[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
ROLE OF PUBLIC EMPLOYEE PENSIONS IN CONTRIBUTING TO STATE INSOLVENCY
AND THE POSSIBILITY OF A STATE BANKRUPTCY CHAPTER
SUBCOMMITTEE ON COURTS, COMMERCIAL
AND ADMINISTRATIVE LAW
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FEBRUARY 14, 2011
Serial No. 112-25
Printed for the use of the Committee on the Judiciary
Available via the World Wide Web: http://judiciary.house.gov
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COMMITTEE ON THE JUDICIARY
LAMAR SMITH, Texas, Chairman
F. JAMES SENSENBRENNER, Jr., JOHN CONYERS, Jr., Michigan
Wisconsin HOWARD L. BERMAN, California
HOWARD COBLE, North Carolina JERROLD NADLER, New York
ELTON GALLEGLY, California ROBERT C. ``BOBBY'' SCOTT,
BOB GOODLATTE, Virginia Virginia
DANIEL E. LUNGREN, California MELVIN L. WATT, North Carolina
STEVE CHABOT, Ohio ZOE LOFGREN, California
DARRELL E. ISSA, California SHEILA JACKSON LEE, Texas
MIKE PENCE, Indiana MAXINE WATERS, California
J. RANDY FORBES, Virginia STEVE COHEN, Tennessee
STEVE KING, Iowa HENRY C. ``HANK'' JOHNSON, Jr.,
TRENT FRANKS, Arizona Georgia
LOUIE GOHMERT, Texas PEDRO PIERLUISI, Puerto Rico
JIM JORDAN, Ohio MIKE QUIGLEY, Illinois
TED POE, Texas JUDY CHU, California
JASON CHAFFETZ, Utah TED DEUTCH, Florida
TOM REED, New York LINDA T. SANCHEZ, California
TIM GRIFFIN, Arkansas DEBBIE WASSERMAN SCHULTZ, Florida
TOM MARINO, Pennsylvania
TREY GOWDY, South Carolina
DENNIS ROSS, Florida
SANDY ADAMS, Florida
BEN QUAYLE, Arizona
Sean McLaughlin, Majority Chief of Staff and General Counsel
Perry Apelbaum, Minority Staff Director and Chief Counsel
Subcommittee on Courts, Commercial and Administrative Law
HOWARD COBLE, North Carolina, Chairman
TREY GOWDY, South Carolina, Vice-Chairman
ELTON GALLEGLY, California STEVE COHEN, Tennessee
TRENT FRANKS, Arizona HENRY C. ``HANK'' JOHNSON, Jr.,
TOM REED, New York Georgia
DENNIS ROSS, Florida MELVIN L. WATT, North Carolina
MIKE QUIGLEY, Illinois
Daniel Flores, Chief Counsel
James Park, Minority Counsel
C O N T E N T S
FEBRUARY 14, 2011
The Honorable Howard Coble, a Representative in Congress from the
State of North Carolina, and Chairman, Subcommittee on Courts,
Commercial and Administrative Law.............................. 1
The Honorable Henry C. ``Hank'' Johnson, Jr., a Representative in
Congress from the State of Georgia, and Member, Subcommittee on
Courts, Commercial and Administrative Law...................... 33
The Honorable Lamar Smith, a Representative in Congress from the
State of Michigan, and Chairman, Committee on the Judiciary.... 35
The Honorable John Conyers, Jr., a Representative in Congress
from the State of Michigan, and Ranking Member, Committee on
the Judiciary.................................................. 36
Joshua Rauh, Ph.D., Associate Professor of Finance, Kellogg
School of Management, Northwestern University, Evanston, IL
Oral Testimony................................................. 41
Prepared Statement............................................. 43
James E. Spiotto, Esq., Partner, Chapman and Cutler, LLP,
Oral Testimony................................................. 54
Prepared Statement............................................. 56
Matt Fabian, Managing Director, Municipal Market Advisors,
Oral Testimony................................................. 96
Prepared Statement............................................. 98
Keith Brainard, Research Director, National Association of State
Retirement Administrators, Georgetown, TX
Oral Testimony................................................. 105
Prepared Statement............................................. 108
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Material submitted by the Honorable Howard Coble, a
Representative in Congress from the State of North Carolina,
and Chairman, Subcommittee on Courts, Commercial and
Administrative Law............................................. 2
Prepared Statement of the Honorable John Conyers, Jr., a
Representative in Congress from the State of Michigan, and
Ranking Member, Committee on the Judiciary..................... 38
Material Submitted for the Hearing Record
Response to Post-Hearing Questions from Joshua Rauh, Ph.D.,
Associate Professor of Finance, Kellogg School of Management,
Northwestern University, Evanston, IL.......................... 138
Response to Post-Hearing Questions from James E. Spiotto, Esq.,
Partner, Chapman and Cutler, LLP, Chicago, IL.................. 144
Response to Post-Hearing Questions from Matt Fabian, Managing
Director, Municipal Market Advisors, Westport, CT.............. 161
Response to Post-Hearing Questions from Keith Brainard, Research
Director, National Association of State Retirement
Administrators, Georgetown, TX................................. 163
ROLE OF PUBLIC EMPLOYEE PENSIONS IN CONTRIBUTING TO STATE INSOLVENCY
AND THE POSSIBILITY OF A STATE BANKRUPTCY CHAPTER
MONDAY, FEBRUARY 14, 2011
House of Representatives,
Subcommittee on Courts,
Commercial and Administrative Law,
Committee on the Judiciary,
The Subcommittee met, pursuant to notice, at 4:02 p.m., in
room 2141, Rayburn House Office Building, the Honorable Howard
Coble (Chairman of the Subcommittee) presiding.
Present: Representatives Coble, Smith, Gowdy, Gallegly,
Reed, Ross, Johnson, Quigley, and Conyers.
Staff Present: (Majority) Daniel Flores, Subcommittee Chief
Counsel; Travis Norton, Counsel; Allison Rose, Professional
Staff Member; and Ashley Lewis, Clerk.
Mr. Coble. Good afternoon, ladies and gentlemen. The
Subcommittee will come to order.
And before we give our opening statements, I have some
unanimous consent requests to have introduced in and made part
of the record: a Bureau of Labor Statistics from the U.S.
Department of Labor news release, dated December 8; a San
Francisco Chronicle op-ed, dated February 13; the National
Governors Association, January 24 of this year; a second Nation
Governors Association letter, dated February the 4th of 2011.
And I would like to have these made part of the record, without
[The information referred to follows:]
Mr. Coble. Folks, to begin with, I want to apologize for my
raspy voice. I have been nursing this cold for about a week
that seems like a month. So it doesn't sound very pleasant, so
bear with me.
And I am going to try to be as objective in my opening
statement as I can, but if we, in fact, create a bankruptcy--
strike that--a State bankruptcy chapter, I see all sorts of
snakes coming out of that pit. But I will have an open mind as
we go along.
Many States are currently suffering a severe budget crisis,
as we all know. High unemployment and depressed property values
have resulted in less tax revenue for States. But despite
taking in less revenue, many States continue to spend as if the
recession never occurred.
In particular, States continue to offer defined benefit
pension plans to their public employees. Defined benefit, as we
all know, means that the employee is entitled to the pension
without contributing or contributing a very small amount.
Making their budget problems worse, States are underfunding
their pension obligations to the tune of $3 trillion. And we
will hear that from one of the witnesses today.
Public employee unions need to realize that they should not
be entitled to be recession-proof. American workers in the
private sector have had their wages frozen during the
recession. The 401(k) retirement plans to which they have
contributed hard-earned dollars have lost significant value.
Some people fear the States will eventually go broke and
ask Congress for a bailout. We all know that bailouts have
consequences. Oftentimes, a bailout merely kicks the current
problem down the road even farther, and they generally don't
encourage fiscal discipline.
Neither should Congress permit States to file bankruptcy,
in my opinion. Though States would have powerful tools in
bankruptcy, like the power to break pension contracts with
unions, States are sovereign entities that must handle their
financial problems themselves, it seems to me.
Bankruptcy for States would cripple the bond markets.
States, as we all know, issue bonds for capital projects like
building roads and universities. Permitting States to break
their promises to bondholders would decrease investor
confidence and damage States' ability to invest in much-needed
Instead, Congress should encourage States to use the tools
they already have to bring public employee unions to the
negotiating table and restructure pension contracts. My home
State of North Carolina is a right-to-work State. Public
employees are not unionized. Rather than demand defined benefit
pension plans, North Carolina's public employees contribute to
a 401(k) administered by the State treasurer.
I am eager to learn more from our witnesses about how
underfunded public employee pension liabilities are
contributing to various State insolvencies. I am also
interested in how bankruptcy for States would impact States'
ability to borrow for capital projects in the bond market.
While I disfavor the approach that lets States go into
bankruptcy, I will be open to suggestions from the witnesses on
alternatives that help States get their fiscal houses in order.
I am now pleased to recognize the distinguished gentleman
from Georgia, Mr. Johnson, for his opening statement.
Mr. Johnson. I thank the Ranking Member. And this is my
first hearing serving with you as Chairman, and I look forward
to our service together on this Committee in the future.
Mr. Coble. Thank you, Mr. Johnson. I appreciate that.
