The Bankrupt United States of America

Sept. 8 (Bloomberg) -- China may start yuan trading versus the Russian ruble within weeks, seeking to encourage use of its currency for global trade instead of the dollar, according to three bankers with knowledge of the matter.

The central bank sent out a document last week allowing banks to apply for ruble trading licenses and the approval process may take three weeks, according to one of the bankers, who asked not to be identified because the process isn’t public. The People’s Bank of China started yuan trading against the Malaysian ringgit on Aug. 19.

Cross-border trade using China’s currency more than doubled to 48.7 billion yuan ($7.2 billion) in the second quarter from the first, according to central bank data, and regulators are encouraging sales of yuan securities offshore. Billionaire Oleg Deripaska’s United Co. Rusal is planning Russia’s first offering of renminbi bonds.

“The push for the internationalization of the yuan is intensifying,” said Dariusz Kowalczyk, a Hong-Kong based senior economist at Credit Agricole CIB. “This is meant to eliminate the dollar from trade settlement.”

A press officer at the People’s Bank, who refused to be named because of the agency’s rules, declined to comment.

China allows trading of its currency, the renminbi, versus the dollar, Hong Kong dollar, Japanese yen, the euro, British pound and ringgit on its interbank market. The Foreign Exchange Trading Center provides daily reference rates for the currencies.

Trading Partners
HSBC Bank (China) Co. and Bank of Communications Co. completed the first yuan-ringgit transactions, according to the trading center, which is affiliated with the central bank. The central bank was investigating the possibility of offering new currency pairs on the interbank market, including the ruble, won and ringgit, an unnamed official at the center said in April.

Brazil, Russia, China and India, known as the BRIC nations, have stepped up cooperation to ensure that the interests of developing nations are taken into account at the Group of 20, which holds a meeting in Seoul in November.

Russian President Dmitry Medvedev in June called for a greater number of reserve currencies in the global financial system. Ba Shusong, deputy head of the financial institute of the State Council’s Development Research Center, warned dollar volatility may affect the value of China’s $2.45 trillion foreign-exchange reserves.

Less Need for Dollars
The trend for developing nations to start trading in each others’ currency “should lead to a lesser need for the dollar in the market,” said Douglas Borthwick, Connecticut-based managing director at Faros Trading LLC. “It will certainly help slow the constant increase in China’s dollar reserves over time.”

China overtook Germany as Russia’s second-largest trading partner in the first six months of this year, helped by exports from Russian commodity producers including Rusal, OAO GMK Norilsk Nickel and OAO Rosneft.

Rusal, the world’s biggest aluminum producer, is preparing for a yuan bond sale, Oleg Mukhamedshin, head of capital markets, told reporters at a China investment conference in Moscow on Sept. 2. The Moscow-based company owns two smelters in China. Yuan deposits in Hong Kong have risen 65 percent this year to 103.7 billion yuan, the highest level since the Hong Kong Monetary Authority allowed yuan accounts to be set up in February 2004.

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Sept. 15 (Bloomberg) -- U.S. state pensions such as Illinois, Kansas and New Jersey are in a “death spiral,” with assets at many insufficient to cover benefits, payouts consuming a growing portion of resources and costs rising twice as fast as investment gains.

Less than half the 50 state retirement systems had assets to pay for 80 percent of promised benefits in their 2009 fiscal years, according to data compiled for the Cities and Debt Briefing hosted by Bloomberg Link in New York today. Two years earlier, only 19 missed the mark. Illinois covered just 50.6 percent of benefits last year, the lowest so-called funded ratio, which actuaries say shouldn’t be less than 80 percent.

Benefits paid by funds in at least 14 states equaled more than 10 percent of assets in the fiscal year, the figures show. In 2007, none exceeded the threshold. The growing burden prompted Colorado, Minnesota, Michigan and other states to trim benefits for millions of teachers and government workers. It also forced fund managers to keep money in short-term low-return investments to pay benefits, reducing chances pensions can earn their way back to financial health.

“Once you get into that dynamic, you’re in a death spiral,” said Michael Aronstein, who manages the $295 million Marketfield Fund of stocks as chief investment strategist at Oscar Gruss & Son, a New York brokerage. “There’s no financial or return solution.”

‘Different Era’
The largest Illinois pension, the $33 billion Illinois Teachers’ Retirement System, paid $3.7 billion of benefits in the year ended June 30, 2009. That’s 13 percent of its assets at the time, up from 8 percent two years earlier, according to annual reports and Dave Urbanek, its spokesman. The New York State system, the best-funded in the Bloomberg data at 107.4 percent, paid out 7 percent of its assets in fiscal 2009.

“Part of the problem with pensions today is they were designed in a different era,” Richard Ciccarone, managing director of McDonnell Investment Management LLC, said at the Cities and Debt Briefing. “When our economy slows we no longer have the economic base to pay the pensions.”

At June 30, 2010, after the Illinois fund’s investments had gained 13 percent and lawmakers borrowed $3.5 billion to shore up the system, benefits in the fiscal year had risen to $3.9 billion, according to Urbanek, or 12 percent of assets.

‘Too Harsh’
Lawmakers in Illinois, which, with California, has the lowest credit rating from Moody’s Investors Service of any state, were unwilling to approve another bond sale, for $3.7 billion, this fiscal year. As a result, the pension may sell $3 billion of assets to cover benefits, Urbanek said.

“Death spiral is too harsh a language,” he said. “It’s a concern, but we’re not on life-support.”

Selling assets, reducing services and cutting costs such as pension contributions are tactics states are using to confront what a June 29 report by the Center on Budget and Policy Priorities, a Washington-based research group, said was a record $140 billion combined budget deficit this fiscal year.

Lawmakers are willing to anger taxpayers and retirees to show investors who buy more than $400 billion of state and local debt a year that something is being done to stem rising costs.

Benefits Growth
Benefits paid by the 100 largest public pensions in the five years that ended June 30 grew an average of 8 percent annually, calculations based on U.S. Census Bureau reports show. In that period, the median annualized investment return was about 3 percent for public funds with more than $5 billion of assets, said an August report from Wilshire Associates, an investment adviser in Santa Monica, California.

