Why Detroit's Pension Funds Failed

A recent Op-Ed in the Detroit Free Press by James Hohman, assistant director of fiscal policy, and Jack McHugh, senior legislative analyst, explains why Detroit’s pension funds are in crisis and why state legislators should take heed to correct similar problems in the state employee and school employee pension systems.

Excerpt:

The failure of Detroit’s pension systems has been blamed on a long list of abuses and unfortunate economic events. Unfortunately, that has had the effect of understating the most fundamental source of the failure: deeply flawed assumptions about future investment and payroll growth.

The state Constitution requires governments to pay for pensions as they are earned, but doesn’t specify a particular formula for doing so. The take-away, essentially, is: “Make good, reasonable assumptions about future investment and payroll growth — ones that don’t require the world to suddenly become free of surprises and setbacks — and, on that basis, set aside enough each year to cover the future benefits each employee has earned for another year of service.”

Two things stand out about this instruction. First, if the assumptions going in are flawed, then the pension system’s performance will reflect that. Second, politicians and policymakers have plenty of room to make such unrealistic assumptions — and strong incentives to do so. Rose-colored assumptions about tomorrow mean officials can get away with putting insufficient amounts into the pension system today.

And that’s exactly what happened in Detroit. 

To read the rest of the piece in the Detroit Free Press, click here.