Dropout Nation

When we last checked in on Bill De Blasio, the New York City mayor was reeling from the fallout from the string of investigations into possible violations of campaign finance law during his successful campaign for mayor as well as on his unsuccessful effort two years ago to help New York State Senate Democrats regain control of the upper house (and essentially give De Blasio control over Empire State politics).

Since then, Hillary Clinton’s former U.S. Senate campaign manager has suffered more setbacks. This includes revelations by the Empire Center that he handed out $2 million in raises to his political appointees, as well as losing out on an opportunity to speak at the Democratic National Convention during prime time, the latter a reprisal from former boss Clinton and her presidential campaign for failing to endorse her run until he had no choice but to do so.

Meanwhile his likely campaign for re-election, already weakened by low poll numbers as well as the unwillingness of the AFT’s United Federation of Teachers to back him, took another hit when Harlem pastor Johnnie Green announced he would challenge the mayor in the Democratic mayoral primary next year. While Green isn’t likely to garner a lot of votes, the move presages the entry of more-formidable candidates such as City Comptroller Scott Stringer (who will likely gain UFT’s backing if he decides to run) and Bronx Borought President Ruben Diaz Jr. (whose support for expanding charter schools would likely attract reformers in the city).

But for Big Apple taxpayers, none of De Blasio’s political problems mean as much for them as the long-term financial woes they and their children face as a result of the long-term mismanagement of the city’s two defined-benefit pensions for teachers and other district employees. As a Dropout Nation analysis of the latest financial statements reveals, the pension shortfalls for the Teachers Retirement System and the Board of Education Retirement System have worsened under the mayor’s tenure.

Let’s start with TRS, the larger of the two pensions. It officially reports a shortfall of $27.5 billion as of 2013-2014, the latest year available. This is a 2.5 percent increase over the officially-reported shortfall in the previous year. But as readers know by now, those reported numbers don’t reflect reality. For one, this doesn’t include $4.2 billion in unrealized losses kept off the balance sheet as part of “smoothing” efforts by the city to avoid dealing with the shocks that come with financial market volatility. Add that number onto the total, and the shortfall would amount to $31.7 billion, or 15.3 percent higher than officially reported. As Dropout Nation noted last year, such accounting tricks can help pensions appear more-solvent than they really are, making it difficult for policymakers to make smart fiscal decisions.

But the smoothing isn’t the biggest problem. What is? That TRS assumes an investment rate of return of seven percent. Not only is this rate of return higher than the six percent median rate Wilshire Associates expects over the next decade, it is even higher than the 2.8 percent rate of return(net of fees) the pension’s investments generated in 20114-2015. [TRS’ rate of return for this year is just 2.7 percent, according to the New York City Comptroller.]

Because of the inflated rate of return, TRS (and ultimately, the city) understates what is likely the true level of insolvency that taxpayers will ultimately have to bear, and thus, results in lower than necessary contributions being paid by the city and teachers. Given that the pension annuities paid to retirees are essentially obligations like bonds, TRS’ assumed rate of return should be much lower, aligned with yields  being gained in the bond market.

To figure out TRS’ true insolvency, Dropout Nation uses a version of a technique developed by Moody’s Investors Service, which assumes a more-realistic 5.5 percent rate of a return on investments. [Moody’s bases its rate of return on the performance of a bond index, which can range between four and six percent.] Based on the formula, using just TRS’ officially-reported number, the pension is underfunded to the tune of $32.9 billion. This is 20 percent more than it officially reports. If the shortfall had to be amortized (or paid off) over the next 17 years, Big Apple taxpayers and teachers would have to contribute an additional $1.9 billion annually, or 60 percent more than the $3.2 billion contributed in 2013-2014.

Yet this number doesn’t include the unrealized losses. Account for those and Dropout Nation estimates that TRS’ insolvency is $38 billion, 20 percent more than the unfunded liability adjusted for unrealized losses. Based on a 17-year amortization schedule, taxpayers and teachers would have to pay an additional $2.2 billion a year, or 69 percent more than contributed to the pension in 2013-2014.

Then there is Board of Education, which officially reports a shortfall of $1.8 billion, a 3.8 percent increase over the previous year. Just like TRS, Board of Education is using smoke and mirrors because it also assumes an investment rate of return of seven percent. The pension’s rate of return in 2014-2015 was just 3.4 percent. [The rate of return for this year is just 3.1 percent, according to the City Comptroller.] The result? Board of Education’s shortfall appears to be lower than it really is.

