During a recent appearance on CNBC's "Squawk Box," investor extraordinaire and "Oracle of Omaha" Warren Buffett discussed a wide variety of fiscal and economic issues. One of the topics Buffett addressed was that of public pensions. Buffett has been an outspoken critic of public pension accounting practices, and, particularly, the assumed annual rate of return of public pension investment funds (which is used as the discount rate to calculate future obligations). Most public pension funds assume, for example, that they will earn 7.75% or 8% a year, on average, while Buffett has said that 6% would be more realistic. See the video below for Buffett's comments on public pensions, starting at about 11:00 in. I have transcribed portions of the interview further down the page.
It was so easy—it was easy for General Motors back in the 60s—to promise pensions and health benefits that later brought the company to bankruptcy. it was easy for the states and municipalities when they were negotiating contracts 20 or 30 years ago to put in cost of living adjustments and retirement after 20 years and back-end loading in terms of the last few years of employment. And all of those things, and those promises, come due so much later, long after the politicians left office, that it's a tremendous problem. But the future does arrive, and when the future arrives and you've made a lot of promises, you're either gonna break the promises, you're going to raise taxes dramatically, or you're going to inflate.
[. . .]
Many states and municipalities . . . have made promises on benefits that really can't be fulfilled if you continue to keep making them. Listen, I would identify with the municipal employee who said, "Look, you made the deal with me. I mean, I came to work here because you said I was gonna get this." But the one thing I think you do is you quit making new promises. I mean, you may be able to fulfill the ones that you've got up to this point but you say, "Lookit, this is gonna bust us and I'm gonna make no more new promises," and that's a tough thing for a politician to say.
At this point, co-host Joe Kernen challenged Buffett by pointing out the significant differences between public-sector unions and private-sector unions, namely, that since public-sector unions do not have to worry about their government employers going bankrupt (leaving employees out of work) they have no real incentive to restrain their demands for ever-greater benefits. Buffett didn't have much of a reply, other than to point out the moral hazard problem, whereby politicians and labor leaders can collude to raise benefits for government workers, knowing full well that the actual costs of their decisions won't be realized until long after they are out of power.
Kernen: But, Warren, if the public employees at the state and local levels are installing the people that give them the benefits through collective bargaining, maybe that's something you need to change.
Buffett: Well, yeah, but you could say that every constituency sort of votes its own interest. You've got the rich capitalists who are trying to keep down the [unintelligible] rate on capital gains . . . .
Kernen: Yeah, but those companies can go bankrupt. I mean, the private unions are negotiating with, if they get too much they know that they won't have a job anymore. The others are negotiating, they're aligned against the taxpayers. The states and the local municipalities can never go bankrupt. That's why there's no reason for them to mitigate their demands, right?
Buffett: Well, people are going to make the best deal they can. . . . Hopefully you've got people on both sides [management and labor] that are mathematically intelligent. The big problem with pensions, with post-retirement medical care and all that, is that the guy that makes the promises is not the guy that has to make the payment.
Buffett then addressed the unrealistic actuarial assumptions that public pension systems are notorious for making, calling them "nuts" and "crazy."
[State and local governments] use unrealistic assumptions . . . in determining how much they had to put in the pension funds to meet the obligations. The pension fund assumptions of most municipalities, in my view, are nuts. But there's no incentive to change them. It's much easier to get a friendly actuary than to face an unhappy public.
[. . .]
I would say that when they have pension assumptions that are assuming they're going to earn 8% or something like that when bonds are yielding what they are now, that's crazy.
[. . .]
The pension fund accounting has been terrible over the years. Many managements, I don't think, understand it very well themselves, and many prefer not to understand it. They care about their own pension, too. We could use a real overhaul of pension assumptions in this country.
Buffett expressed sympathy for both reform-minded legislators struggling today with pension promises made by others years ago and those who took government jobs based on those promises, but noted that the longer reform is put off, the greater the obligations get.
I think, absolutely, they [state and local governments] ought to change the game from this point forward, in terms of hires they're making. And if somebody wants to leave the public sector because now they're not gonna get benefits from this point forward, fine, let 'em do it. But every year that ticks away on this stuff, the obligation gets larger.
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