The U.S. recession and stock-market collapse drained about $835 billion of value from the 100 largest public funds, according to the Census Bureau. As a result, benefit payments by those funds amounted to 7.5 percent of assets in the 12 months ended June 30, 2009, up from about 5 percent two years earlier, the census figures show.

Even an investment rebound in the year that ended June 30, 2010, when Wilshire reported the median return on public retirement funds was about 13 percent, did little to alter the trend. Funds in at least eight states that reported investment results for the fiscal year still spent more than 10 percent of their assets on benefits, Bloomberg data show.

Asset Outflow
“The fact such a large portion of assets is flowing out each year really challenges the longevity of these funds,” said Joshua Rauh, who teaches finance at Northwestern University in Evanston, Illinois. He projected retirement accounts in his and other states would run out of money within a decade. “It will be a crash landing,” he said.

The rising share of assets consumed by benefits is “interesting” but misleading, said Keith Brainard, research director of the Baton Rouge, Louisiana-based National Association of State Retirement Administrators. He pointed to the offsetting effect of annual payments into funds made by workers and state governments.

“Employer contributions tend to fluctuate, but employee contributions are remarkably steady,” he said.

From 1998 to 2008, the most recent full statistics from the Census Bureau, state and local government payments into retirement funds almost doubled to $82 billion. Over the period, worker contributions rose 70 percent to $37 billion.

130 Percent
During the same decade, however, benefits paid increased by 130 percent to $175 billion. Payments from the 100 largest public funds grew by another 9 percent during the first three quarters of the 2010 fiscal year compared to the first three quarters of 2009, according to the census.

The $11 billion Kansas Public Employees Retirement System had the seventh-lowest funded ratio in Bloomberg’s ranking at 63.7 percent in 2009. It paid out benefits equal to 10 percent of its assets in the fiscal year, double the rate of 2007, fund records show.

The pension’s funded ratio fell from 70.8 percent two years earlier and is projected to drop to 41 percent by 2015, according to a February report to state lawmakers. Another market decline could jeopardize the fund, the report said.

“Preservation of sufficient cash flow to fund current benefits may become paramount,” it said, which could constrain investment strategies and make it harder to achieve assumed returns.

Payments Skipped
The problem is magnified in states where officials skipped billions of dollars of contributions.

New Jersey Governor Chris Christie, 48, a Republican who took office in January, withheld $3.1 billion of payments in his first budget to cope with a record $10.7 billion deficit. Since 2004, the state has made only $2.7 billion of the $11.9 billion in scheduled contributions, according to bond-sale documents.

New Jersey’s $68 billion retirement system had a funded ratio of 66.1 percent in the Bloomberg data, the 11th-lowest. The state in August settled Securities and Exchange Commission claims that it failed to disclose the extent of its underfunding in documents for $26 billion in bond sales from 2001 to 2007. It didn’t admit wrongdoing.

Benefit payments are projected at 11.4 percent of available pension assets during this budget year, even after a 14 percent investment gain in the fiscal period that ended June 30, New Jersey records show.

Teachers Pension
Payouts by the New Jersey Teachers Pension and Annuity Fund, which serves about 236,000 working and retired educators, grew to $2.8 billion from $1 billion in the 10 years through 2009, an average annual increase of about 10.4 percent, its yearly reports show. Over the period, holdings returned an annualized 2.3 percent, according to the state’s Division of Investment.

Retiree benefits last year amounted to 11.2 percent of the fund’s $25 billion value, compared to 3 percent a decade earlier. Payments are on track to exceed 11 percent of assets again this year, state budget documents say.

To remain healthy, the New Jersey teachers fund should pay out no more than 9 percent of its assets each year, Scott Porter, of the Philadelphia office of Milliman Inc., the fund’s actuary, told trustees in February. He said benefit costs will rise to $4 billion a year within a decade, making it questionable the state will achieve its assumed 8.25 percent annual investment gain.

“As baby boomers retire and the benefit payments increase, that’s going to keep the market value of assets from growing substantially,” he said.

Lower Benefits Proposed
With such prospects, U.S. governors and lawmakers are proposing lower benefits. Colorado, Minnesota and Michigan are in court defending cuts, including a reduction in annual cost- of-living increases imposed on retirees during the last year.

In Connecticut, where benefit payments rose to $2.7 billion this year from $2.1 billion in 2007 as assets lost almost $5 billion in value, outgoing governor Jodi Rell wants to eliminate guaranteed pension payments for future employees. New Jersey’s Christie plans to revoke a 9 percent increase in benefits awarded in 2001.

Advocates for pensioners say such strategies illegally renege on promises to workers. Politicians themselves caused the problem by failing to make required payments, they say.

“This has been in motion for a long time,” said John Stember, a partner at Stember Feinstein Doyle Payne & Cordes in Pittsburgh, which represents retirees in six states challenging rollbacks.

“The state is making a compelling argument based on a set of facts it’s confronted with now, but that it didn’t necessarily have to be confronted by,” he said.

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Sept. 24 (Bloomberg) -- Nassim Nicholas Taleb, author of “The Black Swan,” said he’s concerned budget deficits in the U.S. are spiraling out of control and may now represent a bigger problem than in countries such as Greece.

“The U.S. is probably the worst of all,” Taleb told Canada’s BNN television network in an interview today. “They are addicted to debt. We have an administration that, unlike the European administrations, is not aware of the risks of mounting deficits, of the addiction to public deficits and to big government.”

Taleb told the cable network, “People are complaining about Greece, but Greece has the IMF putting some discipline in their system. Who can discipline the U.S. government?”

Greece this year has imposed a series of austerity measures, including wage and pension cuts and higher sales taxes, in exchange for a 110 billion-euro ($148 billion) rescue from the European Union and International Monetary Fund. U.S. President Barack Obama inherited what the National Bureau of Economic Research said this week was the deepest U.S. recession since the Great Depression. The government’s outstanding debt is about $13.5 trillion, according to Treasury figures.

Risks to the global financial system are much larger than before the September 2008 bankruptcy of Lehman Brothers Holdings Inc., Taleb said.

‘Making Things Worse’
“People still don’t understand why we had the crisis and they don’t realize that we are making things worse,” he said. “We still have the same level of debt but we are transforming private debt into public debt. We are socializing these risks, and the system has fewer people employed. So we have a lot more risks than we did in 2007.”

