Riley: Barron's Touts Dow 30,000 Unfortunately RI Needs Dow 45,000
Michael G. Riley, GoLocalProv MINDSETTER™
Riley: Barron's Touts Dow 30,000 Unfortunately RI Needs Dow 45,000
A few days after the Dow Jones Industrial Average finally closed above 20,000 for the first time, the pundits on CNBC and periodicals were crawling all over each other to be more bullish than the next guy. Barons magazine (no relation to President Trumps son) proclaimed on the cover “DOW 30,000”. The publishers obviously meant to grab the reader’s attention but most disturbing was the subtitle was “The Dow could surpass 30,000 by 2025.”
The disturbing thing is that most investors would be thrilled with this outcome and you would think retirees, in poorly funded pension plans like Rhode Island and Providence, could breathe a sigh of relief. Their plans would be safe they might think.
Sadly, even such a seemingly great performance by the Dow would severely harm the solvency and sustainability of both our Pension plans. A little present value calculation shows that this would be a compounded rate of return of about 5.2% and that’s if we were 100% invested in the Dow. We are not. In fact, our State pension fund is benchmarked against a 60% Stocks and 40% bond weighted portfolio. With the 10-year treasury bonds yielding 2.5% the expected return given this scenario is the following expected return = 60% times 5.2% + 40% times 2.5% or 3.12% +1% = 4.12%.
GET THE LATEST BREAKING NEWS HERE -- SIGN UP FOR GOLOCAL FREE DAILY EBLASTRhode Island is Screwed
Our pension funds are so underfunded that Dow 30,000 in 8 years doesn’t help. A 4.12% compounded return over the next 8 years in this interest rate environment would set back our pension fund by nearly $2 Billion dollars over the next 8 years. This will mean dramatically higher ARC payments and a substantial increase in State taxes and that’s not even counting bailing out Providence which is 99% certain if we only get to Dow 30,000 in 8 years.
A very good question might be at this point; So, Mr. Riley “How high does the Dow have to be for Rhode Island pension fund break even? Stay viable and avoid crisis?”
The answer is again the 60/40 weighting that produces 7.5% compounded. I believe it’s safe to assume the 40% in bonds will yield 2.5% or higher, maybe 3%. The other 60%, the stock portion, needs to yield 10.8% to achieve a combined yield of 7.5%.
Magaziner needs Dow 45,000 to break even
The State pension fund returned 7.5% in calendar year 2016 with the S&P 500 up 10% and the Dow up 20%. Obviously, the state pension fund is built to underperform markets. So just how high does the Dow Jones Industrial Average need to go for Rhode Island’s complex and expensive portfolio to achieve 7.5% return over the next 8 years?
Not just 30,000 or even 35,000 but …. Are you ready? We are so poorly funded as a state and positioned, even after reform that we need:
DOW 45,000
This is obviously more than double in the Dow over the next 8 years just for us to break even. No big deal, right? I was still on the trading floor when the Dow first closed above 10,000 in March of 1999. It took 17 + years to double to 20,000. Rhode Island needs it to more than double in the next 8 years just to break even….. Good luck Rhode Island!!
Timeline - Rhode Island Pension Reform
2005-2010
January 2009
Governor Don Carcieri makes pension reform a top priority in his emergency budget plan. His three-point plan included:
1. An established minimum retirment age of 59 for all state and municipal employees.
2. Elimination of cost-of-living increases.
3. Conversion of new hires into a 401(k) style plan.
See WPRI's coverage of Carcieri's proposal here.
2009
Rhode Island increased mandatory employee contributions for new and current employees. New Mexico was the only other state to mandate current employees to increase their contributions.
Read the NCSL report here
(Photo: FutUndBeidl, Flickr)
2010
Rhode Island's state administered public employee pension system only held 48% of the assets to cover future payments to its emplyees.
"This system as designed today is fundamentally unsustainable, and it is in your best interest to fix it" - Gina Raimondo
Check out Wall Street Journal's coverage here.
November 2010
Gina Raimondo defeats opponent Kernan King in the election for General Treasurer of Rhode Island using her platform to reform the structure of Rhode Island's public employee pension system. She received 201,625 votes, more than any other politician on the 2010 Rhode Island ballot.
April 2011
Raimondo leads effort to reduce the state’s assumed rate of return on pension investments from 8.25 to 7.5%.