Mr. Johnson. Now, with all due respect to my friends on the
other side of the aisle, I must wonder aloud, why is it that we
are holding this hearing today? Ostensibly, it is about whether
States should be permitted to file bankruptcy. But, from what I
can tell, none of the witnesses claims that bankruptcy is a
panacea for a State's financial troubles.
We seem to agree that allowing States to file for
bankruptcy would result in increased interest rates, making it
more expensive for States to address their financial needs.
Moreover, a State bankruptcy option would create greater
instability in the financial market. There also seems to be
some shared concern about respect for State sovereignty, in
that Federal bankruptcy law could be used to override State
constitutions and laws prohibiting an impairment of contractual
Finally, States already have the tools at their disposal to
address any financial troubles they face, as Majority Leader
Eric Cantor has noted. States have the ability to adjust
revenues and spending and to renegotiate their financial
obligations with creditors.
Indeed, I get the strong sense that State bankruptcy may be
a solution in search of a problem. Why are we wasting time on
what promises to be something of an esoteric discussion about a
proposal that few, if anyone, in Congress, including those on
this Committee, appear to accept?
Instead, we should be talking about what Congress will do
to accelerate economic recovery and create jobs, which, in
turn, will help States recover financially. We should be
talking about the continuing mortgage foreclose crisis and how
Congress will help hardworking American families stay in their
homes. We should be talking about crushing private student loan
debt that threatens to stifle educational opportunities for
people of modest means. We should be talking about how to
improve the bankruptcy process so that it can better help
honest but unfortunate debtors who have fallen upon hard times
because of the lingering effects of the 2008 financial crisis,
a crisis brought about by Wall Street's reckless behavior.
Unfortunately, I suspect we are here talking about State
bankruptcy because of a cynical attempt by the likes of a
future President Jeb Bush or future President Newt Gingrich,
actually, with Jeb Bush being the Vice President, or Jeb Bush
being President, Newt Gingrich being Vice President. I don't
know how they are going to work it out. But they, along with
the infamous Dick Morris and Grover Norquist, they are in an
unholy combination to demonize public employees for political
Let's call this what it is. It is an attack on a group of
workers including State troopers, police officers, firemen,
prosecutors, and teachers. And these proponents of State
bankruptcy simply don't like those groups, and they want to do
whatever they can to help them, so they figure that allowing
States to go into a bankruptcy court and then avoid contracts
that they have signed through collective bargaining, a fair
process, that protect their employees, they want to be able to
get out of those. And they also want to be able to avoid their
obligations to innocent pensioners, elderly people on pensions,
who have worked all their lives and expected to be able to
retire in comfort with health benefits. And they want to
abrogate the terms of those agreements and leave those people
up the road, or up the lake with no paddle in a boat, subject
to the harsh waves of Wall Street.
That is what they want to do, because they want to also
protect bond holders, State bond holders. They want to protect
them in that chapter, or in that bankruptcy process. Can you
imagine that? Trying to balance the budget on the backs of
working men and women, trying to protect Wall Street. This is
And we are talking about public pensions that barely have
an impact on a State's financial health. Less than 3 percent of
all State and local government funding is spent on pension
benefits, as most such benefits are paid out of trusts funded
by employees and their employers. But why let the facts get in
the way of political opportunism?
The proponents of State bankruptcy don't even bother to
hide their true intent. For instance, in a Los Angeles Times
op-ed piece published last month, Mr. Gingrich and Mr. Bush,
Bush III, pointed to the ``stranglehold government employee
unions have on State and Federal budgets,'' end quote, rather
than the severe economic recession of the last few years as the
reasons for the States' fiscal problems.
Even more crassly, Mr. Morris wrote a piece in The Hill
arguing in favor of State bankruptcy because it would, quote,
``break the political power of public employee unions and
undermine the labor-Democratic Party coalition.''
Hopefully, sensible minds on both sides of the aisle,
including Majority Leader Cantor, Judiciary Committee Chairman
Lamar Smith, and Subcommittee Chairman Howard Coble, will carry
the day on the issue of State bankruptcy and not allow naked
political calculations to answer serious constitutional and
And, with that, I will yield back.
Mr. Coble. I thank the gentleman.
The Chair recognizes the distinguish Chairman of the
Judiciary Committee, Mr. Smith.
Mr. Smith. Thank you, Mr. Chairman.
A famous tale by Hans Christian Andersen depicts an emperor
who cares only about his wardrobe. His weavers fashioned him a
garment made from fine fabric they say is invisible only to
those who are unfit to see it. The emperor cannot see the suit,
but he fears being deemed unfit to being king. So he dons his
invisible garment and parades around town. Finally, a small
child calls out from the crowd, ``The emperor has no clothes.''
Much like the weavers in this story, many States have
promised their public employees the finest pension benefits but
have funded their pension obligations with invisible money. In
the private sector, employees generally contribute to their own
retirement and IRAs and withdraw their savings later in life.
In contrast, States have promised fixed payouts to their
retired public employees without requiring any employee
contribution. States are therefore on the hook to pay 100
percent of public employee pensions, in addition to other
retirement benefits like health insurance.
Despite the high cost of these pensions, it is not for
Congress to admonish States for spending their money as their
elected leaders see fit. States are sovereign in our system of
federalism and are free to make even very expensive decisions.
What is cause for Federal concern is that States have so
consistently underfunded public employee pensions that,
cumulatively, they face pension deficits of approximately $3
trillion. Some fear that States will eventually default.
Voters in spendthrift States should demand collective
sacrifice from public employees. Someone must say the emperor
has no clothes.
Notwithstanding States' fiscal woes, the era of Federal
bailouts is over. Congress should not take money from taxpayers
in fiscally healthy States to give to public employee unions in
a handful of spendthrift States.
And while bankruptcy for States may seem like an attractive
alternative to State bailouts, there are constitutional and
policy concerns with this approach.
First, I am unsure whether Congress has the constitutional
authority under Article I to allow a state to seek bankruptcy
relief. States are co-sovereigns in our system of federalism
and have authority to tax and spend.
Even if Congress could enact a State bankruptcy chapter, it
is also highly unlikely that any State would ever take
advantage of it. The National Governors Association and the
National Conference of State Legislatures have announced that
States do not want bankruptcy relief and would not use it.
States currently have ways to put their fiscal houses in
order. Even the Governors in traditionally union-friendly
States already have taken steps to reduce State spending and
reform their public employee pension systems.
I am also concerned that a State bankruptcy option may
actually encourage States to borrow more money, knowing that
they could later restructure their debt in bankruptcy. Future
borrowing levels would thus increase even in spendthrift
States. And borrowing would be at higher interest rates for all
States because lenders would justifiably charge a price for the
risk of State bankruptcy.
Congress should not hinder restructuring efforts at the
State level by passing laws that make it more expensive for
States to access capital in the bond market during a recession,
and it should not pass laws that unfairly punish prudent States
with higher interest rates.
Finally, in a State bankruptcy case, it would be difficult
to prevent the sort of political favoritism of unions over
bondholders seen in the Chrysler and General Motors
bankruptcies. Public employee unions have exerted influence
over State officials to obtain substantial pension benefits.
Why should Congress believe that this same political influence
will not cause State debtors to protect public employee
pensions in bankruptcy?
Still, I remain open to exploring how Congress may play a
role in helping States restore fiscal sanity to their budgets.
And, Mr. Chairman, I look forward to working with my colleagues
to talk about and explore these alternative solutions.
And I yield back the balance of my time.
Mr. Coble. I thank the gentleman.
The Chair recognizes the distinguished gentleman from
Michigan, the Chairman emeritus of the Judiciary Committee, Mr.
Mr. Conyers. Thanks, Chairman Howard Coble and Members of
We welcome the four witnesses today.
And I am impressed with Chairman Coble's description of the
problem, particularly as it relates to bankruptcy. And he was
kind enough to let me see his statement since I didn't quite
understand his presentation.
``Neither should Congress permit States to file bankruptcy.
Though States would have powerful tools in bankruptcy, like the
power to break pension contracts with unions, States are
sovereign entities and must handle their financial problems
``Bankruptcy for States would cripple bond markets. States
issue bonds for capital projects like building roads and
universities. Permitting States to break their promises to
bondholders would decrease investor confidence and hurt States'
ability to invest in much-needed infrastructure.''
And so, Chairman Coble, I agree with you.
And I must say, Hank Johnson's statement was one that I am
in agreement totally with.
And we find ourselves in unusual circumstances.
And my voice is getting like the Chairman's, so maybe I
should give him a written copy of my statement so he can
understand what I actually said, as well.
States aren't in particularly in good shape. A lot of them
are not in the black, but none of them are seeking or going
into bankruptcy. None are in bankruptcy. So wherein does the
urging from Members of the Federal legislature come from that
Now, before bankruptcy, there could be bailout. And from
the Detroit perspective, both automobile companies that sought
bailout are--one has paid off, and the other one is paying off
pretty well. The reason I know they are doing so well is that
they are declaring bonuses for the leaders. So if they aren't
in bankruptcy, this is a hearing that would encourage them, at
least some of the members, to go into bankruptcy.
And I want to thank the witnesses. All of their statements,
except our lead witness, from the professor, have indicated
some need for caution in this area. And I think that is good.