Based on the Moody’s formula, Dropout Nation concludes that Board of Education is actually underfunded to the tune of$2.2 billion. That’s 20 percent higher than officially reported. Based on a 17-year repayment schedule, taxpayers and district employees would have to contribute an additional $127 million a year, 59 percent more than the $214 million contributed in 2013-2014.

Altogether, based on the best-case scenario, New York City taxpayers face a virtual insolvency of $35.1 billion for the two education pensions. That’s $35,885 for every child within the Big Apple’s traditional district and public charter schools. Use the worst case scenario (which includes the unrealized losses), and taxpayers must address an insolvency of $40.2 billion. That’s $41,099 in pension debt for every child in school today.

Given that the Big Apple’s other defined-benefit pensions for city workers are also virtually busted, it is harder than ever to address the insolvency of the two education pensions. Contributions to TRS and Board of Education account for 38 percent of the $8.1 billion in contributions taxpayers put into all of the city’s pensions in 2013-2014, the latest year available, according to the Big Apple’s annual financial report. The city’s plan to increase contributions to all pensions by $600 million a year from 2016-2017 to 2019-2020 will not cut it

By the way: None of this includes the $28.9 billion in unfunded healthcare liabilities for retiree healthcare expenses; these account for 42.6 percent of the $68 billion in unfunded health liabilities on the city’s balance sheet. All of these obligations must eventually be met.

Put it simply, Big Apple taxpayers and children (who will one day become adults) face a fiscal disaster of massive proportions. One that won’t be easy to overcome. This isn’t all De Blasio’s fault. As Dropout Nation noted two years ago, his predecessor, Michael Bloomberg and his contemporaries in city government leadership continually provided generous annuity benefits and healthcare benefits (along with salary increases) in part to get UFT to go along with his systemic reform efforts. In the process, Bloomberg failed to require teachers to pay more toward their retirements, hoping in vain that stock market gains would cover those benefits and reduce liabilities. None of this worked out.

Yet De Blasio has learned nothing from Bloomberg’s failings on this front. Between 2011-2012 and 2013-2014, the contributions made by teachers to their retirements declined from six cents to 4.5 cents for every dollar put in. The collective bargaining agreements struck De Blasio struck with UFT and other unions representing district employees two years ago required no additional contributions to pensions and healthcare expenses (including the $1,700 a year the city pays in prescription drug coverage and other so-called welfare benefits for every retired teacher). The low member contributions, along with the salary increases a decision two years ago to allow 777 teachers to retire early, and other early retirement plans currently in place, are adding to the virtual insolvencies of TRS and Board of Education. Like Bloomberg, De Blasio is betting on investment market gains, even though history has proven this to be unreliable.

De Blasio should have pushed to increase retirement contributions by UFT-represented teachers, who make up the vast majority of current and future annuitants. Don’t think it is possible? Look at the city’s charter schools, whose expansion the mayor has actively opposed. The average charter school teacher in New York contributes 17 cents out of every dollar to their pension, four times the contributions by peers working in the traditional district. Given the low contributions of their traditional district colleagues, can easily argue that charter school teachers (who are also often Big Apple taxpayers) are bearing an unfair share of TRS’ burden.

The consequences of De Blasio’s and Bloomberg’s fiscal recklessness can be seen on the city’s ledger. Teacher benefit costs as a percentage of district spending increased by 53 percent (from 17 cents of every dollar spent to 26 cents) between 2004-2005 to 2013-2014, according to data from the U.S. Census Bureau. If not for the corresponding 63 percent increase in revenue during that period, De Blasio would face the same dire choices confronting Chicago counterpart Rahm Emanuel. The city’s Independent Budget Office expects overall city spending to increase at a slower annual rate (3.5 percent from 2016-2017 to 2019-2010). But those assumptions depend on an average 1,769 Baby Boomer teachers retiring every year, as they have between 2004-2005 and 2013-2014, as well as low initial annuity payouts. Both assumptions are probably optimistic.

If that doesn’t happen, De Blasio will be in for an even tougher time. While the city still managed to wrangle an increase in state aid because of other districts, the mayor can’t expect Gov. Andrew Cuomo and the Republicans in control of the state senate to help him with any pension bailout. Nor can De Blasio count on UFT; having gotten most of what it wanted out of De Blasio (who it didn’t back), the union seems to already be moving on to a more-pliant candidate for mayor.

No matter what happens to De Blasio, the city’s taxpayers and children are stuck with the financial consequences of what could be a very short tenure.