Is Your Pension Baltimore or Scranton?

From aiCIO Magazine's September Issue: Leanna Orr on the emerging trend of pensions lending, and not lending, to their governments. 

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It’s a scary concept: counties and municipalities, unable to raise funds any other way, turn to their pensions with hats in hand. But in practice—and there are now a handful of examples—pension boards don’t always recoil from the administrations that have so often short-changed them. 

“It was a no-brainer—I wish I could get seven and seven eighths guaranteed interest on my own portfolio,” says Joe Zerhusen, chairman of the Board of Trustees for Baltimore County’s employee pension system. The board recently voted unanimously to lend the county $25 million for a “state-of-the-art” recycling plant. NEPC, advisors to the 78%-funded pension, fully supported the purchase. In return, Baltimore County promised full repayment over 15 years with 7.875% interest. As Zerhusen pointed out, bond yields like that are extremely attractive. 

No pension wants to be the hand-out-of-last-resort for a broke administration, but any board approached is politically obligated to seriously consider the request. For Zerhusen and his fellow trustees, Moody’s Aaa/Aa1 ratings of the county were a deciding factor. “Baltimore is an anomaly,” he said. “It’s always been fiscally conservative and careful with debt. You see all those towns in California going bankrupt—they’re a different story. I wouldn’t lend to California.” And, perhaps, nor should most CIOs—unless they’re looking for a lawsuit. 

When a government approaches a public fund in its jurisdiction for a loan, pensions must evaluate the offer as they would any other investment. Otherwise, trustees and advisors risk breaching fiduciary duty, says Lawrence Durkin, who would know. Durkin is solicitor to the pension board of recession-clobbered Scranton, Pennsylvania. The city’s mayor recently asked for $16 million, or 40% of the pension’s assets, to meet current-year payroll obligations. 

“Would a bank make the loan? That’s what you have to ask in this situation. You look at all the regular factors—credit, risk, rate of return—plus legality,” Durkin says. Most states have at least a “reasonable person” standard of care dictated by law. Investing public funds in anything a reasonable, prudent person would steer clear of can qualify as negligence, Durkin explains. Municipal pensions, including Scranton’s, are not backed up by the Pension Benefit Guaranty Corporation, as corporate funds are. Many municipal employees are also ineligible for Social Security. “Most of our members are retired police officers, firefighters, and their spouses, who have no other options if we failed,” Durkin says. “This is it.” 

Pensions facing an outstretched palm from the local administration must ask themselves: Is my fund’s city a Baltimore or a Scranton? And what about the administration? By all indications, Zerhusen and Baltimore County are another step closer to a fully funded pension (and a top-notch recycling system). But in Scranton, it seems highly unlikely Durkin and the board will grant the mayor’s request. And that’s probably a good thing.