Now, you will never catch me quarreling with why a
Subcommittee or the full Committee called a hearing, because no
one has called more hearings that were quarrelsome by the other
side than me. And so, now it is my turn to listen to hearings
that I may not have--would have called myself. But still, maybe
we can think about this a little bit.
Well, look, there are so many conservatives that agree with
my position of going slow that I am re-examining my own
position. I mean, when the gentleman--where is Mr. Cantor from?
Virginia? The gentleman from Virginia and I find ourselves in
agreement. Other leaders are--the only people that I can prove
are urging bankruptcy is Newt Gingrich, the former Speaker of
the House; and Jeb Bush, the former Governor from Florida. Now,
what is motivating them, outside of further busting public
unions, I don't know. But maybe this hearing will shed some
light on it, because that is what I would like to find out
And so, Mr. Chairman, I thank you for your time. And I am
willing to make a copy of my statement available to you.
[The prepared statement of Mr. Conyers follows:]
Mr. Coble. I thank you, sir.
Without objection, other Members' opening statements will
be made a part of the record.
We are glad to have a distinguished panel with us today,
and I will introduce them at this time.
Mr. Joshua Rauh is associate professor of finance at the
Kellogg School of Management at Northwestern University and
NBER faculty research fellow in the corporate finance and
public economics programs. He studies corporate investment and
financial structure, with an emphasis on the ways in which
corporations respond to incentives that are put in place by
Dr. Rauh received his Ph.D. in 2004 from the Massachusetts
Institute of Technology with his dissertation, ``Pensions,
Corporate Finance, and Public Policy,'' which won him the 2004
National Tax Association Dissertation Award. Prior to joining
Kellogg, he held a faculty position at the University of
Chicago Booth School of Business. And he is a former associate
economist for Goldman Sachs International in London.
Mr. James E. Spiotto is a partner in the law firm of
Chapman and Cutler, LLP. He graduated from the University of
Chicago Law School and has represented banks, indenture
trustees, bondholders, or governmental bodies in litigation
over workouts of over 400 troubled debt finances in over 35
different States and in 3 foreign countries.
He is also the author of a chapter on sovereign debt,
defaults, and debt resolution mechanisms for an upcoming book
entitled, ``The Oxford Handbook of State and Local Government
Debt,'' to be published by Oxford University Press. In 1995,
Mr. Spiotto won an award for his presentation on municipal
defaults and bankruptcy at a United States House of
Representatives Subcommittee hearing on the Orange County
Mr. Fabian is the senior analyst--Mr. Matt Fabian--for
Municipal Market Advisors, MMA, an independent research and
strategy provider specializing in municipal bonds. Mr. Fabian
has been a municipal analyst for 13 years and is the author of
a widely read bond publication. He has been the senior analyst
with Municipal Market Advisors since July of 2006.
Prior to his current position, Mr. Fabian spent 2\1/2\
years as the lead municipal research analyst for UBS and headed
up an award-winning group within UBS Wealth Management
Research. Mr. Fabian was the primary source on municipal bond
research for the UBS network of nearly 7,500 U.S. financial
advisors, also advising the company's institutional training
and investment banking clients.
Mr. Keith Brainard is currently serving as research
director for the National Association of State Retirement
Administrators and has held that position since 2002.
Previously, he served as manager of budget and planning for the
Arizona State Retirement System, and he also provided fiscal
research and analysis for the Texas and Arizona legislatures.
He is coauthor of the second edition of the ``Governmental
Plans Answer Book,'' and created and maintains the Public Fund
Survey, an online compendium of public pension data. He has a
master's degree from the LBJ School of Public Affairs at the
University of Texas in Austin.
Good to have you with us, gentlemen. If you will, we try to
apply the 5-minute rule to you all and to us. When the amber
light appears, you will know that the red light is imminent. So
when the red light appears, that will be your warning that it
is time to wrap up. If you could do that, we would appreciate
Mr. Rauh, I will start with you.
TESTIMONY OF JOSHUA RAUH, Ph.D., ASSOCIATE PROFESSOR OF
FINANCE, KELLOGG SCHOOL OF MANAGEMENT, NORTHWESTERN UNIVERSITY,
Mr. Rauh. Thank you very much, Chairman Coble, Members of
The condition of State and local pension systems and the
risks that these systems pose for Federal taxpayers is a
critical aspect of our Nation's fiscal challenges. Pensions
have become more than a means by which State and local
governments provide retirement income for public employees.
They have become a pervasive tool for circumventing balanced-
The mechanism is simple: State and local governments have
promised pensions without setting aside adequate funds. The
bill is then left to future taxpayers when the employees
retire. By that time, the politicians who made the promises are
out of office. In some cases, the bills will be so large that
State and local governments will likely seek substantial
The Government Accounting Standards Board, GASB, has been
complicit in this hidden borrowing by allowing a flawed
accounting of these promises. Under GASB rules, State and local
governments have around $1 trillion of unfunded pension
liability. Using valuations consistent with financial
economics, Professor Robert Novy-Marx and I have calculated
that the already-promised part of these unfunded liabilities
amounts to over $3 trillion.
GASB treats the returns on risky assets as though they were
riskless and certain. The government assumes that the actual
return will be identical to the targeted return, most commonly
8 percent, ignoring the fact that if the assets do not return 8
percent, the taxpayers are on the hook for the downside. GASB
confounds the measurement of the amount of debt with the
government's risky plans for repaying the debt.
Consider how this would work if you could apply it to a
Federal bond issue. Suppose you issued $1 trillion of 10-year
bonds. And suppose further that you spent half the proceeds
immediately and put the other half in a fund invested in stocks
and bonds, hoping that it would grow to repay the debt in 10
Well, obviously, the government has a new debt of $1
trillion and new unfunded liabilities of half a trillion
dollars. But under GASB logic, the government could claim that,
since the expected return on their portfolio is 8 percent,
there was actually no unfunded liability. This would be a way
to deal with the $1.65 trillion budget deficit at the Federal
level. You would just borrow another $1.65 trillion, invest it
in stocks and bonds, claim it will have an expected return of 8
percent. And, under GASB rules, that would be okay.
This is hidden debt, debt that will eventually force
governments to choose among a group of unpalatable options:
slashing public services, dramatically raising taxes,
attempting to cut benefits, defaulting on debt, or seeking a
Many pension systems are approaching a day of reckoning.
Even assuming 8 percent returns, the assets of the systems in
seven States and six big cities would be insufficient to pay
for today's already-promised benefits past 2020. And what this
means is that substantial contributions to the funds will be
needed over the next decade to pay for legacy liabilities.
Some State governments are taking steps to address the
issue, but many are going in the opposite direction. So, for
example, by statute or by contract, many major public pension
funds in Illinois do not contribute anywhere near the amount
required to pay new costs and to begin to pay down unfunded
liabilities. The California State Teachers' Retirement System
contributed only 55 percent of the recommended amount in 2010,
even by GASB standards. And New Jersey made only 5 percent of
the recommended contributions to its State police and teachers
Now, if States perceive implicit Federal backing, they may
lack the incentive to undertake reforms of these systems. So I
would argue that Congress should limit the liability of Federal
taxpayers by providing States with those incentives. It should
condition the availability of Federal money on pension reforms
that limit off-balance-sheet borrowing.
In particular, the Public Employee Pension Transparency
Act, H.R. 567, would be a very useful step. It would condition
Federal tax benefits on disclosure by the States of the true
financial value of these unfunded public pension promises. The
bill establishes an incentive. If States want Federal
subsidies, then they may not engage in off-balance-sheet
borrowing through improperly valued pension liabilities.
Congress should consider further incentives-based
approaches, both carrots and sticks, particularly if the idea
of a State bankruptcy code is not going to be pursued. One
approach would relate to the tax treatment of bonds that could
be used to fund pensions. In a plan I developed with Professor
Novy-Marx, a State would be allowed to issue tax-subsidized
bonds for the purposes of pension funding if, and only if, it
agreed to specific austerity measures, including closing its
defined benefit plans to new workers, enrolling all employees
in a defined contribution plan, plus Social Security. The cost
savings from the new Social Security enrollment would offset a
large portion of the costs from the debt subsidy.
So, in sum, I would say that urgent action at the Federal
level is required to ensure the Federal taxpayers will not be
the ultimate underwriters of State debts. The most useful
action would be the establishment of financial incentives that
encourage States not to gamble with the money of Federal
taxpayers. This is a $3 trillion problem, and the question is
just simply how that $3 trillion is going to be divided up
among State taxpayers and Federal taxpayers and other
[The prepared statement of Mr. Rauh follows:]
Mr. Coble. Thank you, Mr. Rauh. And you beat the red
Mr. Rauh. I sure did.
Mr. Coble [continuing]. Putting pressure your colleagues.
Mr. Spiotto, good to have you with us. You are recognized
for 5 minutes.
TESTIMONY OF JAMES E. SPIOTTO, ESQ., PARTNER,
CHAPMAN AND CUTLER, LLP, CHICAGO, IL
Mr. Spiotto. Thank you, Mr. Chairman Coble. It is my
pleasure to address you today.
Obviously, you all, in framing your statement, have clearly
outlined the problem that is facing States and even local
governments with regard to how do you meet all of your debt
obligations, all of your financial obligations in challenging
times, especially economic downturn.
