscal 2017 spending plan was passed in June.

Still, Mahoney has cautioned that "unforeseen and unknown automatic cost increases would have a devastating impact" on Illinois' ability to fund social services and education.

What Rauner's senior advisor is essentially saying, is that if the TRS does what the Fed and other central banks are forcing it to do, our political careers may be over, and that could be just the beginning.

And here is the punchline: one of Rauner's top Republican legislative allies, Senate Minority Leader Christine Radogno, urged the TRS board to delay a vote Friday to give the public time to weigh in on its possible actions. "This issue is important enough at the very least to put the TRS board on notice we don’t want them taking any action that could cost taxpayers $200 to $300 million without appropriate scrutiny,” she said. The action in question, Radogano is demanding the TRS not take, is to lower its return expectations from the ludicrous 7.5% to something realistic; instead she is suggesting the fund pretend all is well, and avoid the day of reckoning for at least a few more years, ideally until she has quit as Senate Minority Leader, at which point the TRS can by all means go ahead and admit just how terrible its underfunding truly is.

Translation: please keep your heads stuck in the sand, and dare not admit the reality of near-zero returns in the new normal, but instead keep the projected return rate at 7.5%, or else you will not only admit just how much bigger the underfunding hole truly is, but the resultant surge in public anger following the broad rise in taxes coupled with cut to pensioner benefits could lead to millions of furious voters sweeping all of Illinois' current career politicians right into the unemployment office.

Incidentally, this is precisely the fight that countless ponzi schemes, pardon pension funds, across the US will be forced to go through in the coming months, unless somehow the Fed funds a way to guarantee 8% returns every year, or else sending inflation soaring, and wiping out the fund's liabilities.

Since neither is likely to happen for a while, the biggest losers will once again be taxpayers and pensions recipients, who this time will be forced to pay - literally - because their public fiduciaries lied to them, and because other fiduciaries are hoping the lies will continue for at least a few more years.