Taleb, in Montreal today to give a speech to a group of business people, said Canada’s fiscal situation makes the country a safer investment than its southern neighbor.

Canada has the lowest ratio of net debt to gross domestic product among the Group of Seven industrialized countries and will keep that distinction until at least 2014, the finance department said in its March budget documents. Canada’s ratio, 24 percent in 2007, will rise to about 30 percent by 2014. The U.S. ratio, now above 40 percent, will top 80 percent in four years, the department said, citing IMF data.

“I am extremely bearish on the U.S.,” he said. “I am more bullish on Canada. Canada is much more robust than the U.S. You guys have much less debt, much more manageable risks.”

Taleb wrote the 2007 best-seller “The Black Swan: The Impact of the Highly Improbable,” which argues that history is littered with rare, high-impact events. The black-swan theory stems from the ancient misconception that all swans were white.

As the founder of New York-based Empirica LLC, a hedge-fund firm he ran for six years before closing it in 2004, Taleb built a strategy based on options trading to protect investors from market declines while profiting from rallies. He now advises Universa Investments LP, a Santa Monica, California-based fund that bets on extreme market moves.

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Sept. 28 (Bloomberg) -- The U.S. dollar is “one step nearer” to a crisis as debt levels in the world’s largest economy increase, said Yu Yongding, a former adviser to China’s central bank.

Any appreciation of the dollar is “really temporary” and a devaluation of the currency is inevitable as U.S. debt rises, Yu said in a speech in Singapore today.

“Such a huge amount of debt is terrible,” Yu said. “The situation will be worsening day by day. I think we are one step nearer to a U.S.-dollar crisis.”

Yu also said China is worried about the safety of its foreign-exchange reserves including those invested in U.S. Treasuries as the U.S. currency weakens, reiterating his earlier views on the dollar assets. The U.S. will record a $1.3 trillion budget deficit for the fiscal year ending Sept. 30, the Congressional Budget Office said Aug. 19.

The estimated budget deficit for this fiscal year would be equivalent to 9.1 percent of gross domestic product, the CBO said. That would make it the second-largest shortfall in 65 years, exceeded only by the 9.9 percent in 2009.

The CBO also projected the U.S. would have a cumulative deficit of $6.27 trillion in the next decade, higher than its March estimate of $5.99 trillion.

Reduced U.S. Holdings
China, the biggest foreign investor in U.S. government bonds, cut its holdings by about 10 percent to $846.7 billion in the 12 months ended July, according to the Treasury Department.

U.S. Treasuries fail to provide safety or liquidity in managing China’s $2.45 trillion foreign-exchange reserves, Yu said in an e-mail in August. To help cool demand for the securities, China needs to curb the growth of its foreign reserves by intervening less in the currency market, he said.

China should reduce its holdings of U.S.-dollar assets to diversify risks of “sharp depreciation,” Yu said in July. The nation should convert some holdings in U.S. dollars into assets denominated in other currencies, commodities and direct investments overseas, he wrote in a commentary in the China Securities Journal.

The increased convertibility of the yuan will ease pressure on the currency to appreciate, Yu said today at an event organized by Singapore Management University.

The yuan has strengthened almost 2 percent against the dollar since June 19, when China’s central bank said it will pursue a more flexible exchange rate. China maintained a peg of 6.83 yuan per dollar from July 2008 to June 2010.

Yuan Level
China will independently determine the level of the yuan and the U.S. doesn’t need to vote on the issue this week, Vice Commerce Minister Chen Jian said in Taipei yesterday.

The U.S. House of Representatives is due to vote tomorrow on legislation pressing China to raise the currency’s value amid assertions the yuan is undervalued and gives the Asian nation a trade advantage. The legislation would let companies petition for higher duties on Chinese imports.

“The basic trend is for an appreciation” of the yuan, Yu said in an interview after his speech today. “No one can predict the specific pace of the appreciation. This is difficult to say as it depends on circumstances. We should not be speculators.”

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Oct. 4 (Bloomberg) -- New York Mayor Michael Bloomberg said city pension funds have set unrealistically high assumed rates of return on investments, at 8 percent, which may require spending more than has been budgeted for retirement benefits.

“It’s much too high an assumption for us, I think it should be lowered” Bloomberg said today at a news briefing referring to the city’s five pensions holding almost $104 billion. “That’s going to require the city to put in more money. It’s very difficult to see where we could get the money to do that.”

The city, which must balance its budget or face a state takeover of operations, has to close a $3.3 billion budget gap projected for fiscal year 2012, which starts July 1. The deficit is forecast to grow to $4.8 billion in 2014, a period in which officials expect pension costs to increase to $8 billion in 2014 from $7.6 billion now. Last month, the state pension fund cut assumed returns to 7.5 percent from 8 percent.

The real problem, the mayor said, is the pension system itself, which provides defined benefits that can’t be reduced under guarantees the Legislature has placed in the state constitution. While it permits new, less-expensive benefit tiers for future employees, savings wouldn’t be realized for 10 or 15 years, Bloomberg said.

“We’ve been trying to get the governor and the Legislature to vote a fifth tier,” Bloomberg said. “They won’t do it unless the unions ask them to.”

“The taxpayers don’t want to pay for it and the economies of the world don’t really support those kinds of plans anymore,” the mayor said.

Change Needed
Without a change, Bloomberg said, the municipal workforce will shrink, because the city won’t be able to afford a payroll of the current size and cover retirement benefits at the same level as today. The city employed 302,436 in May, according to Marc Lavorgna, a spokesman for Bloomberg.

“We’re going to try to farm things out to the private sector more because the municipal workers just cost too much,” the mayor said. “The bottom line is, you can see in this country, the public is frustrated, they don’t want to spend any more money.”

Representatives of city Comptroller John Liu, who acts as the steward of city pension funds, didn’t immediately comment on the mayor’s remarks.

The state’s $124.8 billion pension fund, the nation’s third-largest, reduced the assumed rate of return on its investments as it recovers from market losses, Comptroller Thomas DiNapoli said. DiNapoli, the sole trustee of the plan, said state and local government employers’ payments to the fund will increase to about 16.3 percent of payroll in February 2012, from 11.9 percent due in February 2011. The fund covers 1 million current and retired government workers.

