Tom Sgouros: Accounting for the Future

Tom Sgouros: Accounting for the Future

I was a guest on WSBE's Lively Experiment this week, and it was thrilling to see my fellow panelists recoil when I suggested that the accounting rules and recent changes to those rules, were largely responsible for the onset of our pension crisis. But it's true, and a lot of our woes are political and legal in nature, not mathematical.

The rules in question have to do with assessing the health of a pension system. Essentially they demand that a system that doesn't have enough money in hand right now to pay all the benefits earned as of now is in deficit. In some situations this makes a lot of sense. A private corporation, for example, could go out of business at any time, so it's important for a private system to be 100% "funded" at all times.

But a state isn't going to go out of business, and accounting rules meant to insure against that event are therefore out of place in the public sector. I don't know about you, but for public sector accounting, I'd rather have rules in place that help a state meet its obligations at the lowest possible cost. But GASB, the Governmental Accounting Standards Board, says otherwise, and instead we have rules that might make things cheaper decades from now, but will bankrupt us in the present for no good reason.

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What are our assets?

I wrote a few weeks ago about the US Postal Service laboring under rules that demand they put money aside right now to pay for the health care of retirees who haven't yet been born. The state pension fund's situation isn't quite as extreme, but the system certainly could have been run at much lower cost over the last decade, and costs are projected to rise to absurd levels in the near future.

When the pension system adds up its assets, it adds up all the assets in its investment portfolio, and then stops. But it needn't stop there. The pension system is part of an ongoing project -- called the State of Rhode Island and Providence Plantations -- which will continue to exist for a long time to come. There is no reason not to include the present value of our future payments into the system as assets just as real as the present value of the debts we will owe to retirees. You don't have to believe me. Why not take the word of the Treasurer's actuaries? As far as I've seen, every single one of the potential plans presented to the Pension Commission so far have lowered the amortization target from 100% to 80%. Left unsaid is their assumption that value of our ability to pay is worth that extra 20%. They don't spell it out, but that's what is behind this recommendation. I only ask what's so magical about 80%?

Six years ago I wrote that we should question the 100% target. In exactly the same way, I want someone to demonstrate to me that 80% is the number that minimizes the total expense of paying our obligations. We don't get that, only mumbling about "best practices." The fact is that 80% would be too low for some systems, and too high for others, depending on the health, age, and pay of the employees and retirees. It's a rule of thumb, not a derived result, and until someone derives it based on the circumstances of our state's fund and the amounts we expect to owe, no one should believe that it actually does what we hope it will: deliver the maximum benefits at the minimum cost.

Accounting rules are not immutable

Here's important news: accounting rules change, and accountants debate them. GASB changed them on us recently, but that's not the only example. After the 2008 financial implosion, banks were desperate to be relieved from the accounting standard that said the assets they held as capital be marked at their fair market value. The value of their capital had dropped so far and so fast that virtually all the big banks in the country would have been insolvent had they been audited. The same bill that established George Bush's TARP program also allowed regulators to give banks a pass on this.

Another case involves endowments for non-profit institutions. Say you were a wealthy alumnus who gave a million dollars to Brown University in the 1970s. By accepting the money, Brown assumed an obligation to keep your fund at a million dollars under the accounting rules in place at the time. In most years there would have been investment income from that million and that's great, and it would have endowed a chair in the economics department whose occupant would say what a great American you are. Unfortunately, in 2008 not only did the university lose the investment income from your fund, but it also lost capital and so acquired an obligation to get the balance back up to $1 million, a disaster. Fortunately, a solution was at hand, and the Uniform Prudent Management of Institutional Funds Act has been wending its way through state legislatures since 2006, so we adopted it in a hurry in 2009, along with 22 other states.

So here's the question: When accounting rules create inconvenience for powerful institutions like Goldman Sachs or Ivy League colleges and big foundations, they get changed. When accounting rules create needless extra expense for state employees and taxpayers, why is it that we don't challenge them? After all, the only beneficiaries of having a pension fund larger than it needs to be are the Wall Street financiers who collect their commissions from it. Oh, wait...

Crossing the Rubicon

I would feel remiss not to observe with sadness the profound change in our country made last Friday, when our government successfully assassinated two of its own citizens, one of whom was Anwar al-Awlaki, without any kind of trial, hearing, or exculpatory shred of due process. Under what law was this killing approved? I had heard once that ours was to be a nation of laws, not of men, but every day seems to show me just how far from that ideal we have fallen.

I'm certainly no fan of al-Awlaki, but I'm also not perfectly sure how Barack Obama reconciles being the guy who pulled the country across this Rubicon with any kind of pride in his Nobel Peace Prize. Perhaps he can have a word with Henry Kissinger to find out how it's done.

Tom Sgouros is the editor of the Rhode Island Policy Reporter, at whatcheer.net and the author of "Ten Things You Don't Know About Rhode Island." Contact him at [email protected].

 

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