Reuters’ Felix Salmon, one of the most influential finance bloggers in the nation, jumped into the discussion Josh Barro and yours truly were having about Rhode Island officials’ justification for refusing to default on the 38 Studios bonds. While Salmon agrees the state’s pensioners would seem more deserving of repayment than the bondholders, he gently chides Josh and me for a bit of “faux naïveté” regarding what’s going on:

The answer is that yes, moral obligation bonds are effectively general obligations bonds in all but name. The state has found a way of issuing bonds without having to get the approval of the legislature, but they’re still obligations of the state, and the state doesn’t distinguish the two types of obligation. And yes, Rhode Island should be paying the lower interest rate rather than the higher interest rate. But that doesn’t mean that voters should have to approve moral obligation bonds: it could equally mean that voters should stop having to approve general obligation bonds.

That is what all governors really want: to have the legislature and voters stop interfering in their borrowing strategy. And that is the real reason why Chafee is staying current on his moral obligation bonds. He wants the world to see voter approval as an anachronism, and in an ideal world he would love it if moral obligation bonds had the same legal backing — and therefore the same lower yield — as general obligation bonds. That way he’d never need to issue a general obligation bond, or get voter approval for such a thing, ever again. It’s a very attractive vision — and it’s not one he’s going to give up just because Rhode Island is suffering a fiscal nightmare these days.

As someone who spends a lot of time listening to Lincoln Chafee, I’m skeptical that the governor has truly thought through the reasons for drawing a distinction between moral-obligation and general-obligation bonds (or not drawing one). But as Salmon makes clear, this debate has demonstrated that there’s no real difference between the two types of debt when it comes to whether taxpayers will have to cover the liability.

• Related: Chafee reveals RI’s confusion about the 38 Studios bonds (May 1)

After reading this story by Dan McGowan and yours truly about why the Rhode Island Senate shifted on same-sex marriage, Bloomberg View’s Josh Barro sees a lesson for proponents in other states (my emphasis):

This is similar to what happened in New York in 2011: passing gay marriage depended not only on four Republican state senators voting yes but also on Dean Skelos, the Senate’s Republican presiding officer, agreeing to let gay marriage come to the floor even though he opposed it. Rhode Island and New York are both examples of the “no fingerprints” strategy for gay-marriage opponents: letting it become law while taking as little credit or blame as possible.

If the Supreme Court doesn’t intervene, this will be a key political theme over the next 20 years: gay marriage opponents strategically acquiescing so they can stop fighting a fight they know is doomed and electorally costly. Rhode Island’s topsy-turvy politics mean that the officials making that calculation today are Democrats (all five Republicans in Rhode Island’s state Senate support marriage equality), but in most states, it will be Republicans who search for ways to lose gracefully on the issue.

Last week’s Target 12 investigation of Scituate’s absentee pension board has sparked a renewed conversation about how the state should handle its troubled locally run pension plans. “There is a concerning set of facts that you’re hearing about in Scituate,” Treasurer Gina Raimondo said on Newsmakers Friday. But, she continued, local officials need to negotiate with organized labor if they want to go into the state-run system (MERS).

Josh Barro, a columnist for Bloomberg View and longtime friend-of-Nesi’s-Notes, also sees a lesson in the Scituate investigation – most municipalities are just not equipped to handle the complicated task of managing a pension fund:

In most states, public employee pension systems are run either by the state government alone or by the state and a handful of the largest cities. For example, New York City is the only municipality in New York state with its own plans; all other cities and counties participate in two large statewide funds.

Pension systems are complicated, and overseeing them properly takes time and expertise. This is a heavy lift for municipalities overseeing small pension plans. …

Of the 110 statewide pension systems covered by the Public Funds Survey, the worst-funded is the Illinois State Employees’ Retirement System, with a funding ratio of 35.5 percent. Sixteen of Rhode Island’s 36 local plans are worse funded than Illinois SERS. …

The more promising long-term fix, floated by some Rhode Island lawmakers including State Treasurer Gina Raimondo, is to close municipal pension plans and have one pension system for municipal workers overseen by the state government.

