[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]





          STATE AND MUNICIPAL DEBT: THE COMING CRISIS? PART II

=======================================================================

                                HEARING

                               before the

                SUBCOMMITTEE ON TARP, FINANCIAL SERVICES
              AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS

                                 of the

                         COMMITTEE ON OVERSIGHT
                         AND GOVERNMENT REFORM

                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 15, 2011

                               __________

                           Serial No. 112-42

                               __________

Printed for the use of the Committee on Oversight and Government Reform










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              COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

                 DARRELL E. ISSA, California, Chairman
DAN BURTON, Indiana                  ELIJAH E. CUMMINGS, Maryland, 
JOHN L. MICA, Florida                    Ranking Minority Member
TODD RUSSELL PLATTS, Pennsylvania    EDOLPHUS TOWNS, New York
MICHAEL R. TURNER, Ohio              CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina   ELEANOR HOLMES NORTON, District of 
JIM JORDAN, Ohio                         Columbia
JASON CHAFFETZ, Utah                 DENNIS J. KUCINICH, Ohio
CONNIE MACK, Florida                 JOHN F. TIERNEY, Massachusetts
TIM WALBERG, Michigan                WM. LACY CLAY, Missouri
JAMES LANKFORD, Oklahoma             STEPHEN F. LYNCH, Massachusetts
JUSTIN AMASH, Michigan               JIM COOPER, Tennessee
ANN MARIE BUERKLE, New York          GERALD E. CONNOLLY, Virginia
PAUL A. GOSAR, Arizona               MIKE QUIGLEY, Illinois
RAUL R. LABRADOR, Idaho              DANNY K. DAVIS, Illinois
PATRICK MEEHAN, Pennsylvania         BRUCE L. BRALEY, Iowa
SCOTT DesJARLAIS, Tennessee          PETER WELCH, Vermont
JOE WALSH, Illinois                  JOHN A. YARMUTH, Kentucky
TREY GOWDY, South Carolina           CHRISTOPHER S. MURPHY, Connecticut
DENNIS A. ROSS, Florida              JACKIE SPEIER, California
FRANK C. GUINTA, New Hampshire
BLAKE FARENTHOLD, Texas
MIKE KELLY, Pennsylvania

                   Lawrence J. Brady, Staff Director
                John D. Cuaderes, Deputy Staff Director
                     Robert Borden, General Counsel
                       Linda A. Good, Chief Clerk
                 David Rapallo, Minority Staff Director

  Subcommittee on TARP, Financial Services and Bailouts of Public and 
                            Private Programs

              PATRICK T. McHENRY, North Carolina, Chairman
FRANK C. GUINTA, New Hampshire,      MIKE QUIGLEY, Illinois, Ranking 
    Vice Chairman                        Minority Member
ANN MARIE BUERKLE, New York          CAROLYN B. MALONEY, New York
JUSTIN AMASH, Michigan               PETER WELCH, Vermont
PATRICK MEEHAN, Pennsylvania         JOHN A. YARMUTH, Kentucky
JOE WALSH, Illinois                  JACKIE SPEIER, California
TREY GOWDY, South Carolina           JIM COOPER, Tennessee
DENNIS A. ROSS, Florida
















