The global rout of financial markets this year is putting pressure on state and local government pension funds in the U.S., many of which were already struggling to pay for the future retirement benefits of public-sector workers.
The hit to the returns of retirement systems for firefighters, police and civil service employees could, in turn, endanger the financial health of local governments that have to pick up the tab, according to a Tuesday report penned by analysts at Moody’s Investors Service.
“Recent U.S. public pension investment losses, which we estimate are approaching $1 trillion, stand to severely compound the pension liability challenge already facing many governments,” said Tom Aaron, vice president at Moody’s, in the note.
Since the financial crisis, such concerns have been shared by municipal bond analysts who have worried a slump in public pension funding levels after a recession could hurt the overall creditworthiness of municipalities.
As of March 20, public pension plans were on pace for an average investment loss of about 21% in the fiscal year ending on June 20, according to Moody’s estimate.
In stocks, the S&P 500 SPX, +9.38% was down more than 24% year-to-date, and the Dow Jones Industrial Average DJIA, +11.37% was on pace for a more than 27% drop over the same period. The major U.S. equity benchmarks managed to roll back a chunk of their losses on Tuesday amid expectations for a fiscal stimulus package to pass Congress soon.
Managers of pension funds for state and local governments have also grappled with the issue of lower interest rates.
On one hand, the fall in Treasury yields have lifted the value of pensions’ fixed-income portfolios, serving as ballast for the broader decline in financial markets.
But this has also had the effect of ballooning the overall liabilities of public pensions by lowering the average return they can expect from bonds, forcing pension fund managers to rely on volatile equity markets and other risky assets to make up for the shortfall.
The 10-year Treasury note yield TMUBMUSD10Y, +7.65% closed at 0.813% on Tuesday, down from around 1.91% at the start of the year, based on Tradeweb data.
Moody’s noted that markets still have the potential to bounce back.
But if stocks and other risky assets fail to stage a substantial rebound and cover the lost ground, the financial hit to public pension plans could leave a hefty bill for local and state governments to pick up.
“Without a dramatic bounceback of investment markets, 2020 pension investment losses will mark a significant turning point where the downside exposure of some state and local governments’ credit quality to pension risk comes to fruition because of already heightened liabilities and lower capacity to defer costs,” said Aaron.