Read Barro’s full piece here.

• Related: Raimondo: Move 36 local pension plans into state-run system (Jan. 30, 2012)

A little-discussed part of last year’s landmark pension law was a section called the Rhode Island Pension Protection Act, which aimed to tackle the concerns highlighted by defined-benefit critics such as Josh Barro, and which won praise from Rhode Island AFL-CIO President George Nee.

The Pension Protection Act says the state Retirement Board or its actuary cannot “change actuarial methods for the sole purpose of achieving a more favorable funding or fiscal result” – as happened in 1990, when former House Speaker Joseph DeAngelis pressured the Retirement Board into raising its investment return forecast so lawmakers could balance the budget with a smaller pension contribution.

“Politics hasn’t been good for the pension fund,” Treasurer Raimondo said at a RIPEC forum in October 2011. “I can’t redo the past. I can make it better going forward. The bill we provide fundamentally restructures it. It puts self-correcting mechanisms into the plan.”

In an effort to prevent future lawmakers from allowing a funding gap to grow, the act says that if a pension plan’s funding level falls below 50.1% or declines for five years in a row the actuary must provide the Retirement Board with five to 10 options for getting it back on track. The General Assembly must choose one of them by June 30; if lawmakers don’t act, the default option will take effect automatically.

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There’s been a lot of pension triumphalism in Rhode Island since the overhaul of the state system masterminded by Treasurer Gina Raimondo was enacted by Governor Chafee and the General Assembly.

Josh Barro, a policy analyst at Bloomberg View, acknowledges that Rhode Island’s pension law is “the most aggressive reform of recent years.” But in a recent National Affairs article, he argues that even its “bold” changes “will not do enough to place the state’s pension system on sound financial footing.”

“Rhode Island still hasn’t been able to overcome the fundamental problems plaguing its pension system,” Barro writes, arguing that the Ocean State “came closer than any other state to success, and yet still couldn’t quite manage it.”

The heart of Barro’s critique is this: by keeping part of the pension plan as a defined benefit – a fixed annuity that’s paid regardless of actual investment returns – the new law still leaves taxpayers facing a significant risk if lawmakers don’t fund the system.

That critique would apply not only to Raimondo’s hybrid system but also to Providence Mayor Angel Taveras’s settlement, which keeps the traditional defined-benefit system in full and counts on future mayors and city councils to act responsibly if the city is to avoid another solvency crisis someday.

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Slate’s Matt Yglesias serves up some real talk about Rhode Island (emphasis mine):

The real truth, as noted in this great Andrew Gelman post from five years ago, is that there isn’t that much change over time in states’ economic well-being. All things considered the best predictor of how rich a state was in 2000 was simply how rich it was in 1929. There are some exceptions to this. … Rhode Island used to be about as rich as Massachusetts and has stagnated terribly. …

[T]he truth is that it’s very difficult to alter to the long-term trajectory of a state’s economic fortune. That’s primarily because people can move. If Mississippi starts doing a much better job of preparing its students to succeed in higher education, a lot of those people will probably leave and move to higher-income states like Connecticut or Massachusetts. Indeed, neither [Deval] Patrick nor Romney was born in Massachusetts. Rather, like many of the state’s most successful individuals they moved to the Bay State from elsewhere to go to Harvard and then stuck around. But creating Harvard was a smart public policy initiative undertaken in the seventeenth century and not something anyone alive today can take credit for.

Right.

This is something too often missed in all the debates over Rhode Island’s economy - after starting at parity after World War II, the state has spent six decades losing ground economically to its neighbors, particularly during the 1980s and 1990s. That’s a major problem for a variety of reasons, many of which were noted by Josh Barro in his must-read post from May.

Yglesias also indirectly references this 2005 Steve Sailer post tabulating “the monetary standard of living by state, as calculated by median income for a family of four divided by the Accra’s cost of living index.” Sailer gives Minnesota the highest standard of living, “at least in terms of things money can buy (i.e., not weather).”