                           C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on March 15, 2011...................................     1
Statement of:
    Liljenquist, Hon. Daniel, Utah State Senator; Robin Prunty, 
      managing director, Ratings Services, Standard and Poor's 
      Financial Services LLC; Dean Baker, co-director, Center for 
      Economic and Policy Research; Robert Kurtter, managing 
      director, Moody's Investors Service; and Andrew G. Biggs, 
      resident scholar, American Enterprise Institute for Public 
      Policy Research............................................    11
        Baker, Dean..............................................    27
        Biggs, Andrew G..........................................    46
        Kurtter, Robert..........................................    36
        Liljenquist, Hon. Daniel.................................    11
        Prunty, Robin............................................    16
Letters, statements, etc., submitted for the record by:
    Baker, Dean, co-director, Center for Economic and Policy 
      Research, prepared statement of............................    29
    Biggs, Andrew G., resident scholar, American Enterprise 
      Institute for Public Policy Research, prepared statement of    48
    Kurtter, Robert, managing director, Moody's Investors 
      Service, prepared statement of.............................    38
    Liljenquist, Hon. Daniel, Utah State Senator, prepared 
      statement of...............................................    14
    McHenry, Hon. Patrick T., a Representative in Congress from 
      the State of North Carolina, prepared statement of.........     4
    Prunty, Robin, managing director, Ratings Services, Standard 
      and Poor's Financial Services LLC, prepared statement of...    18
    Quigley, Hon. Mike, a Representative in Congress from the 
      State of Illinois, prepared statement of the National 
      Education Association......................................     8