The question posed is, given underfunding of pension
obligations for State governments, should there be a chapter
for a State bankruptcy? This question sounds like an easy
solution to a difficult problem, but there are many practical
problems to that. And what I would like to explore with you
today is some of those practical problems and concerns that
need to be addressed and, I think, in considering those, lead
to the conclusion that bankruptcy is obviously, just like it is
for municipalities, the last last resort. And, certainly, there
are many other options available that should be used and can be
used to solve the problem.
First of all, let's look at Chapter IX. Chapter IX was
passed during the depression of the 1930's. Since 1937, when it
was passed, only 620 municipalities have used Chapter IX,
mainly small special tax districts and small municipalities.
There have been a few exceptions. But, by and large, most
municipalities, because of the stigma, because of the cloud,
because they desire to be able to manage their own affairs,
have chosen not to use Chapter IX.
You need to be authorized by your State to file Chapter IX.
There are only 15 States that have unconditionally authorized
their municipalities to file Chapter IX. So all the other
States have either put a condition on it or do not authorize,
presently, their municipalities to file.
You may ask yourself, is there the same demand and cry for
a bankruptcy provision for States that there was during the
Depression? The answer to that is ``no.'' At the time that
Chapter IX was adopted, there were over 4,000 local defaults by
municipalities; there were over a thousand municipalities
desirous of having Chapter IX adopted. As your opening
statements have indicated, States and local governments are not
asking for this at this time, and for good reason.
One of the questions raised is, what about the dual
sovereignty of the Federal Government and the States? And does
this really interfere with the ability of States to deal with
their sovereign issues?
I think the simple fact is, and as we saw from the
development of Chapter IX, any type of bankruptcy application
to the States will cause various constitutional problems, which
will need to be addressed and are not easily done. If you will
recall, back in 1934, when they passed the first version for
municipal bankruptcy, it took Congress and a few Supreme Court
decisions to, by 1937, have something that passed the muster of
The Bivens case and the Ashton case by the Supreme Court
outlined that a Federal judge of a dual sovereign, the Federal
Government, cannot interfere with the revenues, with the
property, with the government, with the affairs of a
municipality. That municipality is a subsovereign of the State.
When you take it on the State level, and given our
constitutional background and the 10th Amendment and Supreme
Court decisions, it will be very difficult to have a Federal
judge be able to navigate those waters. And that difficulty
will cost time, money, and effort and an inability to really
address the problems.
So, on the constitutional basis, it seems that it would be
very difficult to really solve that problem. Chapter IX, in the
passage of that, outlines in the Bivens and the Ashton case
Are there solutions? Yes. States have for a long history
solved their problems. Their general obligations have been paid
since the 1800's. They have done almost anything to make sure
they dealt with their problem. Yes, we have an economic
downturn, but that does not mean that they will not be able to
Are there solutions? We have, in the materials, talked
about a public pension authority that might be established by
the State to deal with these issues. We have talked about
possibly a Federal independent court to deal issues that relate
to unaffordable and sustainable obligations. There are also the
ability to possibly facilitate with issuing bonds.
While there are many different ways of solving it, it
really is the States and their proud history of meeting their
obligations that has to be recognized. They may have difficult
times. They have weathered through it in the past. And they
clearly have done it through the Depression without any need of
bankruptcy or additional help. And I think, with a little
foresight and a little work on their part, they will come up,
as they have in the past, with solutions that will address the
[The prepared statement of Mr. Spiotto follows:]
Mr. Coble. Mr. Fabian, you are recognized for 5 minutes.
TESTIMONY OF MATT FABIAN, MANAGING DIRECTOR, MUNICIPAL MARKET
ADVISORS, WESTPORT, CT
Mr. Fabian. Thank you very much, Mr. Chairman and the
Committee, for inviting me here to speak.
I will skip over the details of my bio in the first
paragraph. But just to emphasize, Municipal Market Advisors,
the company for which I work, is a pure independent research
company, so we don't buy or sell any bonds or securities. We
don't advise in that. We are just--the near entirety of our
revenues come from the sale of research and subscriptions to
Legislating State bankruptcy would certainly disrupt the
current municipal bond market and undermine investor confidence
going forward. We strongly believe that the municipal bond
prices would fall, yields would rise, were States made able to
file for bankruptcy. For longer-maturity bonds, interest rates
could easily rise by 10 to 20 percent versus current levels.
Shorter-maturity bonds should weaken somewhat less.
In large part, the yield increase belies the municipal
industry's already highly conservative practice in assessing
credit and default risk. The prospect of State bankruptcy,
however remote, requires a much more corporate-like measure of
risk and reward. This is because bankruptcy within a Federal
court makes vulnerable the robust protections for bondholders--
for example, first payment priorities and senior liens on tax
revenues now provided by State bond laws and State
The adjustment in yields could happen quickly, but any
increase in rates, and thus increases in the cost of new
infrastructure, would persist in the long term. From a policy
perspective, this means upward pressure on State and local
taxes, downward pressure on spending and State employment.
While the impact would be greatest on States perceived to
be most likely to file for protection, like Illinois and
California, all States, including those who have well-managed
pensions and budgets, would reasonably pay a substantive
penalty while coming to market for new loans. In effect, all
States would suffer for the perceived faults of a few.
And because States and local governments are deeply
intertwined with management of tax collections, spending and
mandates, the impact would not be confined to just States but,
rather, to all local governments. In addition, we would expect
that school districts, which are essentially creatures of the
States, rural issuers, and poor urban governments are those
entities most dependent on State aid for revenue, would feel
the brunt of investor rejection.
It is difficult to isolate the threat of State bankruptcy
as a variable amid the recent losses in the municipal bond
market. It is also contesting with a weaker Treasury market,
the pervasive headlines of looming collapse, and the poor
communication between the industry professionals and our
investors. But keep in mind that, despite these adverse
vectors, long-term municipal yields, as described by the Bond
Buyer 20 yield index of high-grade, general obligation credits,
are still 125 basis points below their average over the last 30
years. So, in other words, while market participants are
following the current debate extremely closely, they are not
yet penalizing issuers to the extent that might be required
should State bankruptcy become law.
And while some observers have defined many States as
already insolvent, professional market consensus does not
support this view. Rather, the majority of institutional
investors, municipal credit analysts, and issuer groups appear
to be believe that States already retain sufficient abilities
to manage their short- and long-term liabilities without need
of bankruptcy or other potential forms of Federal bailout.
Thus, the immense economic and political costs of a
hypothetical State bankruptcy filing reasonably outweigh the
need for such an extreme remedy. We agree with this view.
Proponents of the bankruptcy legislation might argue that
this law would simply add to the State managers' toolbox as a
strategy of last resort. Thus, investors who are more bullish
over States' economic or financial prospects could disregard
the risk of any future filing. But this disregards the
municipal credit analyst's duty to focus on worst-case
scenarios and to protect their portfolios, their investors, and
issuers themselves from default.
And, in practice, investors could not expect all elected
officials within a State legislature to not at least discuss or
threaten the use of bankruptcy while outside observers,
political pundits, dedicated academics, journalists, and the
like could be counted upon to remind the broader markets of the
tool and its potential implications for various stakeholders.
Thus, even an unused bankruptcy law would amplify related
headline risk that has already been highly disruptive to normal
capital market functions, exacerbating systemic illiquidity and
pushing yields and spreads higher.
Thank you very much.
[The prepared statement of Mr. Fabian follows:]
Prepared Statement of Matt Fabian
Mr. Coble. Thank you, Mr. Fabian.
TESTIMONY OF KEITH BRAINARD, RESEARCH DIRECTOR, NATIONAL
ASSOCIATION OF STATE RETIREMENT ADMINISTRATORS, GEORGETOWN, TX
Mr. Brainard. Chairman Coble, Representative Johnson,
Members of the Subcommittee, I would like to wish each of you a
Happy Valentine's Day.
Mr. Coble. Thank you.
Mr. Brainard. Thank you for inviting me to testify today on
this important matter.
Given the unprecedented fiscal challenges facing all levels
of government, the accuracy and integrity of information is
vital. So I appreciate the opportunity to explain to the
Committee how State and local pensions work. Unfortunately,
much of the reporting on these retirement system seems drawn to
those who lack this understanding or who use inappropriate
methods and assumptions regarding their operation.
On the whole, State and local government pensions are
weathering the financial crisis and making measured changes to
ensure long-term sustainability. Only a generation ago, most
plans operated primarily on a pay-as-you-go basis. Since then,
States and cities have worked to advance fund pension benefits
by required employees and employers to contribute enough to a
pension trust during their working years to pay for their
pension benefit. This was done without Federal intervention and
has largely been a success. By 2000, the assets in most public
pension trusts equaled or exceeded expected pension payments.
Public pension trusts are designed to weather market
volatility, and have done so repeatedly over their history.
Even at the market low of the most recent and unprecedented
financial downturn, there was still over $2 trillion in public
pension trusts. Since then, values have rebounded sharply,
researching $2.8 trillion at the end of last year.
The assertion that public employee pensions are
contributing in a meaningful way to State insolvency is simply
not supported by the facts. Spending on public pensions has
consistently been a relatively small amount of State and local
government budgets, slightly less than 3 percent, on average.
