Public Sector Pensions and non-Ricardian Voters

The question of whether the US will become Greece is surely too pessimistic. But the article in today's NYTimes on public pensions does take away one's breath.

In Yonkers, more than 100 retired police officers and firefighters are collecting pensions greater than their pay when they were working. One of the youngest, Hugo Tassone, retired at 44 with a base pay of about $74,000 a year. His pension is now $101,333 a year.

Apparently police officers perform overtime to jack up their payments. Some of this overtime is actually paid work for Con Ed, and according to State Law should not count as overtime.

The city has even arranged for its police to put in overtime as flagmen on Consolidated Edison construction sites. Though a company is paying the bill, the city is actually reporting the work as city overtime to the New York State pension fund, padding future payouts — an arrangement at odds with the spirit of public employment, if not the law.

A spokesman for the New York State comptroller’s office said that the city was in error and pointed to a 1986 decision by the Supreme Court of New York that found that hours worked by police for outside businesses could not be included in their state-paid pensions.

“It has long been established that such overtime from private special duty cannot be included,” said the spokesman, Mark Johnson.

Of course the problem is not special to New York. Roger Lowenstein wrote about this in his book, While America Aged.

The problem is one of political economy. Public sector unions are important vote machines, and pensions impose future costs not present one. Of course if voters were Ricardian this would not work. The Ricardian Equivalence Theorem (which Ricardo did not believe in) says that what matters is the present value of taxation not its timing. So the fact that votes are bought by promising future pensions that are not funded should be completely understood by voters who would consider current taxes to be an equivalent burden. But clearly voters are not Ricardian since they vote for politicians who impose these future burdens all the time.

Structural Rigidities and Financial Crisis

Sometimes it is hard to understand the connection between structural rigidities and financial crises. The connection between excessive regulation and government deficits is not exactly direct. Financial crises tend to be due to problems with banks or with government borrowing. But this article in the NYTimes on Portugal does a good job of clarifying the point.

The specific example is rent control. This is quite severe in Portugal:

José Gago da Graça owns a Portuguese real estate company and has two identical apartments in the same building in the heart of Lisbon. One rents for €2,750 a month, the other for almost 40 times less, €75.

The discrepancy is a result of 100-year-old tenancy rules, which have frozen the rent of hundreds of thousands of tenants and protected them against eviction in Portugal.

What is the connection to the financial crisis? Well, these rules limit production of rental housing, and thus force people to purchase rather than rent housing.

The post-revolution rules helped protect tenants, but also led to a chronic shortage of rental housing. This, in turn, persuaded a new generation of Portuguese to tap recently into low interest rates and buy instead — often in new suburbs — thereby exacerbating the country’s mortgage debt and leaving Portugal with one of Europe’s lowest savings rates, of 7.5 percent.

When the opportunities to borrow at low rates -- due to the euro -- presented themselves, Portuguese households took advantage. Rather than rent and save, households were pushed, by rent control, to borrow and purchase. That would not be so bad if the price of housing was not experiencing a bubble. But the borrowing took place precisely when housing prices departed from rents.

Of course we know that rent control is bad. We just now see how it is bad in other unintended ways.

Negative Equity

Felix Salmon points to this post on Calculated Risk on homeowners' negative equity. Key highlight:

CoreLogic reported today that more than 11.2 million, or 24 percent, of all residential properties with mortgages, were in negative equity at the end of the f irst quarter of 2010, down slightly from 11.3 million and 24 percent from the fourth quarter of 2009. An additional 2.3 million borrowers had less than five percent equity. Together, negative equity and near-negative equity mortgages accounted for over 28 percent of all residential properties with a mortgage nationwide.

In addition there are two noteworthy graphs. One shows negative equity by state. Fortunately, Pennsylvania is 48th. Finally, being near the bottom of the rankings is good. The second graph shows the distribution of negative equity. A rising proportion of such homes have more than 25% negative equity, a level at which it is hard to believe any rational person will not walk away. So more defaults may be imminent. And from the first graph we know that these are likely to be concentrated in a few states.

Greek Tragedy

I loved Cornelius Ryan's book, "A Bridge Too Far," and the movie too. Today, Paul Krugman likens the Maastricht treaty creating the euro as "A Money Too Far." An apt analogy. The resources (rather institutions) necessary to make a currency union effective were unavailable to those behind the treaty, just as Montgomery's plan to take Arnhem Bridge was too ambitious given the reality on the ground in Holland. And in both cases, naysayers were ignored.

The extent of Krugman's pessimism is evident:

Many observers now expect the Greek tragedy to end in default; I’m increasingly convinced that they’re too optimistic, that default will be accompanied or followed by departure from the euro.

Hard to see how this ends in a non-tragic way.

Common Sense on Goldman Sachs

Warren Buffett has provided a throated common sense defense of Goldman Sachs behavior in the Abacus deal. According to the NYTimes, Buffett commented:

“I don’t have a problem with the Abacus transaction at all, and I think I understand it better than most...”

His comments echoed the strong view he had offered just the day before: “For the life of me, I don’t see whether it makes any difference whether it was John Paulson on the other side of the deal, or whether it was Goldman Sachs on the other side of the deal, or whether it was Berkshire Hathaway on the other side of the deal,” Mr. Buffett said.

Buffett argues that the quality of an investment depends on the facts involved, not the identity of who is on the other side:

“I don’t care if John Paulson is shorting these bonds. I’m going to have no worries that he has superior knowledge,” he said, adding: “It’s our job to assess the credit.” The assets are the assets. The math either works or it doesn’t.

I guess it is not surprising that the world's most successful investor would not want to support the view that if an investment proves successful it must be illegal. Since market trades must reflect a divergence of views somebody is going to end up losing on a deal.