Stock Prices and Public Employee Pensions: A History

Many Americans are feeling outrage over top executives who made risky assumptions, looked good in the short run, paid each other massive amounts, and walked out the door with enormous golden parachutes when their bets went sour. Shareholders — and perhaps in some cases taxpayers — are left with the bill. For the past 40 years, however, elected officials and the public employee unions that support them have done the same thing. Whenever the stock market has been on a tear, they have upped the assumption of future rates of return and handed out “free” pension enhancements, claiming the stock market would pay for it all. And later, when the stock market turned down and pension contributions soared, the resulting tax increases, service cuts, and diminished wages and benefits for newly hired public employees have been described as the “inevitable” result of “circumstances beyond our control.” The prior pension enrichments are never given back, just like those executive bonuses. There have been two such cycles in a general sense, as the attached chart shows. In recent years, however, the state legislature has been even more irresponsible – handing out more pension benefits even when the stock market is down, taxes are rising, and services are being cut.

The chart shows the S&P 500 index for the start of March of each year, adjusted for inflation into current dollars, with some of the key pension deals over the years.

The first cycle was generated by the “nifty fifty” stock bubble of the early 1960s. Stock prices tripled in inflation-adjusted dollars in the years from 1954 to 1966 before the fever broke. And right at the peak of the bubble in 1966, following a transit strike, New York City Mayor Lindsay handed out the rich “Tier 1” pensions to transit workers, with strikes by other unions and other pension enrichments following thereafter. When the city’s pension costs (and other costs) soared, the Lindsay Administration followed with borrowing to delay any sacrifices, until the city was broke.

To put some numbers on this, public employee pension contributions by the City of New York rose from 15.5% of wages in 1967 and 12.1% in 1972 to 28.6% in 1982, according to long term data received from the Governments division of the U.S. Census Bureau. The reduction from 1967 to 1972 is presumably a result of the New York City Transit Authority being shifted to the MTA in 1968. The MTA, created with the promise of substantial transportation improvements to the transit system, would use the money for pensions instead.

Throughout the 1970s, as stocks prices retreated (eventually falling nearly back to where they were if inflation is considered), the city had to make up the difference by increasing pension contributions and cutting public services. So did the MTA, which had taken over the subways. The resulting collapse of the public school system and transit system, deteriorated roads and parks, and vastly diminished services, all while hundreds of thousands of former public employees moved from the suburbs (where they were insulated from the problems) to Florida to live in leisure, is considered a great victory of public employee unionism.

With public services essentially wrecked, the unions agreed to bail out the city by agreeing to vastly diminished wages and benefits – for their FUTURE members. That is how they helped — “save the city” — by agreeing to huge cutbacks in public services and the well being of their future members. Following the Tier 1 pension benefits, there were Tier II, Tier III and Tier IV. In 1995, at the end of another fiscal crisis, Giuliani and the unions agreed to a de-facto Tier V, with new hires (except certain titles like police, fire and teachers) forced to contribute 5.85% of their pay to the pensions – compared with nothing for those in Tier I, and 3.0% for those hired previously in Tier IV. The new hires would be allowed to retire at age 57 rather than 62, but that didn’t make up for the change.

Other contract provisions added over the years also provided lower pay and diminished vacation time for new hires in exchange for better raises (and those pensions) for those about to retire. New York City came to have the lowest paid teachers and police officers in the metropolitan region, but one could argue they gave New Yorkers what they paid for – soaring crime and failing schools. In the case of teachers, a rising share were uncertified, while more motivated teachers moved on to the suburbs – where they lived – as soon as they could. In the early 1990s, in lieu of better wages which he couldn’t afford, Mayor Dinkins agreed that school principals would no longer be allowed to see what work the teachers were doing. At the school down the street, the neighbors told me, one of the third grade teachers stopped teaching math (as in zero math teaching — no one lesson) soon after. Didn’t want to be bothered, and had his rights, and just didn’t do it.

In a way the 1960s pension enhancements were an understandable mistake. Millions of baby boomers were moving out of college and swarming into the labor force, and the next 20 years would be characterized by high unemployment and a labor surplus. Better to get the oldsters out of the way to make room for them, was the thinking in the public and private sectors, especially if the bill could be deferred.

When the bill came due, and it was so high no one could afford it, lots of private corporations went broke and abandoned their pensions, leading to the ERISA (federal pension protection legislation) in 1974. For older cities tax increases, the flight of taxpayers, service collapses, and the flight of the middle class were the result. In either the public or private case it didn’t help that soaring pension costs hit right when other problems hit as well, notably a souring economy. But that is the nature of pensions – the bad economy produces lower investment returns requiring more pension contributions at the worst possible time.

