Imagination Time

The New York Times recently ran an interesting article on the pending bankruptcy of Central Falls, Rhode Island. Here’s an excerpt:

The impoverished city, operating under a receiver for a year, has promised $80 million worth of retirement benefits to 214 police officers and firefighters, far more than it can afford. Those workers’ pension fund will probably run out of money in October, giving Central Falls the distinction of becoming the second municipality in the United States to exhaust its pension fund, after Prichard, Ala.

The article goes on to explain that the receiver is asking retirees if they will voluntarily accept a cut in benefits to save the city. It didn’t say what kind of reception the receiver was getting to that question, but we can probably make a good guess.

This looks like a huge problem for the city, and it is, but it’s a much bigger problem for those owed their pension money:

Some of the retirees are in their 90s, and Central Falls, like many American cities, has not placed its police and firefighters in Social Security. Many have no other benefits to fall back on.

When we think about the growing burden of underfunded pensions on municipalities, we typically think about it in terms of how it will affect taxpayers and the availability of other services. After all, public pensions are almost always guaranteed by law. But the law can’t just conjure up money, it has to come from somewhere. Here’s another New York Times article, this time on what happened when Prichard, AL ran out of money:

Then Prichard did something that pension experts say they have never seen before: it stopped sending monthly pension checks to its 150 retired workers, breaking a state law requiring it to pay its promised retirement benefits in full.

This is where imagination comes in. Just because an expert hasn’t seen something before doesn’t mean it can’t happen. We might all be better off if we stopped listening to experts and started thinking for ourselves. Going back in time, these public employee unions would have been smarter to sacrifice some benefits in exchange for guarantees of funding. City leadership would have been smarter to have been more realistic in determining what was an affordable benefit and what wasn’t. Pension fund managers would have been smarter to place a larger emphasis on risk management and loss control. Unfortunately, it’s too late for them now. The die is cast.

It’s a useful exercise to spend some time thinking about the types of situations that could cause your finances significant and prolonged damage.

The point isn’t to become some kind of Chicken Little-esque doom monger. The idea is to occasionally use some imagination to test yourself and your plan. Managing risk is the foundation of portfolio management.