Although this percentage varies by State, for all States but
three the spending on pensions was less than 4 percent of
budgets. For half of the States, it was less than 2\1/2\
Similarly, reports citing pension-fund exhaustion dates for
nearly every State are unfounded. The $2.8 trillion that State
and local retirement systems hold in trust is roughly 14 times
the amount these funds distribute annually. Public employees
and employers contribute to these trusts. Even if they earned a
relatively modest annual return of 6 percent, investment
earnings alone would be enough to pay most of the benefits
distributed each year.
Predictions of widespread insolvency are inconsistent with
findings of the professional actuaries who are certified to
analyze these plans, as well as the findings of the Government
Accountability Office, Center for Retirement Research at Boston
College, Center for State and Local Government Excellence,
bond-rating agencies, and others.
Such predictions are also at odds with my own analysis
that, using even conservative estimates, the typical fund can
continue to pay benefits for 25 years--enough time for States
to make necessary adjustments to restore their plan's
sustainability. Assuming a rate of asset growth consistent with
historic market norms, most funds never run out of money.
Joshua Rauh's calculation uses historically low interest
rates and depressed asset values following the financial
meltdown, and combines these factors with the unlikely
assumption that States and cities will violate their own
constitutional and statutory pension funding requirements. The
outcome of his approach is implausible but attention-getting.
Misrepresenting the true condition of the public pension
community is, in my view, reckless and irresponsible and has
caused needless confusion and turmoil among the public,
policymakers, pensioners, and municipal bond markets. State and
local retirement systems are highly transparent entities that
publish audited annual financial reports in compliance with
generally accepted accounting principles set forth by the
Governmental Accounting Standards Board, with financial
reporting standards set forth by the Government Finance
Officers Association, in addition to sunshine laws in every
Pension benefits and financing structures are being
examined by States and cities across the Nation. A different
range of solutions will be required for each, and a factual
assessment is critical. State and local government retirement
systems do not require, nor are they seeking, Federal
intervention in this process.
Joshua Rauh is the only individual I know of who is calling
for Federal financial assistance for public pensions. His $75
billion estimate of the cost of Federal intervention ignores
the cost to State and local governments, which would be far
more significant. Predictions made on the basis of selective
use of data, inapplicable methods and assumptions, and
calculations in conflict with financial and pension fund
history are unhelpful. They distract from the important
businesses of discerning and responding appropriately to the
Mr. Chairman, thank you. I am happy to answer any
[The prepared statement of Mr. Brainard follows:]
Mr. Coble. Thank you, gentlemen, and appreciate you all
being with us today. We will now examine you all from our
Professor Rauh, how much fiscal difficulty or trouble would
there be if States--regarding the all new public employees--
starting today were forced to have defined contribution as
opposed to defined benefit plans?
Mr. Rauh. Well, thank you very much, Chairman Coble.
I just want to start off by saying that the witness Mr.
Brainard presents some very misleading statistics. And perhaps
this is not surprising given that he represents State
retirement administrators, whose interests in this issue are at
odds with those of the taxpayers.
For example, it was claimed that pension contributions are
a small share of State budgets. Three percent was the number
that was thrown out. First of all, States are not making the
contributions that they ought to be, even under their own
accounting. So this is a bit analogous to looking at--it is
like looking at a sample of households who have stopped paying
principle on their mortgages and concluding that mortgages
aren't a problem for household finance because their principle
payments are a low fraction of their spending.
Second, a figure was cited as the fraction of spending.
Well, that counts the deficits that the States are running. So
it is like saying that someone who is living way beyond their
means and running up a large credit card debt has a relatively
small cash-flow problem because their actual credit card
payments are small.
And, finally, one-third of the revenue that he is counting
on in that calculation is coming from you, actually, the
Federal Government. So the assumption is that you are
completely willing to pick up the pro-rata share of this tab
based on the amount that the Federal Government has been
sending to the States.
So I would say, looking at all owned revenue, excluding
transfers from the government, the contribution share is around
10 percent already, and it is going to have to grow
substantially to pay down this debt.
Mr. Coble. Mr. Spiotto, I mispronounced your name earlier.
I apologize for that.
We saw recently in the Vallejo, California, case that, even
in Chapter IX, the city was unwilling to reject its pension
contract. Would a State be more likely to reject collective
bargaining agreements in bankruptcy?
Mr. Spiotto. The problem you have with trying to reject
your collective bargaining agreements in bankruptcy is, the
next day, you need an agreement with your workers as to what is
fair and affordable to pay them going forward. And the problem
with bankruptcy and the dynamics is that, in rejecting it, you
create an equal issue of how do you pay for it going forward
and what do you pay. And that is a significant problem.
Vallejo filed in 2008. They went through a significant
period of time, tried to negotiate a resolution of their labor
issues, and it took them a long time. They are still in
bankruptcy. They have a plan pending. The time, money, expense,
confusion, and difficulties to the city was significant.
Mr. Coble. Thank you, sir.
Professor, I didn't follow you, whether you responded
directly to my question.
Mr. Rauh. Perhaps I did not.
The answer to your question, which my understanding is,
even if State and local governments froze all promises today,
how deep of a hole would we be in, the answer is $3 trillion.
The number that we calculate is assuming that all future
benefits are going to be fully funded and secured.
So, even if all plans were frozen today and all future work
were put on a defined-contribution-type plan, the number would
still be $3 trillion.
Mr. Coble. Mr. Fabian, who holds most of the State and
municipal paper currently? Or, in other words, if bond holders
are crammed down, who is most likely to suffer?
Mr. Fabian. Well, households--in general, households own
about a third of the municipal bond market directly and about
another third of the municipal bond market through mutual
funds. So, in general, it is individuals who own about two-
thirds of the market. So they would, in theory, be the ones the
most subject to a cramdown.
Mr. Coble. I got you. Thank you, sir.
Mr. Brainard, do you believe any reforms are needed to the
GASB rules to require States to accurately report their pension
liability? Because I am told, oftentimes some of these have
been laced generously with inaccuracy.
Mr. Brainard. GASB has been--Mr. Chairman, GASB has, for
the last few years, been considering a range of changes to
State and local pension reporting requirements. And among the
reforms that they are seriously considering at this point is a
modification to the investment return assumption the plans use
to discount their future liabilities. That modification appears
sound to me.
There are some other adjustments that they are considering
with regard to how quickly public pension plans recognize
investment gains and losses that, generally, we are not
uncomfortable with. And very quickly you get into the range of
GASB reforms that becomes eye-glazing material. I am not quite
sure what level of detail you would like me to get into.
Mr. Coble. I thank you. My red light has appeared, so I
will have to terminate.
The gentleman from Georgia.
Mr. Johnson. Thank you, Mr. Chairman.
Professor Rauh--it is also Dr. Rauh, correct?
Mr. Rauh. That is correct.
Mr. Johnson. And, Doctor, in addition to your duties and
responsibilities as an associate professor, you have some other
professional responsibilities that you tend to. Isn't that
Mr. Rauh. I don't know what you are referring to.
Mr. Johnson. Well, I mean, you do some consulting on the
side, and you write papers for various groups.
Mr. Rauh. For various groups? No, I have never written a
paper that has been commissioned by a group, no.
Mr. Johnson. Uh-huh. Well, who have you written--tell us
some of the folks you have written papers for.
Mr. Rauh. No, I don't write papers for anyone. I write
papers under my own name, and I present them at conferences,
and that is all. I will occasionally----
Mr. Johnson. Well, let me ask you this. You make a little
outside money in addition to your salary as a professor, isn't
Mr. Rauh. I receive--I have a small amount of consulting
income. That is correct.
Mr. Johnson. And you have your own consulting company?
Mr. Rauh. No, I do not have my consulting company, no.
Mr. Johnson. Now, who do you consult for? What companies
pay you to consult?
Mr. Rauh. I have not actually taken money from--I mean,
okay, so--I am not sure whether this is an allowable line of
questioning, but I can----
Mr. Johnson. Well, you inferred that Mr. Brainard had an
interest in preserving the status quo, and I just wanted to
explore what your interest is.
Mr. Rauh. I have never worked for an organization that has
any kind of stake in this particular--this matter, none
Mr. Johnson. Well, what about politicians? Have you been
working with any politicians on this issue? Members of
Mr. Rauh. I was invited by Governor Schwarzenegger to go to
Sacramento and present at a roundtable.
Mr. Johnson. What about Members of Congress? Who have you
been working for here?
Mr. Rauh. I have not worked for any Members of Congress.
Mr. Johnson. You have not consulted with any Members of
Mr. Rauh. I received some e-mailed questions about the
Public Employee Pension Transparency Act----
Mr. Johnson. Yes.
Mr. Rauh [continuing]. From Congressman Nunes' office. I
answered those questions----
Mr. Johnson. Devin Nunes from California?
Mr. Rauh [continuing]. For no fee. Yeah, I mean, I was e-
mailed questions, and I answered the questions.
Mr. Johnson. And these questions concerned the fiscal
health of the State of California in so far as its pension
liabilities are concerned. Isn't that correct?
Mr. Rauh. No. The questions that Congressman Nunes' office
e-mailed me were about simply my calculations that the unfunded
liability was $3 trillion and just some explanations about how
I arrived at that number. That was all. There was no money that
was exchanged hands.
Mr. Johnson. Now, you are of the opinion that the State of
California is in big trouble with its pension obligations.
Mr. Rauh. When one discounts the----
Mr. Johnson. Yes or no.
Mr. Rauh. I don't like to put the word ``big trouble'' on
Mr. Johnson. Okay, but they have some issues.
Mr. Rauh. Five hundred billion dollars of unfunded
liabilities for the State of California. I think that is not a
Mr. Johnson. And you believe that the Federal taxpayers may
be asked to bail out California because of its unfunded pension
Mr. Rauh. I think there are a number of States around the
Mr. Johnson. Is that true or is that false?
Mr. Rauh. California in particular? I think there is a
chance that the Federal Government will be liable--will be
asked to come to the assistance of California. And I think that
part of the issue is that they have borrowed from public
employees to the tune of $500 billion above and beyond the
assets that they have set aside to pay for those promises.
Mr. Johnson. But now they also have--so your concern, you
want to tie the States' hands insofar as its relationship with
its recipients of pensions and with its employees by allowing
them to get out of trouble through a bankruptcy. Is that what
you want to do?
Mr. Rauh. Through a bankruptcy, no, no. I have said nothing
of the kind.
Mr. Johnson. You support California if it decided to avoid
having to pay pensions because they have not funded their--they
have borrowed money from their pension fund?
Mr. Rauh. I have said nothing of the kind. In fact, I want
to be clear. I do not call for cuts in benefits that have
already been promised. All of the proposals that I have made
Mr. Johnson. You are just trying to keep the States from
borrowing from their pension funds. Is that what your
Mr. Rauh. I am trying to stop the States from borrowing
from public employees in a way that is not transparent to
Mr. Johnson. And you figure the best way to do that is to
allow States to avoid the pension obligation.
Mr. Rauh. No, no. Avoid their pension obligations, no. I
Mr. Johnson. That is what a bankruptcy would do, wouldn't
Mr. Coble. The gentleman's time has expired.
Did you have one more question for him?
Mr. Johnson. You know, I don't understand, you are coming
here to testify about allowing States to have an opportunity to
file bankruptcy so that they can eliminate their pension
obligations and thus won't have to come to the Federal
Government for bailouts.
Mr. Rauh. With all due respect, sir, I think you are
putting words in my mouth. I did not--my testimony was not
about that. It was about how we got the situation we are in.
The fact that States owe $3 trillion to public employees is a
Mr. Coble. The gentleman's time has expired.
The gentleman from South Carolina, Mr. Gowdy, is recognized
for 5 minutes.
Mr. Gowdy. Thank you, Mr. Chairman.
Mr. Brainard, I also want to thank you for reminding us it
is Valentine's Day. And in the long run, you saved us more
money than all of the States cumulatively owe by that reminder.
So thank you. If you saw a lot of people visually texting, it
was because of your reminder. So thank you for that.
Mr. Spiotto, you mentioned Bekins. You are concerned about
the constitutionality of Federal involvement in State
bankruptcies. Extrapolate on that for us.
Mr. Spiotto. Yes. The big problem with the Federal
Government setting up a bankruptcy court for the States or a
State is, one, it could only be voluntary because given the
10th Amendment, the Federal Government cannot mandate that.
Asked in Bevins, it is very clear on that from the Supreme
Second, there will be very limited power of any Federal
bankruptcy court to really deal with any problem that the State
And third, States probably, if they had to define their
problems and put it into a hierarchy, they may have a small
number of real problems in their creditor relations. And many
issues they don't want to overturn, they don't want to tip over
that relationship. And it is working quite well.
And what bankruptcy does is throw them all up in the air
and you have to find a solution to them. And it puts the State
in a situation where it has to work through these problems in a
system that doesn't provide any additional funding to them, no
additional tax source, and puts them in jeopardy and puts them
with a cloud, which normally they have worked hard the last
hundred-plus years to avoid; i.e., that they have met their
obligations when they have had to and they have not failed to
And therefore, it puts a cloud without a mechanism to solve
Mr. Gowdy. Mr. Brainard, if I am missummarizing your
testimony, correct me. I thought I heard you say that you think
that there is a sufficient amount of money available for the
next 25 years so long as changes are made in that quarter
century to correct what I assume you would agree are some
What kind of changes would you like to see States make, and
what has taken them so long?
Mr. Brainard. Representative Gowdy, in any number of States
some degree of reform is required. It is going to vary by State
and indeed by individual pension plan.
The National Conference on State Legislatures recently
reported that in 2010, last year, an unprecedented number of
States took action to modify their pension plans. This includes
reducing benefit levels and increasing contributions either
from employers but also from employees.
So the solution is going to be unique, depending on the
unique pension plan but generally it is a reduction in benefits
and an increase in contributions from employees, employers or
Mr. Gowdy. But you don't disagree even with the professor
that some systemic structural changes must be made.
Mr. Brainard. In many cases. Not all.
Mr. Gowdy. Professor, are there any trends among the States
that are in the most serious trouble with respect to right-to-
work status versus union status, Tax Code, regulatory code? Are
there any trends with respect to the States that are in the
most amount of trouble fiscally?
Mr. Rauh. Well, the trend that I am seeing is that there is
a serial correlation, if you will, where the States that have
been in bad shape are kind of getting worse, particularly with
we respect to Illinois which, you know, has simply not been
addressing their pension problems, as well as New Jersey which
simply has not been contributing.
You know, I have observed--it was pointed out that North
Carolina does not have unionized public employees at the State
level. North Carolina is a State that is in reasonable shape
with regards to these matters. But I haven't done a systematic
study across all 50 States to see whether you would find that
Mr. Gowdy. What is ``smoothing?'' Is that a term that is
used as people evaluate their pensions plans, and what is it?
Mr. Rauh. ``Smoothing'' is the idea that instead of having
to look at how much your assets are worth today when declaring
your unfounded liabilities to the public, you can take an
average over a certain number of years. And as a result, in
times when the market is going up very quickly, the value of
the assets that is being reported is understating the market
value of the assets and in times when assets are going down
very quickly it is overstating the value of the assets.
Mr. Gowdy. I am out of time. Thank you.
Mr. Coble. I thank the gentleman. The Chair recognizes the
distinguished gentleman from Michigan, Mr. Conyers.
Mr. Conyers. Thank you, sir.
Point of order before the clock starts running.
As the Chair knows, the PATRIOT Act is on the floor, the
first thing up. And as has been our policy, we do not hold
hearings in any of the Subcommittees when one of our bills is
on the floor.
Mr. Coble. Well, I was told to be here at 4 o'clock, Mr.
Chairman. That is why I was here.
Mr. Conyers. Yeah. But what are you going to do when the
PATRIOT Act comes up on the floor?
Mr. Coble. Well, 5:30 I think is when it convenes, at 5:30.
Mr. Conyers. Oh, okay.
But you agree with the principle that we do not have bills
of the Judiciary Committee on the floor at the same time the
Subcommittees are holding hearings.
Mr. Coble. I am not sure about it. I will take your word
Mr. Conyers. But you have been here almost as long as me. I
mean, Lamar Smith had that rule, Henry Hyde had that rule, Jim
Sensenbrenner had that rule, and now you are not sure.
Mr. Coble. Well, I will state to you, if the gentleman will
yield, I didn't call the hearing. So hold me harmless for that.
I think it has been a good hearing, by the way.
Mr. Conyers. It has been. I quite agree, sir.
But we are starting not at 5:30 but in 10 minutes on the
floor of the House. We just called and checked.
So I don't want you to get in trouble because you weren't
sure. I am here to help.
Mr. Coble. I stay in trouble, Mr. Conyers.
Mr. Conyers. Yeah. But I think we ought to summon the
Chairman of the full Committee here to help us straighten this
up, because I am the floor manager for the minority on the
PATRIOT Act. Hank Johnson has already requested time to speak
on the PATRIOT Act. And you are suggesting that we just stay
here because you are not sure.
Mr. Coble. We are planning to adjourn at 5:20. But we need
to get moving.
Mr. Conyers. No, that is unacceptable.
I would make a point of order and ask someone to call in
Lamar Smith because I don't have an obligation to choose
between this important Subcommittee of yours and my managerial
responsibilities on the House floor. Would you help me with
Mr. Coble. I am not sure. I can't help you with it.
Mr. Conyers. You mean I just make a choice. Since I can
only do one or the other, it is on me and not on the Committee.
Don't we have this in the rules somewhere, Chairman Coble?
Mr. Coble. Well, the Judiciary Committee is on the floor at
5:30, I am told, Mr. Conyers.
Mr. Conyers. Who told me 10 minutes from now?
Counsel. The Intel Committee is up first. The Judiciary
Committee is at 5:30.
Mr. Conyers. Okay. That is good enough for me. And I always
take the counsel for the Judiciary's word for it. We have never
had a disagreement yet. And I thank you, Mr. Chairman.
Mr. Coble. Thank you.
Mr. Conyers. Now, let's begin to see if we can thread
together where we have areas of agreement here.
Here is the Manhattan Institute. More than half of all
State expenditures go to Medicaid, K-12 public school aid, and
other transfer payments. These are the areas, not current
pension bills or debt service, that have been the prime source
of unsustainable and unaffordable spending growth in State
budgets. True or false.
Mr. Brainard. Representative Conyers, I am not an expert on
State finance but that is my understanding, is that K-12,
higher Ed and Medicaid make up the bulk of State and local
Mr. Conyers. Matt Fabian, true or false?
Mr. Fabian. I say true to that.
Mr. Conyers. Thank you. Attorney Spiotto, true or false?
Mr. Spiotto. That is my understanding.
Mr. Conyers. Right.
Professor Rauh, true or false?
Mr. Rauh. On spending, yes, States have spent more on those
things than on other things. But you can't look at this like
spending. This is debt, and it is like debt that is not being
Mr. Conyers. True or false?
Mr. Rauh. I think I didn't understand the question.
Mr. Conyers. You can say ``false.'' It is okay.
Mr. Rauh. I mean, I think if I understand the question.
Mr. Conyers. Well, then why don't you agree with everybody
else and say ``true''?
Mr. Rauh. Have they spent more on that than on pensions?
True. Will they have to spend more on pensions than on this?
Yes, they will have to spend more on pensions in the future.
Mr. Conyers. But you didn't answer my question, sir. My
question is true or false.
Mr. Rauh. I will give you true.
Mr. Conyers. Well, thank you. Thanks for your cooperation.
Because the Manhattan Institute is a--have you heard of the
Mr. Rauh. [Nods head.]
Mr. Conyers. Do you acknowledge that they are a pretty
conservative think tank organization?
Mr. Rauh. I don't understand why their politics would have
any bearing on this.
Mr. Conyers. I didn't say it was political. I said that
they were conservative.
Mr. Rauh. Is that so? I didn't know.
Mr. Conyers. I see. All right.
Let me ask you this: Have you heard of attorney Joe--the
late attorney Joseph Rauh.
Mr. Rauh. Yes, I have.
Mr. Conyers. And your name is Rauh.
Mr. Rauh. Yes, it is.
Mr. Conyers. Are you two related?
Mr. Rauh. Not that I know of.
Mr. Conyers. Well, wait a minute. Everybody commonly knows
all Rauhs are related. I mean whether they know it or not.
Do you realize that he might be turning over in his grave
now to be hearing your testimony?
Mr. Rauh. I don't know why that is here or there.
Mr. Conyers. No. It isn't here, it is irrelevant. But don't
you think that the late Joe--who used to testify before this
Mr. Rauh. I think the late Joseph Rauh would actually care
about the fact that what we have all--all the promises, the
unfunded promises that have been made are going to have to be
paid back in the future and that that is going to crowd out
spending on essential public services like schools and
Mr. Conyers. Perhaps he would.
But I am happy--do you acknowledge any possible
relationship between you, the late Joe Rauh that I knew pretty
well, and my pleasure in meeting you this afternoon, between
you and him?
Mr. Rauh. Do I--I have never met him. I know of his name. I
am not quite sure what you are asking, sir. I don't know of any
relationship between us.
Mr. Conyers. I will explain it to you.
When I meet people named Conyers, and some I don't know,
guess what. They ask are we related. I don't say I don't know.
I say all Conyers are related. They didn't go into probate
court and change their name to ``Conyers'' and neither did you.
So I think it is fair to assume that there is some
relationship, don't you?
Mr. Rauh. Sir, genealogy is not my area of expertise. I
really don't know if we are related or not.
Mr. Conyers. Would you be interested in finding out?
Mr. Rauh. Sure.
Mr. Conyers. Well, thank you. I want to help you in that
respect, if I can.
I thank you, Mr. Chairman.
Mr. Coble. The gentleman's time has expired.
The gentleman from New York, Mr. Reed, is recognized for 5
Mr. Reed. Thank you very much, Mr. Chairman.
I am not going to inquire about anybody's familial
relations with anyone else. I am really concerned about the
issue that we are facing with the unfunded liabilities that are
facing our Nation.
As a city mayor, I saw this issue firsthand. I saw GASB 45
and its requirement that we disclose our unfunded liabilities
and try to quantify that. And when I did that as a mayor, I
tell you my eyes popped out of my head because I said shame on
my predecessors who never dealt with this issue and who now are
saddling me plus the children of my community with these debts.
So I am very comfortable in coming to the conclusion that
we have a serious problem when it comes to this issue. Even Mr.
Brainard, you indicated in your written testimony even today
that even under conservative estimates the median State pension
fund is able to pay benefits until 2030. You said 25 years
today. So 2035 I guess is your verbal testimony.
So my question is, and I do recognize the concern about--I
do recognize the concern about bankruptcy. And I want to make a
note. I believe the State of California issued IOUs. A great
State of our Union had to go to IOUs to meet its monetary
obligations. That is very scary to me. And as a freshman Member
of this Congress, that puts generations of children in jeopardy
that America will not be here because States such as California
are coming up with different types of currency to cover their
So I don't want to make light of this issue. This is a
serious issue. And it is part of a bigger problem that we are
facing in this Nation.
So I recognize the issue with bankruptcy, and I recognize
the issue that that will send, reviewing your written
testimony, to the municipal bond markets and the fact that
people may look at that investment as something where
historically it has always been looked at as a secured
investment, something that is going to keep the rates low
because they are going to fulfill their obligations.
So I am interested in talking to any of you. I guess I will
start with Mr. Spiotto.
H.R. 567 appears to be a solution that is on the table
about requiring transparency on the issue of unfunded
Do you have any comments on H.R. 567?
Mr. Spiotto. Thank you.
I think transparency is always a good thing. And one of the
things that the municipal market has striven for over the years
is more and more transparency. One of the questions is what is
the price or the cost of it. And as you mentioned, GASB 45 was
helpful in bringing to the forefront that issue. And I think
that municipal issuers have, over a long period of time, tried
to make sure that the investors understood what the costs are.
And so I think that bill is an interesting bill from the
standpoint of providing some impetus for more disclosure.
Mr. Reed. I appreciate that.
Professor Rauh, do you want to comment on that?
Mr. Rauh. Yes. Well, I mean to comment on the bill, the
Public Employee Pension Transparency Act, I think this is a
critical step forward because, you know, if States are going to
be running large hidden budget deficits and subjecting Federal
taxpayers to the risk that in the future there will be requests
for bailouts, then it is very important for the Federal
Government and Federal taxpayers to understand just the size of
the unfunded liabilities. And I think that the Public Employee
Pension Transparency Act, H.R. 567, is a very critical step
forward toward doing that, and it would calculate the
liabilities the way that we calculate them.
Mr. Reed. I appreciate that input.
Mr. Brainard, you said that one way that you would look
forward to the States dealing with this issue is that they
would renegotiate their relationships with their employees and
employers with reduction of benefits, increases in
contributions. That would be a contractual renegotiation, would
Mr. Brainard. Representative, with respect, I don't think I
used the word ``renegotiate.''
Mr. Reed. How do you get to reduction of benefits,
increases in contribution to deal with the problem that you are
proposing to us as a solution that would deal with the issue?
Mr. Brainard. The levels of protection, benefit levels and
contribution rates vary by State. And in some States those
levels of protections are more lax, and in other States they
are more ironclad. So to this point I am not aware of a State
that has modified their benefit structure or financing
arrangement that is in contravention to the State constitution
or statutes. Those States in which that is permitted, some have
taken advantage of it.
Mr. Reed. So what you are referring to is the State
legislative makeup that allows the benefits to be redesigned
Mr. Brainard. Yes, sir.
Mr. Reed. Okay. But in the collective negotiation contracts
with employees, that would have to be reopened up, would it
Mr. Brainard. Well, in cases where employees have the right
to bargain collectively; for example, California, public
employee groups, my understanding is last year a number of them
Mr. Reed. So voluntary concessions that they would have to
come to the table to deal with the issue.
Mr. Brainard. Yes, sir.
Mr. Reed. Okay. I see my time has expired.
Thank you, Mr. Chairman.
Mr. Coble. I thank the gentleman from New York.
The Chair recognizes the distinguished gentleman from
Illinois for 5 minutes.
Mr. Quigley. Thank you, Mr. Chairman.
Mr. Chairman, I sure don't need to be convinced that this
is a serious problem. I come from Illinois, which seems to
compete with California to dive off the cliff like lemmings in
not recognizing this as a serious problem. And I see it as, you
know, years of neglect. And in Illinois, it is 20, 30 years of
underfunding and having ridiculous rules about what people
think they can do in providing, in some cases with all due
respect, sweetheart deals to some folks that put this system in
It wasn't until the economic downturn that this really came
to light. The economic downturn is blamed for this, but in
reality that is only part of it. I mean, the symptoms were
there and we weren't paying attention. The economic downturn
just made it so much more dramatic.
And as part of the larger picture, State and local
governments as a whole in terms of financial management or
forgetting the story of Jacob in Genesis that during the 7 good
years, you should save for the 7 lean years. So we know how we
But there is some nuance here. This is my second hearing on
this in less than a week. One more and I get a set of steak
knives, I am told. But everyone seems to be kind of in the
middle. There is not going to be a bailout and States need to
recognize that and act accordingly. They need to reinvent
themselves, streamline, consolidate, and reform, including
their pension plans.