 
          STATE AND MUNICIPAL DEBT: THE COMING CRISIS? PART II

                              ----------                              


                        TUESDAY, MARCH 15, 2011

                  House of Representatives,
      Subcommittee on TARP, Financial Services and 
           Bailouts of Public and Private Programs,
              Committee on Oversight and Government Reform,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 1:42 p.m. in 
room 2154, Rayburn House Office Building, Hon. Patrick T. 
McHenry (chairman of the subcommittee) presiding.
    Present: Representatives McHenry, Amash, Buerkle, Meehan, 
Walsh, Guinta, Quigley, Maloney, Welch, and Speier.
    Also present: Representatives Issa, and Cummings.
    Staff present: Robert Borden, general counsel; Sharon 
Casey, senior assistant clerk; Steve Castor, chief counsel, 
investigations; Benjamin Stroud Cole, policy advisor and 
investigative analyst; John Cuaderes, deputy staff director; 
Gwen D'Luzansky, assistant clerk; Adam P. Fromm, director of 
Member liaison and floor operations; Tyler Grimm and Ryan M. 
Hambleton, professional staff members; Peter G. Haller, senior 
counsel; Christopher Hixon, majority deputy chief counsel, 
oversight; Justin LoFranco, press assistant; Mark D. Marin, 
senior professional staff member; Becca Watkins, deputy press 
secretary; Jason Powell and Steven Rangel, minority senior 
counsels; Cecelia Thomas, minority counsel/deputy clerk; and 
Davida Walsh, minority counsel.
    Mr. McHenry. The committee will come to order.
    This is a meeting of the TARP, Financial Services and 
Bailouts of Public and Private Programs subcommittee. The 
hearing is entitled State and Municipal Debt: The Coming 
Crisis?
    At the beginning of this hearing, as I do with all 
subcommittee hearings, I read the mission statement of the 
Oversight and Government Reform Committee. So that is what I 
will do now.
    The Oversight Committee mission statement: We exist to 
secure two fundamental principles. First, Americans have a 
right to know that the money Washington takes from them is well 
spent. And second, Americans deserve an efficient, effective 
government that works for them.
    Our duty on the Oversight and Government Reform Committee 
is to protect these rights. Our solemn responsibility is to 
hold government accountable to taxpayers because taxpayers have 
a right to know what they get from their government.
    We will work tirelessly in partnership with citizen 
watchdogs to deliver the facts to the American people and bring 
genuine reform to the Federal bureaucracy. This is the mission 
statement of the Oversight and Government Reform Committee.
    With that, I will recognize myself for 5 minutes for an 
opening statement.
    This hearing is the second installment of the 
subcommittee's efforts to examine the causes and severity of 
fiscal problems facing States and municipalities. Today will 
explore the magnitude of the growing budget liability of State 
and municipalities, and its origins. From years of unwise 
fiscal policy to reckless management and collusion between 
elected officials and the public sector unions, a crisis has 
emerged as a great expense to the American people.
    It also has an impact on our markets. It also has an impact 
on people's savings, especially for retirement.
    Leading economists have already labeled 2012 as the States' 
most difficult budget year on record. Forty-four States and the 
District of Columbia are now projecting aggregate budget 
shortfalls totaling $125 billion this year alone. It only gets 
worse each year.
    Even more threatening is the $3.2 trillion in unfunded 
State pension liabilities, and another $383 billion liability 
for local governments.
    To be sure, the budget crunch is closely associated with 
the larger economic stresses facing the country. But years of 
unchecked spending and overly generous benefits have taken 
their toll. There are $3 trillion in municipal bonds 
outstanding across the country. Many State and municipal 
governments face the real possibility of defaulting on their 
debt.
    Ultimately, this hearing is about two things. First, what 
is the real debt burden facing States and municipalities? 
Second, what must be done to mitigate the immediate crisis and 
put these governments back on solvent fiscal paths?
    But let me restate for the record what I said in Part I of 
this hearing, back on February 9th: the era of the bailout is 
over. Let me repeat: taxpayer bailouts are not on the table. 
The past 2\1/2\ years of wasteful spending and irresponsible 
policy under the guise of economic stimulus and emergency 
economic stabilization have emptied the Treasury of every thin 
penny. And even if Washington had more money to spread around, 
a bailout would only serve to delay the coming day of judgment, 
pushing on our children and grandchildren the burden of paying 
for our irresponsible spending.
    There must be other options, and this series of hearings is 
about assessing those options, first understanding the problem, 
and assessing our options to move forward.
    Some States are making bold efforts at reform. In 2009, for 
instance, the State of Utah experienced such massive losses due 
to the market collapse that taxpayer contributions to workers 
pensions would have to rise to $420 million annually to keep 
them afloat. Senator Dan Liljenquist, however, successfully 
championed a plan for reform that will allow the State to 
remain solvent and enjoy greater budget flexibility. Senator 
Liljenquist, thank you for being here today. I look forward to 
your comments.
    At the executive level, Governors like Chris Christie of 
New Jersey and John Kasich of Ohio have begun to push piece by 
piece legislation to reform their pension plans gradually. 
While still others, like the State of Wisconsin, for instance, 
have become the proving grounds for the future. Last week, 
Governor Scott Walker made good on his promise to voters to 
overhaul the entire structure of public sector unions in the 
State. That is a bit of controversy, of course, even the 
President has commented upon that. Governor Walker's 
legislation has met with great resistance, but fomenting 
political chaos will not help to serve or fix this fiscal 
crisis.
    The question before us today may require careful, sober 
consideration. And it is critical and critically important that 
Congress examine the State and municipal fiscal crisis and 
judiciously evaluate reasonable policy options. Today's 
witnesses are all experts in that field, and the subcommittee 
will give them an attentive ear.
    With that, I yield 5 minutes to the ranking member, Mr. 
Quigley of Illinois.
    [The prepared statement of Hon. Patrick T. McHenry 
follows:]




    Mr. Quigley. Thank you, Mr. Chairman.
    Before I begin, I ask unanimous consent to have a statement 
from the National Education Association be entered into the 
record.
    Mr. McHenry. Without objection.
    [The information referred to follows:]



