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Wolf: Borrow billions, drink more, hire cheaper money managers, to fund Pa. pensions

In the proposed 2015-16 budget

Pennsylvania Gov. Tom Wolf in his new budget proposal says he will reduce the $50 billion-plus gap between what Pennsylvania owes current and future retirees, and what it has invested so far to pay them -- a gap that has required large and growing annual taxpayer increases in pension funding -- "by more than $10 billion," through these steps:

- FIRE PRIVATE MONEY MANAGERS: The budget would "institute pension investment reforms to significantly reduce excessive management fees and overreliance on high risk investment strategies," and instead "seek less costly passive investment approaches where appropriate." 

Wolf appears to favor the kind of index funds and other low-fee investments chosen by Democratic-run Montgomery County in 2013 when it fired more expensive "active" investment managers and bought indexed funds from Malvern-based Vanguard Group. Montco says its investments returned 14.2% in 2013, as it was implementing the new indexed approach. The Pennsylvania state pension system, which uses hundreds of high-fee money managers and strategies, returned 13.6%. Both expect to report 2014 numbers soon.

Wolf says these "management reforms would signficantly reduce taxpayer costs." Wolf appears to assume these savings will be passed along to the pension systems with no change in investment returns, as if the only difference between buying actively-managed stock, hedge, real estate or private equity funds, and buying index funds, is that the actively-managed funds cost more and the net, after-fee return from index funds is correspondingly higher.

- BORROW BILLIONS AND BET: "A portion of the current unfunded liability for PSERS would be refinanced to take advantage of historically low interest rates, with all savings reinvested to reduce that liability." Wolf wants to borrow $3 billion and give it to PSERS so it can reduce the recent increase in pension subsidies by school districts and the state treasury.

Can this work? Maybe, if PSERS is lucky enough to invest the money in a fast-rising investment market (as New Jersey did with a pension bond in the early 1990s). But if investment values drop or produce only small returns after the money is borrowed and invested (which is what happened to Philadelphia's 1998 pension bond), PSERS will have less to show for its additional interest payments and the pension system will fall farther behind, instead of closing the gap. 

Given recent bond prices and Pennsylvania's bond rating (third-worst of U.S. states after Illinois and New Jersey), rates for taxable Pennsylvania pension bonds "would be about 3.25% (for 10-year bonds) and maybe 4% in 30 years," Alan Shanckel, municipal bond strategist for Janney Capital Markets in Philadelphia, told me. Pennsylvania would have to pay that percentage and beat its self-imposed 7.5% investment return target each year to make the bond pay.

- DRINK MORE: Wolf hopes to get Pennsylvanians to buy more liquor through the state-controlled Liquor Control Board by opening state stores on Sundays, making liquor more easily available, and "competitive pricing."

In 2016-17, Wolf hopes to raise "$80 million in new profits from liquor modernization," which "will be allocated to school districts to reduce pensoin payments" in 2016-17. The following year, "increased profits" from liquor sales  should rise to $185 million, which "will be transferred annually to pay the full cost of debt service" on the $3 billion PSERS bond.

- PAY MORE: "Beginning in the 2016-17 fiscal year, future employer payments ot SERS and PSERS will fully fund employer obligations" and in future will only increase as fast as inflation.

- END CHARTER SPECIAL TREATMENT: Wolf also wants to reduce what he says are excessive payments to charter school employee pensions under current law.

Re Wolf's pension plans, see also:

Of course there's a strong recent history of Pennsylvania Governors relying on vice to boost state revenues. See also Gov. Ed Rendell's casino legislation; and Gov. Corbett's plans for increasing liquor sales under private management: