Money manager Rob Arnott and finance professor Lisa Meulbroek
have run the numbers on underfunded pension plans and come up with an
interesting – and highly concerning – new angle: That they impose a “stealth
mortgage” on homeowners. Here’s how the Wall Street Journal reported it today:
Most cities, counties and states have committed taxpayers to
significant future unfunded spending. This mostly takes the form of pension and
postretirement health-care obligations for public employees, a burden that
averages $75,000 per household but exceeds $100,000 per household in some
states. Many states protect public pensions in their constitutions, meaning
they cannot be renegotiated. Future pension obligations simply must be paid,
either through higher taxes or cuts to public services.
Is there a way out for taxpayers in states that are deep in the
red? Milton Friedman famously observed that the only thing more mobile than the
wealthy is their capital. Some residents may hope that they can avoid the
pension crash by decamping to a more fiscally sound state.
But this escape may be illusory. State taxes are collected on four
economic activities: consumption (sales tax), labor and investment (income tax)
and real-estate ownership (property tax). The affluent can escape sales and
income taxes by moving to a new state—but real estate stays behind. Property
values must ultimately support the obligations that politicians have promised,
even if those obligations aren’t properly funded, because real estate is the
only source of state and local revenue that can’t pick up and move elsewhere.
Whether or not unfunded obligations are paid with property taxes, it’s the
property that backs the obligations in the end.
When property owners choose to sell and become tax refugees, they
pass along the burden to the next owner. And buyers of properties in troubled
states will demand lower prices if they expect property taxes to increase.
It doesn’t matter if we own or rent; landlords pass higher taxes
on to tenants. Nor does it matter if properties are mortgaged to the hilt or
owned outright. In time, unfunded pension obligations will be reflected in
real-estate prices, if they aren’t already. A state’s unfunded liabilities are
effectively a stealth mortgage on private property. Think you can pass your
property on to your heirs? Only net of the unfunded pension obligations.
We calculated the ratio of unfunded pension obligations relative
to property values in each state. We used 3% bond-market yields as our discount
rate to measure unfunded obligations, because while other assets ostensibly
earn a risk premium above the bond yield, these assets can also underperform.
Unfunded pension obligations range from a low of $30,000 per
household of four in Tennessee to a high of $180,000 per household in Alaska.
They amount to less than 11% of the average home values in Florida, Tennessee
and Utah and more than 50% in Alaska, Mississippi and Ohio.
There are a few surprises. California, Hawaii and New York have
large unfunded obligations, but because property in these states is so
expensive, the average household burden is less than 15% of the average home
price. Meanwhile, West Virginia and Iowa have relatively low pension debts—but
the average household obligation is more than 30% of the average home price
because property is far less expensive in these states.
On average
nationwide, unfunded state and local pension burdens represent 20% of
real-estate values. This ratio can rival or exceed an owner’s home equity,
depending on the size of his mortgage. If real-estate prices adjust to reflect
unfunded pension obligations, many homeowners’ equity could be at risk. As
we’ve seen in Detroit, the public pension stealth mortgage can ultimately
devastate the housing market.
This is yet another confirmation that we’re not nearly as rich
as we think we are. If your home is your biggest asset but a big part of your
equity is secretly claimed by the local government, you don’t really own it.
And if you’re counting on a public sector pension and home equity to finance
your retirement you might be hit with a double whammy when your pension is cut
(despite what the state constitution says, it will be cut one way or another)
at the same time your property tax bill soars to protect what’s left of pension
benefits.
And the pension crisis is actually much worse than Arnott’s and
Meulbroek’s research implies, because they’re using peak-of-the-cycle numbers.
When the next recession brings an equities bear market, pension plans will lose
money, causing their underfunding to explode. So that 20% stealth mortgage is
about to get even bigger.
For more on the coming pension crisis see:
