Governments acted as though the historic gains of the 1990s would continue forever and awarded large benefit enhancements to public employees that some politicians claimed could be paid for at no additional cost to taxpayers. These politicians failed to plan for the inevitable economic downturn and told workers and taxpayers that the plans could cover the promises simply by using the money generated by investments—a mistake that would prove to be disastrous over the next decade.
By the early 2000s, governments were on the hook for retirement promises that were much larger than ever before. When the dot-com bubble burst between 2000 and 2001, returns fell far short of their expectations, and governments quickly found themselves in trouble. Facing significant budgetary challenges and ballooning pension bills, some governments simply did not make their payments, while others underestimated their retirement promises and set contribution levels too low to cover the true cost of workers’ benefits. Their problems grew worse when the mortgage crisis led to the Great Recession in 2008, and investment returns dropped yet again—leaving many cities and states struggling to pay more into the pension systems in order to make up the difference.
Since then, pension plan managers have tried to compensate for the growing debt by doubling their investments in risky, difficult-to-value assets such as real estate, private equity, and hedge funds. Although these bets have paid off in some years, earnings have been well below what the plans anticipated during many others. Now, after years of underfunding and lower-than-expected investment returns, pension debt has hit record highs. Despite the increasing threat, many governments have not done enough to address the problem. Instead, politicians have taken advantage of lax accounting rules to hide the true extent of the pension debt and continue to kick the can further down the road. It’s clear where these decisions will lead. Paying less today will put cities and states in a precarious position for years to come and will only cost workers and taxpayers much more in the future.