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Pension Costs Add to US States' Debt, Moody's Finds

Nicole Bullock, Financial Times
Thursday, 27 Jan 2011 | 6:40 AM ET

Connecticut, Illinois and Hawaii are among the states with the highest combined debt and pension liabilities, according to a study to be released on Thursday by Moody’s Investors Service.

In a bid to give a broader picture of state finances, Moody’s combined their net tax supported debt and unfunded pension liabilities to assess how leveraged states are.

“These costs are serious and they are growing,” said Robert Kurtter, managing director of the state and local government finance group at Moody’s. “If they are addressed [by the states] they are manageable.”

Moody’s research comes amid concern about the strain that pensions will place on US states, which have faced severe budget deficits since the economic recession.

Republican lawmakers are studying ways for states to go bankrupt, a move that could enable them to renegotiate their pensions, but one that will be met with fierce opposition in Congress and the financial markets.

Moody’s used state data from 2009, which shows states’ unfunded liabilities at less than $500 billion, well below other estimates.

The rating agency acknowledged that these figures “may be understated” but added that some of the larger estimates include the unfunded liabilities of local governments.

States tend to use an annual return assumption of 8 percent, higher than those used by corporate pension plans. Some plans can also average gains and losses over a number of years through a process known as smoothing. Studies using more conservative accounting have valued the US public pension gap upwards of $1,000 billion.

In Moody’s study, as a percentage of states’ gross domestic product, the debt and pension liabilities combined range from 16.2 percent in Hawaii to 0.1 percent in Nebraska. For 31 states, these long-term obligations amount to more than 100 percent of annual tax revenue. For 10 states, it is more than 200 percent.

Connecticut has the highest funding needs relative to its economy, taxing power, revenues and population. Combined pension and long-term debt liabilities amount to $9,366 per citizen.

Moody’s found most states that showed restraint with public borrowing were conservative with their public pensions and vice versa. Nebraska and South Dakota, for example, ranked among the lowest for both debt and pension funding needs.

Exceptions include California and New York, which have high debt levels but pensions that were better funded. At $87 billion, or 4.7 percent of its GDP, California is one of the most highly indebted states, but its unfunded pension liability is 2.7 percent of GDP. New York’s debt is 5.35 percent of GDP, but its pension gap is negative 0.91 percent.

Colorado has low debt, but weak pension funding and constitutional constraints to raising taxes put the state high in the ranking when these obligations are combined.

Moody’s does not believe that long-term debt and pension gaps present the same default risk for states.

Pension obligations have an “irrevocable, long-term nature that resembles bonded debt,” Moody’s said. Unlike interest and principal payments on bonds, states have passed laws for relief on pension contributions in tough economic time.

Concerns about defaults in the $3,000 billion municipal bond market have led to record selling by retail investors and a jump in borrowing costs.

Investors, mostly retail, have withdrawn more than $20 billion from mutual and exchange-traded funds that buy municipal bonds in 10 consecutive weeks of outflows, according to Lipper, the fund tracker.

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