The Public Pension Reform Dividend

The burgeoning growth worldwide of unfunded liabilities has received a lot of press lately. Defense spending (future blog), pension liabilities and public sector salaries have been drawing the most ire from both sides of the aisle. Public debt concerns across the world have been much in focus, with the Greek debt crisis and public spending issues in California receiving almost daily coverage in the news.
In a recent NY Times Magazine article titled “The Next Crisis: Public Pension Funds,” David Crane, special adviser to Governor Schwarzenegger, advised his own party members, “I have a special word for my fellow Democrats…One cannot both be a progressive and be opposed to pension reform. The budgetary math is irrefutable: generous pensions end up draining money from schools, social services and other programs that progressives naturally applaud.” When the political party that normally supports public sector employment begins to question the reasonableness of the pension liabilities, there is hope that a constructive solution could be forthcoming.

Much like the “peace dividend” that was unleashed following the collapse of the Berlin Wall (which signaled the impending collapse of the Soviet Union and the end to the costly arms race of the Cold War), we could be witnessing the formative stages of the “public sector pension reform dividend.” Simply put, financial markets performed very well for the decade or so following the collapse of the Berlin Wall as capital was re-directed to more constructive ventures such as drug development and the buildout of the internet infrastructure. If indeed these unfunded liabilities are tamed, capital might once again flow to jobs creating investments which could spur corporate profitability and cause equity prices to resume their historic march upwards. If additional evidence emerges that reform is indeed on the horizon, this would prompt us to become much more constructive on the outlook for common stocks.

Are we just being naïve to think that the crisis will prompt policy action? What other choices do policy makers have as it appears that their backs are to the wall?