Beginning in the early 1980s, the private sector generally stopped offering defined benefit pension plans to new employees, and today few private sector workers have them. Those that do are at risk of losing them through bankruptcy and the Pension Benefit Guaranty Corporation, established by ERISA, may be heading for bankruptcy itself. It has recently been investing in hedge funds to get out of the hole, just in time for the collapse of that type of investment. That, as far as private sector pensions are concerned, is the end of the story.

But for public sector pensions the cycle repeated. Another bull market started in 1982, allowing the City of New York to reduce its pension contributions to more reasonable levels. From 1991 to 1997, NYC’s pension contributions varied from 9.0% to 10.0% of wages, a reasonable amount when combined with the (much lower) contributions of the employees themselves. When that solid stock market turned into an unsustainable bubble after 1995, however, the irresponsibility, and the selling out of the future, began.

First the city and state cut the employer pension contributions, in the case of the State of New York (which also provides the pensions for public employees outside New York City) to zero. Former State Comptroller Carl McCall got great credit from local governments for eliminating their required payments. For the city, contributions were cut to around 8.0% of wages in 1998 and 1999 and under 5.0% of wages in 2000 and 2001, in the latter case after deals by the state and city administrations that also enriched pensions.

McCall, courting union support to run for Governor, pushed a provision to provide an inflation adjustment for public employee pensions, something that most of those who would benefit, many already retired, had neither worked nor bargained for. McCall claimed that the improved pensions would be “free” — the rising stock market would pay for it all. But at the same time, McCall’s staff was writing report after report claiming that the state’s fiscal situation was not as good as then-Governor Pataki claimed it was. Pataki was benefiting from an unsustainable boom on Wall Street. Working at City Planning, I used to receive and read those reports. So McCall knew the stock market boom would not go on forever, but pushed the pension enhancement anyway.

Former Mayor Giuliani, looking to run for Senate in 2000, wanted lots of money to hand out in the form of tax breaks, jobs, temporary improvements in services, etc in the short run, and was willing to sacrifice the city’s future to do it. So he agreed to a deal with the unions that eliminated the employees’ pension contributions — but only for those with more than 10 years’ seniority. As a result those hired before 1995 pay nothing. Those hired after 1995 pay 5.85% (for DC 37) for 10 years and 2.85% ever after. In exchange, the unions agreed not to challenge his assumption that the stock market, beginning at 2000 peak levels (look at that chart again) would go up from there, ever after, meaning the City of New York didn’t have to put as much in either.

Pataki, who I blame for much but not for this, vetoed the pension enhancements several times before giving in, and then taking credit, for the deal. He later vetoed a deal for transit workers to retire at age 50 after working 20 years, instead of 55 after 25 years. It had passed the state legislature unanimously. In response the Transit Workers Union went on strike.

As part of the same 2000 deal, to make it seem like all these favors handed out wouldn’t cost anything, the assumed rate of return on the city and state pension funds was increased from 7.0% to 8.0%. Voila, there was plenty of money! Well if the S&P 500 had gone up 8.0% per year from the beginning of March 2000 to the beginning of March 2008, it would have been at 2,731 a month and a half ago. In reality it was at 1,330, or less than half as much. And NYC and local governments elsewhere had to make up all that money, in addition to the soaring cost of retiree health care.

How has that affected the share of our taxes going to the retired, as opposed to those providing public services today? Well, NYC pension contributions equaled 27.4% of wages and salaries in FY 2008 according to the January financial plan, and will equal 28.5% of wages and salaries in FY 2009. Does that number seem familiar? It is 0.1% less than the prior peak level in 1982. So far.

And how has the city paid for this? In the last recession, the City of New York (now in the Bloomberg Administration) raised property taxes by 18%, since partially reduced, agreed with DC 37 to cut the pay of new hires in most government jobs by 15%. When the police contract went to arbitration, the Bloomberg administration proposed a 40% cut in the pay of new hires to get the city out of the hole. The union accepted — leading to new police officers paid $25,000 per year. The Bloomberg Administration later cut the same deal with the firefighters without the benefit of an arbitrator, and agreed with the UFT to reduce the pay scale for new teachers by 6.0% compared with those hired previously.

