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Newsmakers

Providence Pension Mulls Issuing $515 Million in Bonds, Following POB Trend

But bonds don’t always outperform stocks over the long run, according to one expert.
By Anna Gordon


Providence Mayor Jorge Elorza is urging the state to approve a pension bond issuance of $515 million. The Providence pension is among the most underfunded in the country with over $1 billion in unfunded liabilities and a funded ratio of 22%.

“We’re not looking for a state bailout, we’re not looking for a state guarantee, we’re not asking the state to step in in any way,” Elorza told the Rhode Island House Finance Committee. “Doing nothing is not an option.”

Pension bond issuance can seem like a simple solution to politicians since it does not require the government to raise taxes or decrease benefits to support the pension. Instead, governments borrow money at a fixed rate by issuing bonds, with the hopes that the investment returns on the borrowed money exceed the interest rates the government is required to pay on the bonds.

In June of this year, the city will ask voters in a nonbinding referendum what they prefer. If issued, the bonds would have an interest rate of approximately 4.3% or 4.4%. Providence’s pension has seen a 7.4% annualized return on its investments since it was created in 1996.

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“On paper, it looks like an arbitrage opportunity,” said Andrew Biggs, a senior fellow at American Enterprise Institute who studies pension funds. “You’re borrowing low, investing at a higher rate, and your pension immediately becomes better funded.”

But borrowing money to invest it in the stock market is not actually an arbitrage opportunity, according to Biggs. That’s because with the potential for increased returns also comes a risk for disastrous losses.

“The return on stocks is essentially equal to the safe return on some Treasury bonds plus some risk premium,” said Biggs. “Borrowing to invest doesn’t make you richer, it just means you’re taking more risk.”

If the bond issuance is timed poorly, like right before a recession, pension funds could actually lose money. Such was the case in Puerto Rico, when its pension fund issued bonds in 2008, just as the stock market crashed.

Biggs, who was on the control board overseeing Puerto Rico’s debt restructuring in 2016, cautions that Puerto Rico’s pension was exceptionally run and that it is unlikely to see that level of financial disaster repeated at other public pension funds. He also said that it is more likely that Providence returns will outperform bond interest. Nevertheless, he wouldn’t advise any pension to take on pension obligation bonds, or POBs.

He cautioned that even over the long run, bonds sometimes outperform stocks. Between October 1981 and September 2011, the S&P index returned 10.8% annually while the 20-year Treasury bond returned 11.5% annually.

According to S&P Global, public pensions have increased borrowing by more than double this past year. This is likely in part due to the low-interest-rate environment. Between January 1 and September 15, 2021, S&P rated approximately $6.3 billion in new public pension bond issuances, compared to $3 billion worth of bonds throughout 2020. This increase is even more significant when considering that the amount issued in POBs in 2020 was the highest issued in a decade, according to Pew Charitable Trusts.

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Home > News > Risk > What It Would Take for Powell to Get His Soft Landing
Risk

What It Would Take for Powell to Get His Soft Landing

Former New York Fed head Dudley thinks the central bank’s quest is doomed. Is he right?

By Larry Light



For Jerome Powell’s Federal Reserve, it sounds like top hits from the 1960s, 1980s, and 1990s—when the central bank engineered a soft landing for the economy when it hiked interest rates.

But former Fed official Bill Dudley charges that these are bogus comparisons. To him, the rate boosts were so mild that they produced no swelling of the unemployed ranks. That won’t be the case this time, as inflation has gotten out of hand, Dudley declares.

If the current Fed’s forecasts, of continued economic growth and abating inflation, come true, then odds are that Powell can get his soft landing. In his March 16 press conference, announcing a quarter-point rise in the Fed’s benchmark rate, he said, “We expect inflation to return to 2%, while the labor market remains strong.”

Dudley, once New York Fed president, is right in one sense: The central bank’s increases in the benchmark federal funds rate, in 1964, 1984 and 1993 were mild and unemployment actually went down then. What he fails to mention is that in each of those times, the economy was doing well.

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To Dudley, Powell is acting too late. The result, he writes in an essay for Bloomberg, is that Powell’s Fed “has made a hard landing virtually inevitable.” Right now, the Fed has waited too long, in Dudley’s view. “The Fed has never achieved a soft landing when it has had to push up unemployment significantly,” he says.

For Powell to pull off the delicate task of a soft landing, he had better hope that the economy cooperates. The conventional wisdom is that gross domestic product growth will slow from 2021’s 5.6%. The Conference Board, for instance, projects that GDP will slacken the pace to 3.0% this year and 2.3% in 2023. That is pretty much in line with what the Fed estimates. What’s more, the Fed foresees no worsening of the already low unemployment rate, 3.8%.

In other words, the Fed expects economic expansion to be good enough to get by and the pleasant job situation to be status quo.

Indeed, in two of the Powell-touted three soft landings, the economy was in high-growth mode.  GDP growth in 1964 was a healthy 5.8%. In 1984, GDP expanded 7.2%. But in 1993, the economy increased 2.75%, more like what we expect up ahead for the U.S. Yet no recession or jobless surge occurred.

What’s different is that, back then, inflation was rather mild, compared with the current level: a 7.9% annual jump in the Consumer Price Index as of February. Inflation was 1.3% in 1964, 4.3% in 1984, and 3.0% in 1993.

The Fed anticipates that, starting this year, inflation will move back to a 2% to 3% range for its preferred measure, the personal consumption expenditures price index, or PCE, now 6.1%. Reason: supply tangles will unsnarl, shortages will end, and hot demand will return to normal.

Maybe that will recur in the near future, or not. Powell pointed out in a recent speech “that no one expects that bringing about a soft landing will be straightforward in the current context—very little is straightforward in the current context.”

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How Escalating Inflation Can Produce a Recession

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Will the Fed’s Just-Started Tightening Squelch the Stock Market?

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