14% 2010 Return
New York City’s five pension funds provide retirement benefits for its police, firefighters, school employees and civil-service workers with more than $103.8 billion in assets under management as of March 31. On Sept. 28, its largest plan, the New York City Employees’ Retirement System, which covers more than 180,000 active and about 130,000 retired workers, reported a 14 percent return in fiscal year 2010, which ended June 30.

“Some years you make money, some years you don’t,” Bloomberg said. “It’s overstating it a little bit to say the only one who’s done that well is Bernie Madoff, but 8 percent for a long period of time is not something that very many pension funds have ever achieved.”

The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.

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Oct. 8 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said the U.S. fiscal deficit is “scary” and the federal government needs to cut spending on entitlements.

“We’re involved in a dangerous game,” Greenspan said yesterday at a foreign-exchange conference in New York sponsored by Bloomberg LP, the parent of Bloomberg News. “We’re increasing the debt held by the public at a pace that is closing” the gap between our debt and “any measure of borrowing capacity,” Greenspan said. “That cushion is growing very narrow.”

U.S. companies may be holding back on investment because of the rising federal deficit, which causes uncertainty about future tax policies, Greenspan said in an opinion article for the Financial Times this week. Weak investment by businesses in capital equipment and fixed assets has helped to crimp the U.S. economic recovery, he said.

“You need” austerity, said Greenspan, a paid speaker at the event. “We’re going to have to start to cut” from government entitlement programs, he said, adding that reducing the budget is better than raising taxes in closing the U.S. budget deficit. Still, Greenspan reiterated that he supports allowing tax cuts enacted under President George W. Bush to lapse at the end of 2010.

The White House Office of Management and Budget in July projected the deficit for fiscal 2010, which ended Sept. 30, at $1.47 trillion and the gap for fiscal 2011 at $1.42 trillion. President Barack Obama formed a commission in February charged with presenting a plan by Dec. 1 on how to reduce deficits over the next decade.

Succeeded by Bernanke
Greenspan, 84, was chairman of the Fed from 1987 until 2006, when he was succeeded by Ben S. Bernanke.

“It is crucially important that we put U.S. fiscal policy on a sustainable path,” Bernanke said in an Oct. 4 speech.

“The only real question” is whether adjustments to taxes and spending will come from a “careful and deliberative process” or from a “rapid and painful response to a looming or actual fiscal crisis,” Bernanke said in Providence, Rhode Island. U.S. lawmakers should consider adopting rules that limit federal spending or debt, he said.

Greenspan said that if the Fed decides to expand its balance sheet through purchases of bonds, a process known as quantitative easing, it may not be enough to get “money moving” and spur growth in the U.S. economy.

Should the Fed increase “excess reserves and they just sit there on the asset side of commercial banks’ balance sheets not being relent, you’ve merely gone through an interesting bookkeeping exercise,” Greenspan said. “You’ve got to break that psychology that prevents that current trillion” in reserves from being relent, he said.

Record Low
Two-year Treasury yields fell to the lowest ever yesterday, setting or matching a record for a fifth consecutive day. Investors have stepped up bets that the Fed will resume buying bonds to keep borrowing costs low.

“It is very difficult to think through the scenario by which you induce” commercial banks to lend, Greenspan said. “If you don’t do this, quantitative easing can’t do anything to speak of.”

U.S. central bankers have kept their benchmark lending rate near zero for almost two years. In March, they finished $1.7 trillion in purchases of Treasuries, mortgage-backed securities and housing agency bonds.

A slowdown in growth in the middle two quarters of this year prompted the Federal Open Market Committee last month to warn that inflation rates were “somewhat below” its mandate to achieve stable prices and full employment.

New York Fed President William Dudley, who is also vice chairman of the FOMC, went further in an Oct. 1 speech when he called current levels of unemployment and inflation “unacceptable.”

“Further action is likely to be warranted,” Dudley said.

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Oct. 12 (Bloomberg) -- Philadelphia will run out of money by 2015 to pay pension obligations with existing assets, and Chicago and Boston by 2019, a study by economists at Northwestern University and the University of Rochester forecasts.

The report, “The Crisis in Local Government Pensions in the United States,” warns that mounting liabilities threaten “the ability of state and local governments to operate.”

The study examines 77 of the largest municipal defined pension plans, covering 2 million public employees and retirees, roughly two-thirds of the nation’s total. The estimated liability of all municipal retirement funds is $574 billion, according to economists Joshua Rauh of the Kellogg School of Management at Northwestern University and Robert Novy-Marx of the University of Rochester.

Chicago residents face the highest individual burden for pension liabilities from seven municipal retirement plans, amounting to nearly $42,000 per household. New York City residents face the second-highest per-household burden, just under $39,000.

These amounts are in addition to the estimated $3 trillion in unfunded liabilities that taxpayers will shoulder from state retirement systems, which Rauh and Novy-Marx examined in a 2009 report.

Urban Concentration
“The fact that there is such a large burden of public employee pensions concentrated in urban metropolitan areas threatens the long-run economic viability of these cities, as residents can potentially move elsewhere to escape the situation,” wrote Rauh and Novy-Marx.

The combined per-household liability for state and municipal pension underfunding for Chicago homeowners would total $71,000, or about $76 billion total, the report said.

The average household obligation for unfunded state and local pension debt is $41,165, the study said.

Philadelphia will be the first to run out of money from existing assets. Rauh said the “day of reckoning” for that city and others may arrive sooner if pension funds do not earn the anticipated 8 percent return on equity that most funds hope for.

Mayor Michael Nutter said last month that he plans to end the city’s defined benefit retirement system, which promises a set level of pension payments to retiring employees based on their pay and length of time on the job.

“We’re the last bastion of defined-benefit plans, which are unsustainable,” Nutter said of government systems at the Bloomberg Cities & Debt Briefing in New York. “Pensions are the fastest growing part of our budget.”

Hiding the Bill
Government pension accounting requirements effectively obscure the true costs of pension promises, Rauh said. The combination of underfunding and poor investment returns presents a growing financial threat, he said.

The study calculates that by 2015, Philadelphia’s expected pension-benefit payments will compose 19 percent of the city’s anticipated revenue. In Boston, benefits will consume 27 percent of 2019 revenues. And in Chicago, promises will gobble up 53 percent in 2019.

