States and municipalities typically offer defined-benefit pension plans to their employees. They are supposed to set aside money every year to fund their future obligations. The amount of money depends on the size of the obligation and the rate of return that they get on the assets in the pension plan. With the collapse of the central bank credit-driven stock market bubble, many such plans are finding that their present assets are not sufficient to cover their future liabilities. The article cites a report estimating that 80% of such plans are under-funded. Instead of setting aside more money from their current spending (which would require either raising taxes or cutting other expenditures), they are issuing bonds, according to this Bloomberg article.
There are myriad problem with this approach. One, according to a report cited in the article is “Using pension obligation bond proceeds to pay current and subsequent year pension contributions is considered by Fitch to be a type of deficit financing — the use of borrowing funds to pay for an annually recurring expense.’’ Another is that borrowing to invest in stocks or bonds introduces more leverage into the finances of these plans. The state government is able to borrow funds at some rate, say 5%, which they invest in stocks and bonds. They are betting that the assets return more than the carrying cost of their debt. They must earn at least 5% just to stay even. Another report cited by Mysak calls this a ”risky arbitrage transaction”.