As for Rhode Island? It was way down the list at #40, far behind Connecticut (#15), Massachusetts (#20) and Vermont (#33). (The other two New England states weren’t ranked due to lack of data.)

The Stephen Hopkins Center for Civil Rights will hold a panel Wednesday at noon at The Old Statehouse (150 Benefit St., Providence) to discuss something that has been largely off the table in the state so far – whether Rhode Island should default on the moral obligation bonds it sold to benefit 38 Studios.

Revenue Director Rosemary Booth Gallogly criticized that idea on Newsmakers earlier this month, saying the state can’t afford to risk its bond rating even though the 38 Studios bonds aren’t general obligation bonds. The panel will hear a countervailing view from Bloomberg View’s Josh Barro, who previews his thinking today:

Performing on the 38 Studios guarantee will cost nearly $100 million, a nontrivial amount in a state with just more than a million residents. Rhode Island lawmakers owe taxpayers an explanation of why the state issues moral-obligation bonds. If the answer is in order to preserve the option of default, they should provide guidance as to what kind of circumstances would lead the state to consider defaulting — and how that guidance relates to 38 Studios.

If the answer is that the state uses moral obligations to create general obligations, lawmakers should admit that’s an invalid reason, and stop issuing moral-obligation bonds.

Joining Barro on the panel are former R.I. Supreme Court Justice Robert Flanders and Roger Williams University Law Professor John Chung. The Hopkins Center is a libertarian legal-aid group organized last year that has taken a number of stands, including siding with Governor Chafee in the dispute over Jason Pleau.

• Related: Josh Barro: Rhode Island should default on 38 Studios bonds (May 29)

Rhode Islanders who picked up their New York Times this morning probably did a double take when they reached the op-ed page and saw Providence native Joe Nocera’s column blaming the American Legislative Exchange Council – ALEC – for Woonsocket’s plight. Nocera picked up the theme from former WPRO reporter Bob Plain, who’s been covering Woonsocket for liberal blog Rhode Island’s Future.

But as Plain admitted Tuesday, his case for linking ALEC and Woonsocket is based solely on “enough circumstantial evidence to at least raise the question.” And Providence Phoenix editor David Scharfenberg, who previously looked into whether ALEC was behind Rhode Island’s voter ID law, is unconvinced:

[P]laying the ALEC card seems a bit cheap here. Brien is an unabashed conservative, with or without ALEC. And while the group may provide the legislator with a bit of intellectual succor, there’s no evidence to suggest it had anything to do with Brien’s decisionmaking on Woonsocket’s finances.

Josh Barro, now writing for Bloomberg View, says Nocera hasn’t done his homework:

The truth is that Woonsocket is the most indebted municipality in Rhode Island, relative to its property tax base, and a majority of its debts are related to pension and health benefits for municipal retirees. …

Whatever happens in Woonsocket, there will be a lot of hard choices made and pain experienced. Defenders of the public employee compensation status quo desperately wish that weren’t the case, and that Woonsocket’s troubles were simply invented or created by ideologically-driven conservatives. As actual lawmakers in Rhode Island — most of them Democrats – are learning, the situation isn’t nearly that simple.

Substance aside, Rhode Island Public Radio’s Ian Donnis adds a shrewd meta observation from the media-critic perspective: “This is further evidence that Plain has energized the liberal blog in a way not seen since the era of its founder, Matt Jerzyk.”

• Related: Q&A with NYT’s Nocera on paywalls, Providence and CEO pay (April 11, 2011)

If 38 Studios can’t pay off its $75 million EDC loan, as appears likely, it’ll be up to Rhode Island taxpayers to step in and cover the principal and interest payments bondholders are due through 2020, at a cost of nearly $90 million.