If all other spending were shut down, the report said, Chicago would have to dedicate about eight years of tax revenue just to cover pension promises.

Six large cities are listed as most vulnerable -- Philadelphia; Boston; Chicago; Cincinnati; Jacksonville, Florida; and St. Paul, Minnesota -- because they are projected to run out of money from existing assets no later than 2020. Another 36 cities and counties are projected to be in similar trouble by 2030.

Going to Washington
As the financial problems deepen, political pressure will build for a government bailout, first with cities going to states for help, followed by states going to Washington, Rauh predicted.

“Without fundamental reform of the compensation systems that these state and local governments are using, we are headed to a debt crisis of some kind for some subset of U.S. state and local governments, on a five to 10 year horizon,” Rauh, an associate professor of finance at Kellogg, said in an interview.

States will “cease to be able to function” because the accumulation of debt will prevent some of them from borrowing money, Rauh said.

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Oct. 27 (Bloomberg) -- Illinois, which shares the worst state credit rating with California, is draining its pension funds as candidates for governor promote plans that would cover less than a quarter of a record budget gap.

Democratic incumbent Pat Quinn, challenger Bill Brady, who is a Republican state senator, and the rest of Illinois’s leaders have not managed to align rising spending with revenue that plunged in the recession. Illinois government “has long been characterized by an unwillingness to enact the politically difficult fiscal measures needed to balance its budget and fund its pension plans,” said Moody’s Investors Service in September.

The Illinois State Board of Investments, which manages about one-fifth of pension funds, can’t wait, William R. Atwood, its executive director, said in an interview. The board is selling $80 million of assets a month to pay benefits, he said.

“We’re not planning on the election solving our problems,” said Atwood. “We have to prepare for the worst.”

Neither candidate’s campaign responded to a request from Bloomberg News to detail his ideas to resolve the $13 billion deficit, the state’s biggest ever and equivalent to about half its budget, or to fix its pension funds, whose liabilities will rise to $79.1 billion in fiscal 2011.

“It’s such a large problem that if one candidate got the cuts he wanted and the other one got the revenue increase he wanted, it still wouldn’t fill the hole,” said Tom Johnson, president of the Taxpayers Federation of Illinois, an advocate for fiscal responsibility.

Deeper Still
The deficit is widening, said Comptroller Daniel Hynes, who warned in an Oct. 4 report that the next governor may face a $15 billion gap when he prepares a budget in January.

The inaction has boosted Illinois’s borrowing costs by as much as $551 million a year, according to a Aug. 30 report from the Civic Federation, a Chicago-based government watchdog.

Quinn, 61, who took over in January 2009 for ousted and now convicted governor Rod Blagojevich, proposed a one-percentage- point income tax increase early in the year. The General Assembly didn’t include the increase when it passed the final budget. Quinn’s budget director predicted to Bloomberg News in July that the Legislature will approve a two-percentage-point increase after the election; the governor has said he won’t accept more than one percentage point. Each percentage point added to the existing 3 percent rate would generate $3 billion a year.

Brady, 49, has said he will balance the budget through spending cuts and not tax increases. Brady has proposed an across-the-board, 10 percent reduction in spending, affecting all programs. That would save about $2.6 billion.

‘Hard Medicine’
Neither candidate has a concrete solution, said Faraaz Kamran, 38, who works for Madison Capital Funding LLC in Chicago, helping private-equity firms finance buyouts in the health-care industry. He doesn’t expect the candidates to discuss cuts until after the election because of the political price.

“There is hard medicine to be had and no one wants to talk about giving it because it’s not palatable to voters,” said Kamran.

Quinn, on his campaign website, lists top issues as women’s rights, jobs and growth -- “a crucial component of Illinois’s economic recovery” -- along with veterans and military families, health care, ethics reform, the environment, education and services for gay, lesbian and transgender residents. Brady’s top issues include creating jobs and economic growth, protecting residents from higher taxes and ethics reform.

Pain Awaits
“They probably don’t want people to realize what’s ahead,” said Alan Schankel, director of fixed-income research for Janney Montgomery Scott LLC, a money management firm in Philadelphia. “It’s going to be painful for taxpayers.”

Beyond the budget gap lies the pension gorge. Illinois has the worst-funded state system, with just over half the assets needed to pay claims, according to data compiled by Bloomberg. It hasn’t funded obligations since fiscal 2011 began July 1. State lawmakers made no appropriations to pay for pensions and didn’t approve Quinn’s plan to sell $3.7 billion of bonds to fund contributions this year. With no new cash, the funds must sell assets to pay benefits, Atwood said.

Running Short
Illinois has $64 billion of assets to pay an estimated liability of $126.4 billion, enough to cover about half the benefits for 722,913 workers, according to bond documents. The unfunded liability will rise to $79.1 billion in fiscal 2011, according to a May report from the Illinois Commission on Government Forecasting and Accountability.

“If you have no money to balance your budget, where will the money come from for your pension contributions?” asked Thomas Metzold, who oversees $7 billion of tax-exempt investments as co-head of municipals at Boston-based Eaton Vance Corp., which has shunned Illinois debt.

Quinn said he wants to borrow $3.7 billion with bonds to pay what the state is obligated to contribute to the funds this fiscal year. He also wants to redesign Illinois’s five public employee retirement plans to cut costs. The state borrowed for its 2010 contribution.

Brady, who has criticized Quinn’s borrowing as irresponsible, said Oct. 5 that he would consider issuing $50 billion of bonds to cover the unfunded pension liability.

Illinois’s five state pension funds have started selling assets to make payments to retirees. “If you keep withdrawing money to pay retirees, you’re going to devalue the value of the fund,” said Metzold.

Who’s in Charge?
Two funds have cut projected returns in recent weeks because of the damaging effect of liquidating assets, Atwood said. Having fewer assets means the state’s unfunded liability will rise more quickly, he said.

The pension crisis figured in Moody’s Investors Service changing the state’s bond rating status to negative from stable Sept. 23, a sign of the potential for another rating cut, said Ted Hampton, a Moody’s analyst. Moody’s ranks the state A1, fifth-highest, an assessment it shares with California.

“Not knowing who will be at the controls makes the outlook more murky,” said Hampton. “Based on the statements of the Democratic incumbent and his opponent you can expect very different outcomes. It’s difficult to know where the process is headed.”

