Many investors in the municipal-bond market are concerned that retirement costs will eventually cripple states, particularly in Illinois and New Jersey, which also have settled SEC charges related to pension disclosures. State retirement systems have far less funds than they need to meet all their projected payouts, with the Pew study putting the combined shortfall at $915 billion as of 2012.
Instead of trying to reduce its pension obligations, Kansas wants to earn some money by borrowing at 5%, and then investing the money in its pension fund, where it thinks it can earn 8%. This would represent an arbitrage opportunity, except for the fact the the pension investments are in higher risk securities which naturally earn a risk premium. This means that the extra return that they generate are compensation for the additional risk that Kansas will incur.
Even under the best circumstances, pension bonds come with the risk that expected spreads won’t materialize. Since Oakland, Calif., sold the first pension-obligation bonds in 1985, cities and states have issued about $105 billion of the debt, the Center for Retirement Research said last year. Those deals have had returns averaging 1.5% annually since 1992, thanks to market gains following the financial crisis, the center said.
...The danger of debt is probably the issue he's most passionate about: He gives the sense that the city's unfunded liabilities and debt really do keep him up at night.
"What do you think is gonna happen when our national economy, as it will do cyclically — when our national economy goes sideways for several years?" Fox asks. "We're going to see a lot of municipal bankruptcies. Because unfunded liabilities are too big, the balance sheets are way out of whack, you have way too much debt at the municipal level, and a lot of cities are going to go bankrupt. That's not gonna be an accounting adventure, that's gonna have a real bad effect on people who live in these cities."