But as Marcia Van Wagner of Moody’s noted last week, these are moral obligation bonds, not general obligation bonds, which means the state only promised to ask for money to pay them off: “Once the appropriation request is submitted [by the governor] to the legislature, the state’s legal obligation has been met and the legislature may decide not to appropriate the funds,” Van Wagner wrote.

The possibility that Rhode Island would actually default seems remote; state officials from Governor Chafee on down told Moody’s taxpayers will make bondholders whole, and the Department of Revenue is already mulling how to deal with the burden left by 38 Studios. But writing in his new Boston Globe column, Josh Barro suggests Rhode Island should seriously consider stiffing bondholders:

Generally, states should perform on their moral obligations. But Rhode Island’s government has more moral obligations than it can possibly service. The state still struggles under a huge unfunded public employee pension obligation, even after a major set of pension reforms last year, which will freeze cost of living adjustments for current retirees for as long as 15 years.

Surely, the state had a moral obligation to pay those pension benefits in full. If it couldn’t afford to meet that obligation, how can it afford to appropriate the nearly $100 million that it will take to pay off the 38 Studios bondholders with interest? A default will surely make it difficult for Rhode Island to issue more moral obligation bonds — but if that means no more 38 Studios-style deals, so much the better.

Read the rest here. And Josh isn’t the only one writing about the 38 Studios deal:

• The Globe’s reporters looked at why it unraveled so fast and the demand for 38 Studios’ ex-workers.
• CNNMoney’s Ken Sweet reports the deal was flawed from the start and suggests the Chafee administration should have sought an injunction to keep the workers in place.
• Joystiq’s Alexander Sliwinski reports a “Reckoning” sequel was already in the works, though Electronic Arts passed on it.
• Big Huge Games’ lead designer wrote about the collapse and why it means no “Reckoning” patch.
• My WPRI 12 colleagues tried without success to interview Governor Carcieri.
• Chafee’s comments about the violence and sexism in video games sparked some debate.
• The Worcester T&G’s Peter Cohan explained why Massachusetts didn’t do what Rhode Island did.

Lastly, Curt Schilling wrote Sunday on Facebook: “Phillipians [sic] 4.4-4.9.” (Here’s the verse.) Oh, and if you missed it Friday night, Chafee and Raimondo are arguing over why she wasn’t at a 38 Studios briefing.

Update: Schilling tells his side of the story.

• Related: Josh Barro on why RI’s economic problems are so intractable (May 4)

One of the biggest problems in Rhode Island policymaking, I think, is a lack of perspective – the state’s problems are looked at narrowly and locally, without paying nearly enough attention to national and global factors.

Forbes’ Josh Barro, one of the smartest analysts in the country today and a Nesi’s Notes favorite, isn’t stymied by that, since he lives in New York City. But he’s been keeping a close eye on Rhode Island over the past year and a half, and he’s got some important insights to offer us:

Within New England, Rhode Island faces a major structural disadvantage. Rhode Island’s per capita income in 2010 was $27,700. That’s actually slightly above the national average, but it’s far below Massachusetts ($33,200) and Connecticut ($35,100).

As a result, Rhode Island has both higher taxes and lower public expenditure than its neighbors. As of 2009, Rhode Island collected 10.1 percent of state GDP in taxes, outstripping Connecticut (9.9 percent) by a little and Massachusetts (8.9 percent) by a lot. But despite that, Rhode Island governments had only $4,638 in per capita tax revenue to work with, less than Massachusetts ($5,014) or Connecticut ($6,434).

In other words, any given Rhode Island taxpayer can expect tax savings by moving to Connecticut or Massachusetts, where he or she can also expect more generous government services. As such, it’s really hard for Rhode Island to stay competitive. Trying to match its neighbors on service delivery will mean having an outsized tax burden, and trying to match their tax rates means providing a lot less government.

(That may explain why Rhode Islanders feel overtaxed and think government services are inadequate.)

The whole article is a must-read for Rhode Islanders (and not just because I may have goaded Josh into writing it on Twitter). Fair warning – his conclusion will be a little depressing for locals. But if he’s right, we ought to start having a much more difficult, more nuanced conversation around here.

