WASHINGTON Allowing U.S. states to declare bankruptcy would not solve their persistent public pension problems, a leading scholar who spooked municipal debt markets by showing states and local governments could not cover $3 trillion in pension liabilities, told lawmakers on Monday.
"The evidence on ... bankruptcy at the municipal level suggests that a federal bankruptcy proceeding for states would not be a panacea," Joshua Rauh, a professor at Northwestern University, told a congressional hearing on allowing states to file for bankruptcy.
"If the political reality is that public unions will require pensions to be paid regardless, then a bankruptcy framework for states does not help the restructuring of that type of debt," he added.
Still, Rauh said the threat of bankruptcy might give states leverage in renegotiating pensions and labor contracts.
States currently cannot declare bankruptcy because the U.S. Constitution recognizes them as sovereign entities. But as their unfunded pension liabilities swell -- the most conservative estimate puts the total bill at $700 billion -- Republicans in Congress are turning a cold shoulder to helping states.
Last week, key Republican lawmakers in the House of Representatives introduced legislation that threatened states with a steep penalty for under-reporting pension liabilities -- eliminating federal tax exemptions for municipal bonds.
Republicans, emboldened by Tea Party support for getting tough on spending that helped them take control of the House, are suggesting the radical step of states declaring bankruptcy, which allows for labor contracts to be thrown out.
Still, after the first committee hearing on the bankruptcy issue last week, representatives would not say when legislation allowing bankruptcy would be introduced. Instead, the chairman of the sub-committee on bailouts, Patrick McHenry, said he would continue to hold hearings that would lead to a report on how to address states' pension and budget problems.
"A bankruptcy code for states would also send a signal to municipal markets that the federal government has no intention of bailing out states," said Rauh. "Of course, there is a bankruptcy code for corporations in the United States, and that has not stopped federal bailouts of corporations."
Rauh last year released a paper questioning the returns state and local governments expect on investments made by their public pensions. He found that a portfolio with an expected rate of return of 8 percent has only about a one-third probability of achieving that rate over the next 30 years.
Most state and local pension funds, though, expect the 8 percent rate because of historically high returns. Rauh lowered the estimated returns and found that pension funds could be short as much as $3 trillion.
Public pension funds' investments were hit hard by the financial crisis and employers lowered contributions to the funds as revenue collapsed. State officials blame the pension obligations for part of their budget woes.
"To address the solvency issue, state and local governments need to make contributions that substantially exceed the present value of the new benefits employees are accruing," said Rauh. He added that "without significant tax increases," state and local governments could not keep pension promises and take care of other debts.
(Reporting by Lisa Lambert; Editing by Dan Grebler)