Brady held an eight-point lead over Quinn, according to a Rasmussen Reports poll released Oct. 21. The poll of 750 likely voters Oct. 20 had a margin of error of plus or minus 4 percentage points.

Governors in Trouble
No matter who wins, Illinois residents disgusted by corruption won’t be easily persuaded to support spending cuts, said David Yepsen, director of the Paul Simon Public Policy Institute at Southern Illinois University in Carbondale.

Blagojevich, convicted for lying to federal agents, is the fourth of the past nine governors to face charges. His predecessor, George Ryan, was convicted in 2006 of trading favors for trips and cash. Otto Kerner, in office from 1961 to 1968, was convicted on corruption charges after being appointed a federal judge. Dan Walker, governor from 1973 to 1977, was found guilty of crimes committed after he left office.

“No political leader has the capacity to lay out the Churchillian message that tells people what they don’t want to hear,” said Yepsen. “The public just doesn’t trust them.”

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Proposals to fix the deficit are coming fast and furious in Washington these days. One major target: Social Security.

Whether you favor cutting Social Security may depend on how you view the Social Security trust funds, which currently contain $2.5 trillion for retirement benefits. That's $2.5 trillion that, according to some people, don't actually exist.

Here's the back story.

If you look at your paycheck, in the spot where it lists deductions, there's a line that says "FICA." That's the money that gets taken out of your check to pay for Social Security.

For the past 25 years or so, the amount of money the government has raised through those taxes has been greater than what it's been spending to fund Social Security.

The surplus came largely from the baby boomers — and we're going to need that extra money when they retire and start collecting Social Security.

This is where the $2.5 trillion trust funds come in.


The government has invested all that money in Treasury bonds, which are traditionally considered among the safest investments in the world.

But a Treasury bond, remember, is the way the government borrows money. So the government is lending the Social Security surplus to itself. And the obligation to repay those loans is the trust funds.

"They are nothing like any trust fund that any one of us would think of," says Maya MacGuineas of the New America Foundation. "It conjures up an image of really holding savings, and it doesn't do that at all."

But there's another way to think about what the government is doing here.

The federal government owes $2.5 trillion to the Social Security trust funds. And if the government doesn't pay that money, it will default on its debt — something the U.S. has never done in its history.

By the middle of the next decade, the Social Security surplus will turn into yearly deficits as more Baby Boomers retire. And the government will have to come up with hundreds of billions of dollars a year to cover its obligations to the trust fund.

At that point, the debate over whether or not the trust funds exist becomes a moot.

"The policy choices that we have to make good on Social Security obligations are exactly the same with the trust fund or if we'd never had the trust fund," MacGuineas says. "Raise taxes, cut Social Security benefits, cut other government spending, or borrow the money. That's the only way to repay the money."

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November 29, 2010

The debt that haunts us has roots in the past and threatens our future.

This much seems clear from the work of a White House commission that is looking for ways to rein in the federal debt.

The National Commission on Fiscal Responsibility and Reform wraps up its work this week. But members of the bipartisan group may or may not reach a consensus on steps to reduce the red ink.

So, in preparation for the commission's report, NPR is borrowing a page from Charles Dickens and the story of one man's redemption.

A New World View
In A Christmas Carol, an old man wakes up with a whole new view of the world. That's what the authors of the report hope the country will do after they issue their report on the debt this week.

Most of the time, the only people losing sleep over the federal debt are government accountants and professional scolds. But this year, the specter of red ink seems to have a lot more ordinary Americans tossing and turning.

"I think it's a national problem," Bernie Marony told NPR on Election Day. "I think it needs to be solved. And I think we need to live within our means."

Another voter, Didi Wojtal, said: "I am extremely worried about government spending. We need to balance our checkbook like the American taxpayers do."

http://media.npr.org/assets/news/2010/11/29/eop_custom.jpg?t=1291063024&s=3
Courtesy of the National Commission on Fiscal Responsibility and Reform
A comparison of the deficit as a percentage of GDP from 2011 through 2040 under the co-chairs' proposal compared with current policy.​

President Obama insists he is ready to tackle this tough issue. So, when Congress balked at creating a commission to help cut the debt, Obama appointed his own panel.

The 10 Democrats and eight Republicans who make up the commission have been studying the problem for months by reviewing the tax code, discretionary spending and entitlement programs like Social Security.

A Plan For Spending Cuts, New Taxes
And the co-chairs — former Wyoming Sen. Alan Simpson and Erskine Bowles, who served as President Clinton's chief of staff — have already gone public with a draft proposal.

As Bowles told a breakfast organized by The Christian Science Monitor, lawmakers can either deal with the rising debt or have a fix thrust upon them by those who've been lending the nation money.

"The problem we face is real," Bowles said. "The solutions are all tough. And what Alan and I decided was, everything had to be on the table."

The Simpson-Bowles plan includes significant spending cuts and new tax revenues. Predictably, Simpson says, it drew immediate protests from both the left and the right.

"We have irritated hopefully everyone in the United States, and especially every group," he says. "The groups have organized against us and will come like harpies off the cliffs with their taloned hands and fingers out. You can be savaged on the right and the left, which is good — [a] good place."

Another Plan For Cutting The Debt
A second bipartisan group issued its recommendations for cutting the debt a week after Simpson and Bowles unveiled their plan.

While there are important differences, both maps lead in the same direction. For example, both would increase tax revenues not by raising rates, but by cutting out deductions. Income tax rates would actually come down.

Both plans would curtail Social Security benefits for future retirees, while increasing payments to the neediest seniors. In other words, both plans involve compromise.

And chief economist Diane Lim Rogers of the fiscal watchdog The Concord Coalition says both are reasonable.

"As soon as we can get the conservatives to realize that in these proposals are pro-growth tax reform proposals, and the liberals to realize that in these proposals are Social Security reforms that actually strengthen the safety net, as soon as they can realize that, we'll be getting somewhere," she says.

The Challenge Of Digging Out
Even talking about raising tax revenues or cutting spending is difficult while the country is still trying to dig out from the recession. But Rogers notes that none of the proposals would take effect before 2012 at the earliest.

"I think it's possible to start talking about or remind policymakers about the need for fiscal responsibility even in a time when you're running big budget deficits," she says.