Her proposal includes plans to suspend the Cost of Living Adjustment (which allows for raises corresponding with rates of inflation for retirees), changing the retirement age to match Social Security ages, and adding a defined contribution plan.
May 2011
Raimondo releases “Truth in Numbers”, a report detailing the pension crisis and offering possible solutions. She continues to work to raise public support for her proposal.
"Decades of ignoring actuarial assumptions led to lower taxpayer & employee contributions being made into the system." - Gina Raimondo (Truth in Numbers)
Read GoLocalProv's analysis of the report here.
Read the Truth in Numbers report here.
October 2011
Governor Lincoln Chafee and General Treasurer Gina Raimondo present their pension reform legislation proposal before a joint session of the General Assembly.
“Our fundamental goal throughout this process has been to provide retirement security through reforms that are fair to the three main interested parties: retirees, current employees and the taxpayer…I join the General Treasurer in urging the General Assembly to take decisive action and adopt these reforms.”- Gov. Lincoln Chafee
October 2011
Head of Rhode Island firefighters’ union accuses Raimondo of “cooking the books” to create a pension problem where one did not exist. Paul Valletta Jr. states that Raimondo raised Rhode Islanders’ assumed mortality rate to increase liability to the state, using data from 1994 instead of updated information from 2008, and lowered the anticipated rate of return on state investments.
“You’re going after the retirees! In this economic time, how could you possibly take a pension away?” Paul Valletta Jr (Head of RI Firefighters' Union)
Read more from the firefighters' battle with Raimondo here.
Check out the New York Times' take on RI's pension crisis here.
November 17, 2011
The Rhode Island Retirement Security Act (RIRSA) is enacted by the General Assembly with bipartisan support in both chambers. RIRSA’s passing is slated to reduce the unfunded liability of RI’s pension system and increase its funding status by $3 billion and 60% respectively, level contributions to the pension system by taxpayers, save municipalities $100 million through lessened contributions to teacher and MERS pension systems, and lower the cost of borrowing.
Read more from GoLocalProv here.
November 18, 2011
Governor Lincoln Chafee signs RIRSA into law. According to a December 2011 Brown University poll, 60% of Rhode Island residents support the reform. Following its enactment, Raimondo holds regional sessions to educate public employees on the effects of the legislation on their retirement benefits.
Read about how Rhode Islanders react to RIRSA here.
January 2012
Raimondo hosts local workshops to explain the pension reforms across Rhode Island. She also receives national attention for her contributions to the state’s pension reforms. The reforms are given praise and many believe Rhode Island will serve as a template for other States’ future pension reforms.
Read about the pension workshop here.
Read Raimondo's feature in Institutional Investor here.
March - April 2012
Raimondo opposes Governor Chafee’s proposal to cut pension-funded deposits. She continued to provide workshops on the pension reforms.
December 5, 2012
Raimondo publicly opposes Governor Chafee’s meetings with union leaders in an effort to avoid judicial rulings on the pension reform package. In response, Chafee issues a statement supporting the negotiations.
Read more about Raimondo's opposition here.
Read about Chafee's statement here.
March 2013
Led by the Rhode Island State Association of Fire Fighters, unions protest the 2011 pension reform outside of the Omni Providence where Governor Lincoln Chafee and General Treasurer Gina Raimondo conduct a national conference of bond investors.
Read about Raimondo's discussion of distressed municipalities here.
April 2013
The pension plan comes under increased scrutiny as a result of the involvement of hedge funds and private equity firms. Reports show that $200 million of the state pension fund was lost in 2012.
"In short, impressive educational credentials and limited knowledge of investment industry realities made Raimondo ideally suited to champion private equity’s public pension money grab." - Ted Seidle (Forbes)
Read GoLocalProv's coverage of the State Pension Fund's losses here.
Read Ted Seidle's criticism of Raimondo in Forbes.
June 2013
Reports show that the State’s retirement system increased in 2013 by $20 million despite the reforms being put into effect the previous year.
Read GoLocalProv's investigation into the rising pension costs here.
September 2013
Matt Taibbi publishes an article in Rolling Stone detailing Raimondo’s use of hedge funds as a questionably ethical tool to aid with pension reform.
Read Taibbi's article in Rolling Stone.
Read GoLocalProv's response to Taibbi here.
October 2013
As Raimondo eyes the role of Governor of Rhode Island in 2014, more behind-the-curtain information about the 2011 pension reform comes to light.
Read more from GoLocalProv about the players in the pension battle here.
