At the Freakonomics Blog at the NYT: The Big Three and Underfunded Pensions (12/2/08).

They point to (and quote from) this abstract (”Public Pensions are Underfunded”)in the NBER Digest.

The extent to which public pensions are underfunded has been obscured by governmental accounting rules, which allow pension liabilities to be discounted at expected rates of return on pension assets … Novy-Marx and Rauh collected data on the largest defined benefit (DB) pension funds sponsored by U.S. state governments. …

They studied all plans with more than $1 billion of assets. There were 112 such plans at the end of 2005. …

States back pensions with stocks, bonds, cash, private equity, real estate, and hedge fund exposure. But the typical investment strategies, in conjunction with accounting rules, make the pension funding situation look much better than it actually is. Under the government accounting logic, states always could eliminate their underfunding, no matter how large, simply by investing in sufficiently risky assets. In fact, investing in riskier assets may raise expected returns, but it also increases the probability of a severe underfunding. Under current investment strategies and a standard equity premium of 6.5 percent, there is a two-thirds chance that state pension plans will realize a shortfall in 15 years. The expected conditional shortfall is almost $1.5 trillion in 2005 dollars.

Under any plausible discounting assumptions that reflect the true present value of state pension promises, the underfunding in state pension plans is larger than the total magnitude of outstanding state bonds.

Yowza!

See also an earlier entry here:  Pension Tension