The second cycle had the same pattern as the first, in other words. When stocks are up, enhance the pensions for those cashing in and moving out, and say it will be free. When stocks are down, cut services, raise taxes, and cut the pay of future employees. Take another look at that chart. We’ve got many more years of a secular bear market before it is over. Prices have yet to regress to the mean, and that other den of thieves — the executives — continue to feel free to continue to award themselves richer and richer salaries while paying a 2.0% dividend, half the inflation rate before taxes. Moreover, a partial recovery of the stock market — and city tax revenues — deferred some of the sacrifices that are coming, until the next recession, now coming on.

But why wait.

As I wrote here, Mayor Bloomberg cut another pension deal with the UFT to provide teachers with full pensions at age 55 instead of 62, after working 25 years instead of 30. The state legislature passed it with no debate and almost no votes against. In the State Senate, the plan passed unanimously after the statewide teacher’s union agreed to endorse a Republican in a special election. Governor Spitzer signed it just before his prostitution scandal broke — I knew he was screwing the young before anyone else. Effective immediately, those age 55 get to retire without paying in an extra dime to the pensions. Bloomberg and the UFT say that much higher pension contributions by future teachers (reducing their take home pay), also a part of the deal, will pay for it over and above the additional $100 million the city agreed to kick in to the pension plan. But press coverage of the deal was very limited, the assumptions behind this assertion are nowhere to be found, and no press releases were issued when the deal was approved. But it appears that the cost of retiree health care was not included in the assertion that this gift of years of leisure on someone else’s dime would cost almost nothing.

Soon after, budget cuts for the city schools were announced. And perhaps, when things get really bad, they will agree to pay new teachers $25,000 per year too, perhaps getting a wavier of certification requirements from the state as they do so. I’ve been getting e-mails with the propaganda — that the school budgets are being cut because all the money is going to administration. But I know, based on data from the U.S. Census Bureau, that isn’t the cast (see this post — new data is out and I’ll have it up soon). The extra money is going to pensions and other benefits, but now with the recession that money isn’t extra anymore, so actual education is being cut — and things will get much, much worse a year from now.

What makes this deal different? The pension enhancement was passed not at the peak of a stock bubble, but at a point where everyone knows that things are going downhill. And instead of Step One being a richer deal for those cashing in and moving out and Step Two being a worse deal for those hired in the future, the two steps were combined into one deal.

Imagine a situation where only half of the tax dollars you pay go for public services and benefits, with the other half going to retired public employees and debts. That is where we are going. That is what has been done to us. Again.

And again and again. Every year, the state legislators introduce many bills enriching the pensions of public employees (including themselves), or groups of public employees, or even individual public employees. Many pass, always unanimously and without debate, and some are signed by the Governor. Governors routinely issue press releases in this state for grants in the low seven figures. These vastly expensive deals go unreported.

What about the members of public employee unions, who have been on the wrong side of all these deals. Why don’t they revolt and demand more pay for those who have been victimized by multi-tier deals in the past, not richer retirement benefits for those cashing in and moving out? Why don’t they demand equity from those who came before? Like voters, these union members do not have a voice. The deal isn’t that union members give money to unions to represent them. It is that state and local government seizes money from union members as a condition of their employment, and then hands it over to the unions in exchange for political support for the incumbents. And if someone gets uppity and tries to force an actual election? Then the ballots suddenly disappear, as they did at the Civil Service Technical Guild when I worked at City Planning.

This is about the point where, in the past, I would follow with another post concerning what should be done about pensions, for the benefit of the majority of people, whose without special deals, and the future. But, as I wrote here, I’ve given up on that. The limited number of interests that control our social institutions — public, corporate, non-profit — are going to keep taking more and more until those social institutions collapse, and no one has a say or a way to stop it.

So instead I have the following request for the public employee unions and state legislators, including the one who is now Governor. Stop dragging this out by taking things one step at a time. Why not take things to their logical conclusion right now, so the rest of us can get used to what our future will be like?

Just pass a new bill that says that any public employee with more than 10 years seniority (including accumulated sick days) gets to retire immediately, with a full pension, guaranteed health care, and a permanent parking placard at three-quarters pay, on the “presumption” that they shouldn’t have to work to provide benefits for the people who don’t count, the people who don’t count should have to work to provide goods and services for them. And to pay for it, future public employees will be required to work 50 years at the minimum wage without vacations before retiring at age 80 with a pension of $1.98 per year. If no one is willing to show up and work for that, all public services and benefits would simply disappear — but taxes would not. After all, providing younger generations and those relying on public services with anything more wouldn’t be fair, would it?