Josh Barro of Forbes argues Chafee’s embrace of far-reaching changes to how cash-strapped municipal governments operate is part of a larger trend:

Chafee is coming out for mandate reform for the same reason that mayors like Chicago’s Rahm Emanuel and Los Angeles’s Antonio Villaraigosa are aggressively pushing pension reform. A majority of the typical local government budget consists of compensation costs. States and localities face significant political and economic barriers to collecting new revenue. When budgets get squeezed, the practical choice is often between reining in compensation costs per employee or cutting back on service delivery.

For politicians who care about providing high-quality government services, public employee compensation reforms have become the best available option.

Bob Plain of Rhode Island’s Future thinks I missed a crucial distinction between Chafee’s ideas and Carcieri’s:

[T]he big difference is Chafee’s bottom-up approach. Carcieri’s proposal was a blanket exemption to every municipality and Chafee’s is need-based. RI Future has held the former governor’s feet to the fire for cutting so much money from cities and towns that had so little. So did Chafee earlier this week.

Here’s hoping that Chafee’s proposal sparks a big debate in the General Assembly about the disparity between the haves and have-not communities in Rhode Island as this is arguably the biggest affliction affecting the entire state.

Monique Chartier of Anchor Rising thinks it’s foolish that some of the savings would go into pension funds:

Many cities and towns do not have the revenue to properly fund their pension plans. Some cities and towns do not have the revenue to maintain day to day operations, much less try to make up underfunded and very generous pensions. Accordingly, how could they have the money to reinvest, exclusively or otherwise, into their pension systems?

The Projo reports labor leaders are not happy:

Governor Chafee’s proposal to let financially distressed cities and towns make significant changes to union contracts represents a “fundamental assault” on the labor movement’s “core values,” according to George H. Nee, president of the state AFL-CIO. …

[James Parisi, lobbyist for the Rhode Island Federation of Teachers and Health Professionals] said giving certain cities and towns the ability to freeze annual salary increases for teachers and change medical benefits were particularly offensive, considering local chapters have, over the years, made concessions in their contract negotiations. …

Paul L. Valletta Jr., lobbyist for the State Association of Fire Fighters, said the proposal essentially allows executives of financially distressed cities and towns to “rip up” collectively-bargained union contracts.

“I actually thought this governor thought more of working men and women of this state,” he said. “This opens up everything. There are no protections anymore.”

And in case you missed it earlier this morning, my take is that Chafee sounds a lot like Carcieri:

Chafee’s pitch on Thursday sounded much like his predecessor’s in December 2009. ”I urge the General Assembly to pass the municipal tools articles immediately upon returning to session,” Carcieri said. “There is no need to debate them again this year. Pass them and free the cities and towns to manage their own budgets.”

New York is the only state in the nation where government employees are more unionized than here in Rhode Island. Last week’s item reporting that statistic brought this response from regular commenter GaryM:

This begs the question, why does NY State have one of the best funded state pension systems in the nation, and RI sits at the extreme opposite end in the toilet? After all, NY faced the same ups and downs in the markets as we did.

It does appear to go beyond union control and probably has more to do with the average RI citizen being so tolerant of crooked behavior in their political system.

I’ve wondered about that, too. The last Pew study of all the states’ pension systems showed New York’s was 101% funded, while Rhode Island’s was at 59%. (It’s now at 48% after those much-discussed assumption changes.)

What gives? I put the question to Nesi’s Notes regular Josh Barro, a senior fellow at the Manhattan Institute and a New Yorker himself. In an email, Barro said Empire State pensioners have the judiciary to thank:

New York’s pensions are subject to a court decision that has forced the state to fund the system aggressively. The state and its municipalities are forced by the courts to pay their ARC [annual required contribution] annually.

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Josh Barro knows pensions.