Obama has avoided commenting on either of the plans until his own commission has a chance to finish its work. But he told a gathering of business leaders in Japan this month that he's not willing to cut government spending in areas he sees as growth engines, such as education or clean energy.

"We will make sacrifices," Obama said. "But everyone here should know that as long as I'm president, we are not going to sacrifice America's future or our leadership in the world."

A Future That's Not Set In Stone
Of course, unless the government gets control of its debt, it may not have the money, or the borrowing capacity, to make those investments in the future.

But as Dickens wrote, the future is not set in stone.

"Men's courses will foreshadow certain ends, I accept it," Ebenezer Scrooge said in A Christmas Carol. "But if those courses be departed from, the ends must change. Tell me that is so, by what you show me."

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...There is no shortage of Marley-like spirits warning Americans of the dangers of deficits.

"We confront a quiet killer that is eating away at the foundation of America," said former Sen. Pete Domenici, leader of one of the many deficit cutting groups.


But how did the world's biggest economy and most powerful government end up with deficits so threatening and large?

*****​

"No longer will older Americans be denied the healing miracle of modern medicine," President Lyndon Johnson said at the signing of the Medicare Act in 1965. "No longer will illness crush and destroy the savings that they have so carefully put away over a lifetime so that they might enjoy dignity in their later years."

But now the cost of Medicare threatens to crush the whole federal budget. And Social Security benefits for the baby boom generation will add to that burden. Fortunately, there are many ways to fix Social Security's shortfall; for example, modestly raising payroll taxes, cutting benefits or raising the retirement age. But Medicare is a different story, MacGuineas says.

"When it comes to Medicare and health care in general, we just don't know how to fix it," she says.

While a growing population of elderly is part of Medicare's problem, the largest threat is the rising cost of health care. If those cost increases remain unchecked, Medicare and Medicaid, the health program for the poor, could consume nearly a third of the total budget just 10 years from now.

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Dec. 29 (Bloomberg) -- Pittsburgh’s City Council ordered Mayor Luke Ravenstahl to attend a meeting today to hash out a plan to avoid a state takeover of the underfunded municipal pension, which may more than double its cost to taxpayers.

A vote to compel Ravenstahl to come before the council’s finance committee followed about six hours of debate on shoring up the pension system using parking fees. The retirement plan has about $325 million in assets to cover $1 billion in promised benefits, according to a consultant’s report. The city has until Dec. 31 to show the state how it will bolster the plan.

“It’s merely an accounting gimmick to get past Dec. 31,” said Scott Kunka, Ravenstahl’s finance director, on the proposal to use parking fees over the next 30 years to support the pension system. “It’s just a bad concept,” he said.

Pittsburgh, whose pension problem was called a “financial Armageddon” by two city councilors yesterday, joins cities such as San Diego and states such as Illinois and New Jersey that may cut services or raise taxes to meet ballooning retirement costs. Those states and 18 others skipped payments or underfunded their retirement systems from 2007 to 2009, according to an October report from Loop Capital Markets in Chicago.

Ravenstahl will attend today’s meeting, according to Joanna Doven, his spokeswoman.

Dec. 31 Deadline
Unless Pennsylvania’s second-largest city identifies at least $200 million in new assets for the fund before Jan. 1, the state’s Municipal Retirement System will begin the process of taking it over. The city may be ordered to double its $46 million contribution by 2015 and to make payments equal to more than one fourth of its budget by 2017, according to a report prepared for the state.

Under a proposal from Council President Darlene Harris, the pension fund would receive $880 million over 30 years from increases in garage and parking-meter rates. It is the latest attempt to provide a substitute for Ravenstahl’s plan to raise $452 million through a long-term lease of parking facilities to a group led by JPMorgan Chase & Co. in New York.

“It’s not a perfect solution, but it’s better than we have been talking about,” said William Peduto, the chairman of the council’s finance committee, which heard testimony on Harris’s proposal yesterday. The council adjourned without voting on the plan after Ravenstahl declined to endorse it.

Debate on Harris’s proposal evolved into a fight over whether the mayor is serious about keeping the pension system under city control.

Cooperation Required
“This plan does not work unless there’s cooperation,” said Doug Shields, a council member. “What is really very clear to me is these people got their marching orders to sabotage this plan.”

Harris’s proposal isn’t feasible because municipal parking authority revenue is dedicated to repaying debt under covenants with bondholders, Kunka said in response.

Pittsburgh’s pension system includes three retirement plans for about 7,000 active and retired firefighters and government workers. Under Pennsylvania law, the state must begin taking control if the city’s obligations are less than 50 percent funded as of Dec. 31.

Moody’s Investors Service changed its outlook for the city’s A1 rated general-obligation bonds to negative on Nov. 23, citing a potential rise in pension costs under state control.

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Jan. 28 (Bloomberg) -- Moody’s Investors Service said it may need to place a “negative” outlook on the Aaa rating of U.S. debt sooner than anticipated as the country’s budget deficit widens.

...the chance that Congress won’t reduce spending and the outcome of the November elections have increased Moody’s uncertainty over the willingness and ability of the U.S. to reduce its debt, the credit-ratings company said yesterday...

...The threat of a lower rating may cause international investors to avoid U.S. assets. About 50 percent of the almost $9 trillion of U.S. marketable debt is owned by investors outside the nation, according to the Treasury Department in Washington.

U.S. debt has increased from about $4.34 trillion in mid-2007 as the government increased spending to bail out the financial system and bring the economy out of recession. The budget deficit has increased to 8.8 percent of the economy from 1 percent in 2007.

“Because of the financial crisis and events following the financial crisis, the trajectory is worse than it was before,” Hess said...

...The U.S. has the highest government debt-to-government revenue of any Aaa rated country, Moody’s said yesterday. The ratio, at 426 percent, is more than double that of Germany, France and the U.K. and more than four times higher than Australia, Sweden and Denmark, according to Moody’s...

more...
http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aHr04uJe9_OQ

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Feb. 14 (Bloomberg) -- Barack Obama may lose the advantage of low borrowing costs as the U.S. Treasury Department says what it pays to service the national debt is poised to triple amid record budget deficits.

Interest expense will rise to 3.1 percent of gross domestic product by 2016, from 1.3 percent in 2010 with the government forecast to run cumulative deficits of more than $4 trillion through the end of 2015, according to page 23 of a 24-page presentation made to a 13-member committee of bond dealers and investors that meet quarterly with Treasury officials.