    
    Mr. Quigley. Thank you.
    Mr. Chairman, I would like to thank you for convening 
today's hearing, the second hearing on State and municipal 
debt. I would also like to thank our five witnesses for 
contributing their time and expertise.
    In fiscal year 2012, 44 States are projected to have a 
budget deficit of at least 5 percent. Although troubling, this 
is a short-term fiscal problem that has more to do with the 
current economic downturn than with underfunded pension 
programs. Once the economy gets going, State revenues will go 
up and budget deficits will shrink.
    In the long term, however, we have an accounting problem 
unique to six or eight States, among them Illinois, California, 
Ohio, and New Jersey. For years, under both Republican and 
Democratic leadership, these States have grossly underfunded 
their pension programs.
    No one has to tell me there is a problem. I am from 
Illinois. Illinois is one of the worst examples, with $162 
billion unfunded liability. Its pension system is less than 50 
percent underfunded. This level of under funding is reflected 
in Illinois' bond rating. In the last 5 years, its bond rating 
has taken a nose dive. Before it raised taxes, an outcome 
nobody wanted, its bonds were considered only slight less risky 
than Iraq's.
    Its bond rating is still poor. And that means it is much 
more expensive for Illinois to borrow money. According to 
Laurence Msall of the Civic Federation, bad bond ratings were 
costing Illinois taxpayers $551 million extra per year in 
interest payments. States like these need to take common sense 
steps to shore up their pension systems.
    Reform is important not only to protect taxpayers, but also 
to protect the beneficiaries of public sector pensions. These 
pension systems provide retirement security for millions of 
Government workers. We have a responsibility to ensure that we 
are not shortchanging them.
    Pension reform should restore long-term solvency to pension 
systems, so that workers can depend on a steady retirement 
income. We can keep defined benefit plans, while taking 
reasonable steps like increasing worker contributions and 
realigning retirement age, COLAs, and term of service. In some 
States like Illinois, pension reform will have to go farther 
than in others.
    What we have to avoid is a one size fits all approach that 
doesn't distinguish between the bad apples and the good. And we 
also have to remember that the onus must be on State 
governments to reform themselves. One model for troubled States 
might be the recent series of pension reforms in Massachusetts. 
Under Governor Deval Patrick, Massachusetts has passed several 
pension reform packages. Just earlier this year, in January, 
the Governor proposed eight reforms that would improve the 
long-term sustainability of the State's pension system. 
Officials have estimated that these reforms will save 
Massachusetts billions of dollars over the next 30 years. They 
are also an important step toward a higher bond rating and 
lower borrowing costs.
    On February 8th, the Bond Buyer reported that Standard and 
Poor's revised Massachusetts' outlook to positive from stable, 
based on strong management practices. Of course, every State 
and municipality is different, and pension reform would have to 
be tailored to each specific situation. Still, the 
Massachusetts example demonstrates that pension reform can be 
achieved that not only increases bond ratings but decreases 
borrowing costs, and that also protects workers and guarantees 
them a steady retirement income.
    I thank the chairman and I yield back.
    Mr. McHenry. I thank the ranking member, and I certainly 
appreciate the panel being here today.
    Members will have 7 days to submit opening statements for 
the record. We will recognize the panel now. I will introduce 
the whole panel, then we will begin with you, Senator 
Liljenquist, to give your opening statement.
    The Honorable Dan Liljenquist is a member of the Utah State 
Senate. Mr. Robert Kurtter--I sorry, I am bouncing around--is 
the managing director for U.S. State and Regional Ratings at 
Moody's. Mr. Dean Baker is co-director of the Center for 
Economic and Policy Research. Thank you, Mr. Baker, Dr. Baker, 
I am sorry. Ms. Robin Prunty is the Team Leader for State 
Ratings at Standard and Poor's. And Mr. Andrew Biggs is a 
resident scholar at the American Enterprise Institute for 
Public Policy Research.
    It is the policy of the committee that all witnesses be 
sworn in before they testify. So if you will please rise and 
raise your right hands.
    [Witnesses sworn.]
    Mr. McHenry. You may be seated. Let the record reflect that 
all the witnesses answered in the affirmative.
    Now, in order for us to have time for discussion, we do 
have votes on the floor in less than an hour, so if you could 
keep your comments to 5 minutes. The clock will register for 
you, as you can see, with 1 minute remaining it moves from 
green to yellow. That means hurry on up and finish. And any 
time that you don't use is really a gift. So if you can 
summarize your statements, we will also let you offer your full 
statements for the record.
    With that, Senator Liljenquist, you are recognized for 5 
minutes.