Barro, a senior fellow at the Manhattan Institute in New York City, is an expert on state and local finances and the author of “Dodging the Pension Disaster.” We spoke in May about how Rhode Island’s leaders should approach pension reform; on Friday, Barro emailed his thoughts on the ideas Treasurer Raimondo outlined today:

Overall, the plan laid out by Treasurer Raimondo and Governor Chafee strikes me as a very good approach.

It is particularly important that the new system is for all accruals by workers in the future – not just for workers not yet vested or not yet hired. This is very important so that the state can start achieving real savings quickly and stop awarding pension benefits that are larger than necessary to attract and retain workers. As you note, this mirrors the process for changing pension benefits that is typical in the private sector (in compliance with ERISA), but it has not been typical in the public sector; most states, to their detriment, have been enacting pension benefit reforms that do not apply to the current workforce, meaning that meaningful savings will not be realized for years or decades.

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Even the Big Apple is taking notice of the financial crisis in our smallest city.

The Manhattan Institute’s Josh Barro tweeted earlier that he discussed Central Falls this morning on, of all places, New York City talk radio station WOR. Barro walked host Josh Gambling through the basics of the city’s situation and what could happen to the pensioners.

“He seemed particularly struck by the lack of an upstream guarantee; i.e., the pensions are guaranteed only by the city government,” Barro told me in an e-mail. “We also talked about the lack of backstops in this case, because public pensions are not in the PBGC and Central Falls workers are not in Social Security.”

Barro made the same case to Gambling that he made to me – that defined-benefit pension systems are generally a bad idea in the public sector, but if they are used, governments should be required to stick to a contribution schedule and they should be run on the state level, not locally.

You can listen to their discussion here.

Now that Treasurer Gina Raimondo has released her much-anticipated report on Rhode Island’s pension system, all eyes are turning to the General Assembly as lawmakers decide what action to take in response. The Center on Budget and Policy Priorities’ Elizabeth McNichol offered her thoughts here on Thursday.

Josh Barro is the Walter B. Wriston Fellow at the Manhattan Institute for Policy Research in New York City and author of many articles on state and local finances, including “Dodging the Pension Disaster.” He discussed Rhode Island’s situation with me in a phone interview earlier this week.

Our State Retirement Board just approved new investment return and longevity assumptions that reduced the pension system’s funded ratio to about 48%, with an unfunded liability of about $7 billion, giving it among the biggest shortfalls in the country. How do those numbers strike you?

Well, 48% is quite bad. It’s worse than most states. It’s not the worst in the country; I don’t know if the Illinois funds have released all the updated figures, but the estimate I’d seen recently is that Illinois is at 38% funded. So you can do even worse than 48%, but it’s definitely significantly worse than average.

So if you were a state official in Rhode Island, what are the first steps you’d take to address this?

There are two things you have to do when you have a big unfunded pension liability like this. First is come up with a plan to deal with closing the gap, and usually that mostly just involves putting a lot of money into the pension system over time. And then the second thing you have to do is make sure that further gaps don’t form in the future, because this is really unaffordable for the state.

In my view, that should involve fundamental pension reform, particularly moving away from this defined-benefit structure, which allows funding gaps like this to form – putting employees on plans that look more like 401(k) plans, where the government contributes its money up front. Then there’s no risk of an unfunded liability forming the future because investments underperform.

And I’d note that you don’t just have to make changes for new employees. There are no national-level restrictions that prevent you from making changes that apply to benefits that current employees will accrue in future years. Private companies do this all the time – they say that you get to keep the pension benefits that you’ve earned to date, but going forward we’re going to offer you a different deal that’s more affordable and better matches our business objectives. So similarly, a state should be able to say to employees, going forward we can’t afford to let you accrue the same pension benefits that you’ve accrued in the past. And that will free up some savings to put toward closing the unfunded liability you already have.

There are a bunch of things there I want to ask you more about, but let’s start with what you said about putting a lot of money into the pension system. I know you’re not an expert on Rhode Island, but we have a troubled economy and a structural budget deficit – is it politically and financially feasible for states like Rhode Island and Illinois to find enough money to cover the pension gap?