But to bankruptcy, I have just heard so many concerns
within the bond market and among many others about the
ramifications on that.
So if I could start briefly with you, Mr. Fabian, you seem
to speak of what is almost a contagion if there is not just
bankruptcy but do you also see that potential if pension funds
had something more than a big hiccup in terms of affecting the
bond market not just in the 8 to 10 States that are problematic
Mr. Fabian. So the question is about an event happening
within the pension funds?
Mr. Quigley. Short of a bankruptcy.
Mr. Fabian. Sure.
Well, the municipal market right now--the issue of
bankruptcy, the issue of a collapse is something that would
affect the market regardless. The municipal market right now is
particularly vulnerable because we have been under a fairly
intense media assault, a warning of a looming collapse of the
market. So this fear of bankruptcy is for sure attracting the
attention of everyone in the market. Certainly all of our
subscribers and probably many more.
The idea of something outside of bankruptcy, I am not
exactly sure what that might be but I am thinking of----
Mr. Quigley. Defaults?
Mr. Fabian. On the pensions?
Mr. Quigley. Well, some major financial hiccup in that
Mr. Fabian. The one thing--there is a study on----
Mr. Quigley. Payments on loans for those bonds.
Mr. Fabian. The way that most States are set up--actually
Illinois is an excellent example. For Illinois to actually--
what Illinois does is they actually sequester cash about a year
ahead for the debt service that is due over the coming year.
And they have the access, the first access to all revenues of
the State regardless of where they came from to fill up that
fund. And that fund can't be used for any other purpose. And it
is a monthly set-aside. So and just in case the legislature
doesn't actually appropriate or the governor doesn't
appropriate, there are mechanisms to do it for them.
So the risk of them actually defaulting on their bonds is
extremely low. It is hard actually to see the scenario in which
With Illinois, there is a study by the Boston College
Center for Retirement Research which shows that, you know, were
Illinois to just continue to underfund its pension, in 2022 to
2027, I believe, their cost of converting from a pension fund,
which is a simply PAYGO system of pension funding, would
increase the--it would cost about an additional 12 percent of
the State's budget.
Mr. Quigley. I don't mean disrespect. I am just short on
time. We are all leaving.
To put that to you, Professor, the problem that Mr. Fabian
talked about earlier to the bond market of bankruptcy and
affecting all the States, not just the 8 to 10 who have been
Mr. Rauh. I think the risk is that we are referring to if
there is no bankruptcy code introduced then the risk that one
is looking at at that point is you know what happens if a few
years down the line, you know, when some States have been
relying even more on borrowing to fund pensions if the muni
markets at that point say you know what, we have had enough of
this and we are not interested in buying the new bonds at an
And just to give a perspective, I mean if you look at bonds
on Greek debt, you know, a month before the Greek crisis that
erupted in Europe and the European debt crisis, the spreads
were really small over German bonds. Those bonds were trading
very close to looking like German bonds. And then all it really
took was a couple auctions where investors weren't interested.
And all of a sudden the rates spiked and then there was
So I think the risk of contagion is there a bankruptcy code
Mr. Quigley. Thank you.
Mr. Coble. The gentleman's time has expired.
The distinguished gentleman from Florida, Mr. Ross, is
recognized for 5 minutes.
Mr. Ross. Thank you, Mr. Chairman.
Professor Rauh, from tone of what I have heard, I
appreciate Mr. Brainard wishing us a Happy Valentine's Day, I
can just about bet, though, you are not on his Christmas card
But more importantly, as I have read some of his reports,
he indicates that on the whole State and local pensions are
weathering the financial crisis and making measured changes to
ensure their long-term sustainability. It goes on to refer to a
study authored by you saying it promotes confusion by mixing
apples with oranges. And then goes on further to also say that
the method used to determine future pension liabilities of
States and localities is not recognized by governmental
How do you respond to that, Professor?
Mr. Rauh. Well, those governmental accounting standards are
flawed in the perspective of finance, economics, and, frankly,
Mr. Ross. I guess what I am concerned about is that we are
talking about government pensions. But yet on the private side,
is there more uniformity for regulating or evaluating private
Mr. Rauh. There is more uniformity and that is because
there is also more Federal involvement. I mean of course the
Federal Government explicitly insures defined benefit pension
plans that are sponsored by corporations. And you know part of
the 1974 ERISA legislation that introduced that insurance was
that a regulatory layer was also applied where companies had to
calculate their liabilities using certain assumptions and they
also had to contribute to the funds under certain pre-specified
With State and local pension plans, we are kind of
operating under the idea that the States are on their own and
therefore they haven't been regulated up until now. And I think
that the Public Employee Pension Transparency Act recognizes
that there is some systemic risk.
Mr. Ross. So presently under the GASB, is there any
statement of actuarial assumptions that must be made or
disclosed by anybody who is accounting for the pension funds?
Mr. Rauh. To be sure, there are some standards of practice
that have to be followed. But there is also wide leeway. And in
particular, I think the biggest problem is the expected return
on planned assets and being able to assume that because your
portfolio made 8 percent in the past it is going to make 8
percent in the future and then to write down, reduce the value
of your debts as a function of that.
If I go to a bank and try to take out a second mortgage and
the bank rejects my application, I can't go back the next day
and say, look, I rebalanced my assets and now I am holding more
equities which are going to have a higher expected return in
the future, you know, will you reconsider.
Whereas for State and local governments, the fact that they
can assume 8 percent returns in their portfolios allows them to
reduce the value of the debts that they are stating to the
public, and these standards misrepresent the value of the
liabilities. They misrepresent how much State and local
taxpayers owe to public employees. It is often beyond what is
being set aside.
Mr. Ross. As I understand it, there is no uniformity
between States in terms of their accounting practices of their
Mr. Rauh. Well, there are some frameworks that all of the
States follow because they are voluntarily following the GASB
recommendations. But I mean to give you an example, I mean
there is something under GASB called the actuarially required
contribution. But of course you know the State of New Jersey
contributed 5 percent to the actuarially required contribution
to its teacher and police fund. So in what sense is that
required. It isn't really required.
Mr. Ross. It is a relative term.
Mr. Rauh. I like to call it a recommended contribution.
Mr. Ross. Mr. Brainard, the Public Employee Pension
Transparency Act that we have talked about, you shouldn't have
any objection to that, should you, or your members?
Mr. Brainard. Representative Ross, we do object to it.
Mr. Ross. I mean why? If it is going to make it more
uniform, more accountable and, more importantly so that the
pension recipients are going to have some idea of what is being
done with their plan and the posting of 20-year plan of the
actuarial assumptions made, what would be wrong with that?
Mr. Brainard. Representative, I understand the appeal on
the surface. However, if you dig down a little deeper you will
recognize that we believe, as has happened on the corporate
pension side, the use of current interest rates, which is what
this legislation proposes to measure public pension funding
liabilities, introduces extreme volatility.
Mr. Ross. More so than the discount rate now being used?
Mr. Brainard. Yes, sir, absolutely. The purpose for the
discount rate currently in place as promulgated by GASB is to
promote--to oppose volatility and promote consistency in the
funding level. And we believe that the introduction of current
interest rates makes the condition of the pension funds a
condition more of current bond yields than the underlying
dynamics of the plan itself.
Mr. Ross. So you would assume then that the accountability
of the government pension plan should remain status quo?
Mr. Brainard. I think that government pension plans are
accountable to the taxpayers in each of the States, sir.
Mr. Ross. And not to a board.
Mr. Brainard. Well, those----
Mr. Ross. An appointed board.
Mr. Brainard. Representative, those boards are appointed by
governors and legislative members and elected by--appointed by
legislators and they work within a statutory framework that is
approved of course by every legislature.
Mr. Ross. Would you recommend that any of your pension
plans purchase any of the bonds issued by your States?
Mr. Brainard. Representative, that is a very broad
question. But there are many--my understanding of the municipal
bond market is that there would be many prudent investment
opportunities, yes, sir.
Mr. Ross. Thank you.
Mr. Coble. I thank the gentleman from Florida. And I thank
the Members for staying with us to the last doll is hanged. I
would be remiss if I did not extend Happy Valentine's greetings
to each of you. Thank you for your testimony.
Without objection, all Members will have 5 legislative days
to submit to the Chair additional written questions for the
witnesses which we will forward and ask the witnesses to
respond as promptly as they can do so, so that their answers
may be made a part of the record.
Without objection, all Members will have 5 legislative days
to submit any additional materials for inclusion in the record.
With that, again, I thank the witnesses and those in the
audience, and this hearing is adjourned.
[Whereupon, at 5:30 p.m., the Subcommittee was adjourned.]
A P P E N D I X
Material Submitted for the Hearing Record
Response to Post-Hearing Questions from Joshua Rauh, Ph.D., Associate
Professor of Finance, Kellogg School of Management, Northwestern
University, Evanston, IL
Response to Post-Hearing Questions from James E. Spiotto, Esq.,
Chapman and Cutler, LLP, Chicago, IL
Response to Post-Hearing Questions from Matt Fabian, Managing Director,
Municipal Market Advisors, Westport, CT
Response to Post-Hearing Questions from Keith Brainard, Research
Director, National Association of State Retirement Administrators,