While some of the lowest borrowing costs on record have helped the economy recover from its worst financial crisis since the Great Depression, bond yields are now rising as growth resumes. Net interest expense will triple to an all-time high of $554 billion in 2015 from $185 billion in 2010, according to the Obama administration’s adjusted 2011 budget.

“It’s a slow train wreck coming and we all know it’s going to happen,”

more...

http://noir.bloomberg.com/apps/news?pid=20601103&sid=aZEV5iOQjv7g

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trysail said:

http://noir.bloomberg.com/apps/news?pid=20601103&sid=aZEV5iOQjv7g


Geithner Tells Obama Debt Expense to Rise to Record
By Daniel Kruger and Liz Capo McCormick

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Loring2 said:

Geithner and Obama are not in control of the situation and this is not meant as a political slap at either. The problem is more sinsister.

A few days ago we had a failed auction on a $16 Billion 30 year Treasury offering.

Now both you and I know the rules on buying this type of TBond and they weren't followed. A mysterious buyer appeared and this is not supposed to happen. It has sinister implicaions to me and other people that I know; including some in Europe.

Failed auctions of course mean that our credit limit has been reached.
Tell me what you know Trysail, if you would

Loring

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...Fiscal economics is not a simple subject. Economics isn’t a class taught in high school. Indeed, only a minority even take a college class in economics. It certainly isn’t core to any liberal arts curriculum. Since most Americans don’t have a firm grasp of economics, politicians feel they can spin the truth toward their own bias. The problem becomes the following. Half truths become lies. An effort to control health care spending doesn’t mean the system is going to abandon your dying parent. Setting the starting age for Social Security one year later isn’t devastating.

We would be a lot better off if the problem were expressed in simple English that anyone with a high school education could understand. Once the problem was acknowledged, then one can seriously weigh alternative solutions.

Let me start by laying out the problem in English. The new budget just presented by President Obama projects spending of a little over $3.7 trillion and income of about $2.6 trillion. I don’t care if you are a corporate CEO or simply trying to sell a few widgets out of your garage. We all can see those numbers don’t add up. The solutions, as viewed from 30,000 feet are simple. We can try and raise revenues or we can cut spending. It is plain for all to see that it would take a 42% increase in revenues to close the gap. It is also obvious that no one is going to suggest a 40% tax increase. Nor would such an increase work anyway because it would crush the economy and actually cripple revenue creation. Therefore, while some increases in taxes might help and an improving economy might push revenues up a bit higher, clearly they only way a truly major dent in the deficit is going to happen is to do something about expenses. That means attacking the big buckets of Social Security, Medicare, other entitlements, and defense. It would be nice and cozy if that weren’t necessary, but it is.

The reason all this is necessary is that deficits add up and the only real way they get funded is by borrowing. If the government were simply an ordinary business, it would have established bank lines. But those bank lines are finite in size. At some point the size of your debt outstanding or the size of your losses would force the bank to say no more. If you reached that point, you would be left with just two choices; close down or chop costs unmercifully to balance the books.

That is exactly what we face as a nation. Right now, the bank window is open. It is wide open. The Treasury today can borrow money anywhere in the world for just a few basis points. But fast forward just a few years and look at a potential debt burden of $20 billion. Let us also assume that interest rates gradually return to normal and the cost of that debt is 4% per year. That would mean that every budget would start with an $800 billion interest payment. Put a different way, we would have to have an economy where revenues exceeded spending by $800 billion every year just to balance the budget. No way!

If the problem seems starkly apparent, then it should be equally as apparent that at some point in time, no one is going to want to lend to the United States. If that happens, there will be only two options. The first is drastic spending cuts that go way beyond trimming fat. It means massive cuts in entitlements and complete austerity in virtually all the discretionary parts of the government. The only other alternative is for the government to print massive amounts of money to fund the debt. That sounds too good to be true and it is. It would result in massive inflation and a sharply devalued currency. Think Zimbabwe...

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If the Federal government were scaled down to the size of the average US household, here’s what its finances would look like:

The Federal government would earn $50,000 a year in tax revenue (the same as the average US household).

• It would be $325,000 in debt.
  
• It would pay almost $10,000 a year in interest on that debt.
  
• Last year, it would have spent $79,000.
  
• This year, it is hoping to spend $86,000.
  
• The $100 billion in spending cuts (that some politicians view as draconian) would be equivalent to the household cutting its $86,000 in planned spending down to a mere $83,700. Not a bad start, but the household has another $33,700 to go before it balances its budget.

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The solutions, as viewed from 30,000 feet are simple. We can try and raise revenues or we can cut spending. It is plain for all to see that it would take a 42% increase in revenues to close the gap. It is also obvious that no one is going to suggest a 40% tax increase. Nor would such an increase work anyway because it would crush the economy and actually cripple revenue creation. Therefore, while some increases in taxes might help and an improving economy might push revenues up a bit higher, clearly they only way a truly major dent in the deficit is going to happen is to do something about expenses. That means attacking the big buckets of Social Security, Medicare, other entitlements, and defense. It would be nice and cozy if that weren’t necessary, but it is.

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DeeZire said:

In the 1950's, the tax rate for the super rich was over 90%, and that was one of the most prosperous eras in the history of the USA. I'd suggest the writer of the above quote has an agenda, and that agenda is not about the deficit, it's about cutting government services.

The writer mentions it would take a 40% tax increase to balance the budget. If the rich pay over 50% of the taxes in this country, (as they often complain about) it would simply be a matter of keeping tax rates static for everyone except the rich, where we could reinstate the 90% rate from the 1950's. There's your balanced budget.

We could also cut defense spending in half, and still be spending more on defense than anyone else. We could also means test social security payments, and ration end-of-life care for Medicare. (Rationing is what you do when you don't have an endless supply of money. Do we have an endless supply of money for Medicare? Nope.)

The idea that we must cut funding for Public Broadcasting and the heating assistance program for the poor in order to balance the budget is an insult to the intelligence of the American public. With the ever widening income gap between rich and poor, why must society at large suffer so that the rich can get even richer? I find it comical that this country was founded by immigrants fleeing the very same economic conditions we are now creating in the USA.

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