Well, it obviously depends on the specific financial situation of the state. I’m not specifically an expert on Rhode Island, although I do know about the pressures you face being surrounded by Massachusetts and Connecticut, which have higher average family incomes, so you’re trying to keep up with government spending in states that have a significantly deeper tax base to finance their spending.

Essentially, these unfunded liabilities are like debt. They’re promises made to government employees for work that they already did, and so you can’t take lightly the idea of defaulting on those promises. The sorts of situations in which states should think, “Well, gee, maybe we can’t even afford to pay the pension benefits employees already earned or that retirees who are already done working earned” – I think the situation in which you’d think about defaulting on those is the sort of situation where you’d think about defaulting on your bonds, which is to say a very dire situation that is akin to a bankruptcy in the private sector.

Even though states can’t technically go bankrupt legally, they could default on various obligations. But it’s not something that generally they should be doing. It’s always an option if things get really, really bad, but I don’t really think you’re there yet. I don’t even think Illinois is there yet. You do have a long time to pay off these obligations – they represent payments that are due over periods of years and decades, so even though the numbers are very large, you do have a long time to cope with them.

So I would say that it is theoretically possible for a state to have built up a pension liability that is literally unaffordable, but you should think very hard before you think about defaulting on it.

That’s interesting to hear, because a lot of folks around here seem to want current retirees who are getting pension benefits to have those reduced.

When the state makes promises, sometimes those promises might be unwise, but still you have to tread very carefully before you break them. I wrote a piece about the two kinds of pension promises. Basically, I think we need to draw a distinction between when you promise someone something and they did work for you in the past based on that promise – say, a retiree who worked 30 years as a cop because he expected to get this specific kind of a pension – as compared to when you’ve hired someone and they’ve worked for you for a couple of years, and they think they have some sort of promise that they will get to participate in this pension system while they’re working for the next several decades.

The second one is not the same kind of promise. We can say, well, we’re not going to offer you that kind of promise anymore, and if they don’t like that they can leave their job and go work somewhere else.

Certainly there are some states that have defaulted at least a little bit on vested pension benefits, particularly by changing cost-of-living formulas -

Yeah, that’s something we’ve done already, and it’s being litigated.

First of all, that may not even survive litigation – they may have some federal claims that it violates the contracts clause of the U.S. Constitution. I’m not a lawyer – I don’t know how that stuff’s going to stand up, but in a lot of states I think it’s likely that those reforms will not stand up.

Then also, generally, I think the state needs to honor the promises it makes. Clawing back somebody’s vested pension benefits is not that different from reaching into their bank account and taking back money that you paid them in a previous year. So in general, no, I would say that states should not be defaulting on pension benefits that vested in the past.

Unfortunately, I think states are somewhat pushed to that because they have other avenues that are closed off to them. I think it should generally be pretty easy for states to modify pension benefits that people will earn in the future, but in practice they tend to face tremendous political and sometimes legal barriers to doing that. So I think lawmakers are feeling a little bit desperate and are sort of looking for any way they can find to reduce their pension liabilities and their pension costs, and if more of the options that should be on the table actually were, then I think they wouldn’t have to resort to these undesirable options.

Another policy option being discussed here by Governor Chafee and others is “re-amortization,” which would stretch out our unfunded liability payments over a longer period. What do you think of that idea?

In general, I think re-amortizations are a bad idea. They’re effectively a way of borrowing money. You’re putting less money into the pension system but you’re not accruing fewer liabilities in the pension system. So in fact you’re really hiding the cost of the pensions that you have – you’re pushing more of it off to tomorrow and making the system look more affordable than it really is.

That said, if you coupled the re-amortization with reforms that really did produce long-term cost savings – particularly if you coupled it with reforms that applied to future benefits for current workers, and not just for new workers – I think it would be fine to have a re-amortization as part of that deal. Essentially, if the state took its medicine by reforming the pension system in a way that would produce real savings then it would be OK with me if they did a re-amortization to provide a little bit of a short-term fiscal boost.

