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The Little State With a Big Mess

Mary Williams Walsh|The New York Times
Sunday, 23 Oct 2011 | 12:19 PM ET

On the night of Sept. 8, Gina M. Raimondo, a financier by trade, rolled up here with news no one wanted to hear: Rhode Island, she declared, was going broke.

Maybe not today, and maybe not tomorrow. But if current trends held, Ms. Raimondo warned, the Ocean State would soon look like Athens on the Narragansett: undersized and overextended. Its economy would wither. Jobs would vanish. The state would be hollowed out.

Broad Street, Central Falls, Rhode Island
Photo: Marc N. Belanger
Broad Street, Central Falls, Rhode Island

It is not the sort of message you might expect from Ms. Raimondo, a proud daughter of Providence, a successful venture capitalist and, not least, the current general treasurer of Rhode Island. But it is a message worth hearing. The smallest state in the union, it turns out, has a very big debt problem.

After decades of drift, denial and inaction, Rhode Island’s $14.8 billion pension system is in crisis. Ten cents of every state tax dollar now goes to retired public workers. Before long, Ms. Raimondo has been cautioning in whistle-stops here and across the state, that figure will climb perilously toward 20 cents. But the scary thing is that no one really knows. The Providence Journal recently tried to count all the municipal pension plans outside the state system and stopped at 155, conceding that it might have missed some. Even the Securities and Exchange Commission is asking questions, including the big one: Are these numbers for real?

“We’re in the fight of our lives for the future of this state,” Ms. Raimondo said in a recent interview. And if the fight is lost? “Either the pension fund runs out of money or cities go bankrupt.”

All of this might seem small in the scheme of national affairs. After all, this is Little Rhody (population: 1,052,567). But the nightmare scenario is that Ms. Raimondo has seen the future of America, and it is Rhode Island. As Wall Street fixates on the financial disaster in Greece, a fiscal wreck is playing out right here. And the odds are that it won’t be the last. Before this is over, many Americans may be forced to rethink what government means at the state and local level.

Economists have talked endlessly about a financial reckoning for the United States, of a moment in the not-so-far-away when the nation’s profligate ways catch up with it. But for Rhode Island, that moment is now. The state has moved to safeguard its bond investors, to avoid being locked out of the credit markets. Last week, the General Assembly went into special session and proposed rolling back benefits for public employees, including those who have already retired. Whether the plan will succeed is anyone’s guess.

Central Falls, a small city north of Providence, didn’t wait for news from the Statehouse. In August, the city filed for bankruptcy rather than keep its pension promises to its retired firefighters and police officers.

Illinois, California, Connecticut, Oklahoma, Michigan — the list of stretched states runs on. In Pennsylvania, the capital city, Harrisburg, filed for bankruptcy earlier this month to avoid having to use prized assets to pay off Wall Street creditors. In New Jersey, Gov. Chris Christie wants to roll back benefits, too.

In most places, as in Rhode Island, the big issue is pensions. By conventional measures, state and local pensions nationwide now face a combined shortfall of about $3 trillion. Officials argue that, by their accounting, the total is far less. But with pensions, hope often triumphs over experience. Until this year, Rhode Island calculated its pension numbers by assuming that its various funds would post an average annual return on their investments of 8.25 percent; the real number for the last decade is about 2.4 percent. A phrase that gets thrown around here, à la Rick Perry describing Social Security, is “Ponzi scheme.”

That evening in September, Ms. Raimondo walked into the Cranston Portuguese Club to face yet another angry audience. People like Paul L. Valletta Jr., the head of Local 1363 of the firefighters union.

“I want to get the biggest travesty out of the way here,” Mr. Valletta boomed from the back of the hall. “You’re going after the retirees! In this economic time, how could you possibly take a pension away?”

Someone else in the audience said Rhode Island was reneging on a moral obligation.

Ms. Raimondo, 40, stood her ground. Rhode Island, she said, had a choice: it could pay for schoolbooks, roadwork, care for the elderly and so on, or it could keep every promise to its retirees.

“I would ask you, is it morally right to do nothing, and not provide services to the state’s most vulnerable citizens?” she asked the crowd. “Yes, sir, I think this is moral.”

FOR many Americans, the Ocean State conjures images of Newport mansions and Narragansett chic. The overall reality is more prosaic. Rhode Island today is a place where the roads and bridges rank among the worst in the nation and where jobs are particularly hard to find. Unemployment rose faster during the 2008-9 recession than in any other state. The official jobless rate is now 10.6 percent, versus the national average of 9.1 percent.

The textile mills and jewelry manufacturers that once employed thousands here have dwindled away. The big employers today are in health care and education, both of which rely heavily on government spending that has been drying up.

Many states and cities can credibly say their pension plans are viable, even when those plans are not fully funded. That is because state retirement funds, like Social Security, pay out benefits bit by bit, over many years.

But unlike, say, California, with its large, diverse economy, Rhode Island is so small that there is little margin for error. Leaving the state, to escape its taxes, is almost as easy as moving to the other side of town. Efforts to balance the state budget by shrinking the public work force have left Rhode Island with a problem like the one that plagues General Motors: the state has more public-sector retirees than public-sector workers.

More ominous still, in each of the last 10 years, the state pension fund paid more money to retirees than the fund collected from state employees and taxpayers combined. The fund is shrinking, even though the benefits coming due are growing.

For all the pain here, one important constituency — Wall Street — seems satisfied enough. To reassure its bond investors, Rhode Island passed a special law this year giving them first dibs on tax revenue. In other words, bondholders will be paid, whatever happens. Ms. Raimondo has at times been accused of selling out ordinary Rhode Islanders to Wall Street interests, but she says hard choices must be made.

Ms. Raimondo remembers better times in Rhode Island. She grew up in a suburb of Providence, rode public buses to public schools and played in public parks. Her grandfather, who arrived from Italy, studied English in the evenings at the Providence Public Library. (That library system lost its financing from the city in 2009, closed branches and shortened its hours. These days, it is seldom open after 6 p.m.)

But Ms. Raimondo also learned early on about economic forces at work in her state. When she was in sixth grade, the Bulova watch factory, where her father worked, shut its doors. He was forced to retire early, on a sharply reduced pension; he then juggled part-time jobs.

“You can’t let people think that something’s going to be there if it’s not,” Ms. Raimondo said in an interview in her office in the pillared Statehouse, atop a hill in Providence. No one should be blindsided, she said. If pensions are in trouble, it’s better to deliver the news and give people time to make other plans.

BY any standard, Ms. Raimondo is a high achiever. She graduated from Harvard, collected a law degree from Yale and attended Oxford as a Rhodes scholar. After a stint in New York in the venture capital business, she helped found Rhode Island’s first venture capital firm, Point Judith Capital.

Then, in 2009, with zero political experience, she ran for the state office of treasurer. Although she is a Democrat in a heavily Democratic state, she stood out because she refused to promise that state jobs and pension benefits would be protected no matter what. She won by a landslide, receiving more votes than any other candidate for any state office. Her long-term ambitions, in politics, business or both, are the subject of speculation in Providence.

No sooner had she been sworn in than the S.E.C. called. She learned that the commission was investigating the finances of various cities and states, including Rhode Island, to determine whether bond investors were receiving truthful information. At the heart of the S.E.C. inquiry were pension funds.

Ms. Raimondo said she wasn’t entirely surprised. When she disclosed the investigation, she said: “For months, Rhode Island has been listed among several states with precarious finances. This challenging position is, in part, due to our significant and growing unfunded pension liability.” Her first priority, she vowed, would be to ensure that the numbers were right.

Others made similar pledges before. Rhode Island has been trying to fix its pension system for years; it has announced four “reform” plans since 2005, each of which has claimed to reduce costs for the state and cities. It has raised minimum retirement ages, slowed accrual rates, capped cost-of-living adjustments — but always for the youngest or least senior public workers. Retirees, and workers poised to retire, were spared, even though the numbers clearly showed that reducing payments to retirees was the only sure way to fix things quickly.

In recent months Ms. Raimondo has crisscrossed the state in an attempt to sell a different remedy, one in which everyone takes a hit. Yes, it would hurt. But at least the state would avoid having to come up with yet another plan in a year or two. The defined-benefit structure, very popular with public employees, could survive. Still, the battle lines are clear. Eight public workers’ unions have already sued, saying the pension changes of 2009 and 2010 were illegal.