But in practice, when states do those re-amortizations it usually is a way of putting a Band-Aid on a problem and avoiding finding a real solution.

That’s actually the approach our treasurer, Gina Raimondo, put forward in her study this week  - allowing a re-amoritzation so long as other steps are taken. Another suggestion made this week was that the pension fund could take over our big slot parlor, Twin River, or the state Lottery. What about that?

That sounds like a gimmick. You can move money around on the state’s balance sheet – one thing a lot of states has done is issue bonds and then use the money from those bond proceeds to put in the pension fund.

Illinois has done a lot of that, right?

Right, and it hasn’t worked very well for Illinois. It’s basically a way of trading one kind of debt for another. So if the state owns a valuable asset, like the stream of future income off the Lottery, and it sticks that in the pension fund, the state hasn’t become more fiscally sound – it’s just moved stuff around on its balance sheet. I mean, currently that lottery revenue gets used for other stuff, right?

Yeah, gaming money is about 11% of our general revenue now I believe.

OK, so now your pension fund is more solvent but then you have this big hole that’s formed in the rest of your budget.

You’re a proponent of transitioning state retirement programs from defined-benefit to defined-contribution plans, but I’ve heard people express concerns that the transition costs of switching would be overly high. What do you say to that?

The transition costs I would say are an illusion that’s created by the manner in which pension accounting is done.

First of all, people often conflate this with the discussion about Social Security privatization, which would in fact entail huge transition costs. The difference here is that unlike Social Security, defined-benefit pensions are supposed to be fully funded. So if you do the transition, you have to come up with all the money to close the funding gap by the time all the retirees and active workers are dead essentially. But theoretically you’re supposed to be doing that anyway – you’re supposed to be shoring up the funds to 100% funding by making all those same payments.

Now the way the accounting rules work, they can change the schedule on which you’re supposed to make those payments and effectively encourage you to move to a faster amortization schedule, and I’d say two things about that. One is that that’s not really a new cost – it just means more payments up front and shallower payments in the future, the present value of which should be the same. The other is that the government can simply ignore the GASB rules that tell them to speed up the amortization. I mean, governments all over the country are already ignoring so many GASB directives on pensions that they can feel free to amortize on any schedule they want.

Politically, I think that’s a tough sell. I can sit down in a room with some pension administrators and we could structure a way to do that such that the schedule of payments is not changed at all by the fact you had a transition – politically, it would be difficult to sell people on that, especially because it would probably involve a pension bond issuance.

That’s been a real stumbling block, and I think that’s unfortunate because I don’t think there’s a real transiton cost issue even if there is an imagined one.

Any other bottom-line thoughts you’d like to offer Rhode Islanders as this debate on pensions moves ahead?

When you take a step back, there’s a reason that Rhode Island and so many other states are in the trouble that they’re in right now, which is that defined-benefit pensions are basically a structure with which state lawmakers cannot be trusted. They involve making promises over periods of decades. They involve state lawmakers now making decisions for political benefit, and being able to send the bill to people who will be in office far in the future.

It was very common around the country about a decade ago to give out a pension “sweetener” – around 1999 or 2000, the stock market was doing very well, pension balances looked very strong, and there was this idea that, oh, it’s free money we can give away. Now of course that wasn’t true, first of all because there was the risk the stock market would decline – and then some states used accounting tricks to artificially inflate the funding situation for their pension funds.

But basically, behavior like that is inevitable because pension funds are so complicated. People are paying attention to them right now because there’s been so much trouble, but five years ago no one was watching except the public employee unions, which obviously had very good reason to be very well informed about these issues. And so policy gets made without lawmakers necessarily even understanding it, and not necessarily for the benefit of taxpayers. So part of the benefit of a simpler compensation system is simply that it is simpler, and therefore it’s easier for the public to hold lawmakers accountable for the decisions they make about it.

(photo: Manhattan Institute)