On a September evening out in North Scituate, at the historic Old Congregational Church, Ms. Raimondo told a crowd about what had happened in Vallejo, Calif. That city filed for bankruptcy in 2009 and, after grueling negotiations, left pensions intact but drastically cut bus service, police patrols and other government functions, along with the pay of the city workers who provide all those services.

“That’s not what we want for Rhode Island,” Ms. Raimondo said. “That’s not the future we want for our children.”

Others in the crowd had their own stories. Several retired teachers said they had played by the rules and sent a part of every paycheck to the pension fund, as required by law. One man demanded pension cuts for state troopers and judges. A woman said her aged father would be unable to buy medicine if the state stopped adjusting his pension for inflation.

“I feel your anger,” Ms. Raimondo told the crowd. “In many ways, I’m angry myself. Many of the shenanigans that went on in past years were just wrong.”

In some ways, the central question is not only what the government owes to pensioners but what citizens owe to one another. From the pews of the church, Cindy Gould, a fourth-grade teacher, said that under the current system, she had 11 years to go until retirement. Under Ms. Raimondo’s plan, she might have to work longer. But, Ms. Gould, 54, said she was willing to do so if that meant the elderly would get the medical care they need.

Since the last recession hit, states and cities around the country have embarked on pension changes, often following the Rhode Island pattern. Benefits for state employees who have not yet been hired are usually the first to be cut. Then come changes for those now on the payroll, often in the form of higher mandatory contributions.

Retirees have mostly been off-limits, until now. In many instances, laws or legal precedent shield them. In the corporate sphere, they are supposed to bear losses only in bankruptcy. But those rules do not apply to states, which may not declare bankruptcy in any case. If a government homes in on retirees, a lawsuit is sure to follow, and the resolution will take years. But Ms. Raimondo says Rhode Island doesn’t have years. This isn’t a question of politics or law, she says, but of simple math. To get the numbers right, Ms. Raimondo quickly assembled a panel of experts that included academics, mayors and union officials. The goal was to figure out what a public pension should be and what Rhode Island could afford. Inflation protection every year, for people who in some cases retired in their 40s, started coming into focus.

Analysts also took a close look at the projected long-term investment return for the pension system: 8.25 percent. Everything rested on hitting that target, but the state’s actuary said there was less than a 30 percent chance that would happen over the next 20 years. The board voted to lower the assumption to 7.5 percent. (Given the recent run in the financial markets, even that figure may seem optimistic.)

As a result of that change, the state’s pension shortfall instantly rose to $9 billion from $7 billion. The unions said Ms. Raimondo had manufactured a crisis.

She denied it. “This is about the truth,” she said, “and about doing the right thing.”

Then, as if on cue, Central Falls declared bankruptcy. The city’s pension fund wasn’t just underfunded. It was completely out of money. A receiver for the city sought court permission to reduce by as much as half the base pensions of retired police officers and firefighters.

Suddenly the pension crisis wasn’t an abstraction any more. The unthinkable had happened, and the odds were that it would happen again unless the state acted quickly.

Other mayors began stepping forward and warning that their communities were on the brink, too. Here in Cranston, Mayor Allan W. Fung said that unless things changed, he would have to eliminate trash collection, services to the elderly and recreation programs for children, as well as reduce the size of the police force and fire department.

Over in Woonsocket, John W. Ward, the president of the City Council, said that all summer parks programs had been eliminated and that teachers were working with larger classes than their contracts allowed. Half of Woonsocket’s streetlights were out because the city couldn’t afford to replace them. His son, daughter-in-law and granddaughter had moved to another state.

“To allow the pension system to remain largely unchanged will make it impossible for Woonsocket, and every other urban community, to survive,” Mr. Ward said.

AT the Portuguese Club in Cranston, José M. Berto raised his hand. At 62, he told Ms. Raimondo, he was on the cusp of retirement.

“We’re looking at a Ponzi scheme that would make Bernie Madoff look like a Boy Scout,” said Mr. Berto, a supply officer for the state.

He asked if Rhode Island’s pension problem was the worst in the nation.

Ms. Raimondo said it was.

“I don’t like her message,” Mr. Berto said after the session. “But she has been honest, forthcoming. We’re in trouble. We’re just in so much trouble.”

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