  STATEMENTS OF HON. DANIEL LILJENQUIST, UTAH STATE SENATOR; 
ROBIN PRUNTY, MANAGING DIRECTOR, RATINGS SERVICES, STANDARD AND 
POOR'S FINANCIAL SERVICES LLC; DEAN BAKER, CO-DIRECTOR, CENTER 
  FOR ECONOMIC AND POLICY RESEARCH; ROBERT KURTTER, MANAGING 
   DIRECTOR, MOODY'S INVESTORS SERVICE; AND ANDREW G. BIGGS, 
  RESIDENT SCHOLAR, AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC 
                        POLICY RESEARCH

              STATEMENT OF HON. DANIEL LILJENQUIST

    Mr. Liljenquist. Thank you, Chairman McHenry, Ranking 
Member Quigley and members of the committee. It is an honor to 
be with you today.
    If there is an upside of an economic downturn, it is that 
taxpayers throughout the United States are waking up to the 
massive liabilities incurred by State and local governments. In 
particular, financial commitments made to public employees are 
driving policy debates throughout this country. Defined benefit 
pensions are at the heart of these policy debates, as 
policymakers wrestle with the approximately $3 trillion 
unfunded pension liabilities.
    For years, public employee pension plans have largely been 
exempted from taxpayer scrutiny because of the long-term nature 
of pension commitments and the assumption that today's market 
losses will be made up by tomorrow's gains. However, the market 
crash of 2008 revealed just how much market risk taxpayers are 
bearing to guarantee pension benefits for public employees.
    Utah's pension system is a case in point. If I might, I 
would like to spend a couple of minutes discussing the 
situation in Utah. Going into 2008, Utah's public employees 
pension systems were over 100 percent funded. Utah has always 
paid the full required actuarial contribution to its pension 
systems, and has not raised retirement benefits for 20 years. 
Utah's retirement system has been and still is recognized as 
one of the best-run pension systems in the country.
    However, market losses in 2008 blew a 30 percent hole in 
Utah's pension fund, opening up a $6\1/2\ billion unfunded 
liability. To put this number in perspective for the State of 
Utah, our constitutional debt limit is set at 1\1/2\ percent 
the total assessed value of real property in the State. That 
value is currently $4.4 billion, and we borrowed $3.3 billion 
of that $4.4 billion or approximately 75 percent.
    Adding Utah's official debt to Utah's newly recognized 
unfunded pension liabilities, Utah's total debt is $9.8 
billion, which is 223 percent of Utah's constitutional debt 
limit.
    In the fall of 2009, Utah's Joint Retirement Independent 
Entity sub-appropriations committee, of which I am the Senate 
co-chair, requested an in-depth actuarial review of Utah's 
pension liabilities. For the first time in our State, we asked 
our actuaries, instead of looking in the rearview mirror, to 
look forward for 40 years and assess a variety of scenarios to 
give us a better understanding of where we are going. The 
report highlighted some troubling facts.
    First, we realized that Utah, and I would say any other 
State, if you look forward, cannot grow its way out of these 
pension problems. We would have to average, in Utah, 13 percent 
returns year over year for 20 years to grow out of the 2008 
losses. If Utah's pension system averages its assumed 7 3/4 
rate of return, and we do nothing else, Utah's pension system 
will be bankrupt by approximately 2040.
    Second, we realize Utah must dramatically increase 
contributions to the pension system required to compensate for 
the 2008 losses. These contributions will increase and continue 
to increase over the coming years, and stay there for an 
amortization period, which is 25 years. Our total contributions 
will equate to approximately 10 percent of Utah's general and 
education funds for 25 years to pay off 1 year's worth of 
losses.
    Finally, the study from our actuaries showed that Utah 
cannot absorb another year like 2008. For example, if we hit a 
6 percent return over the next 25 years, we are bankrupt now as 
a State and don't know it. Because we are hoping that we can 
get the market returns we need to meet the commitments we have 
made to our employees.
    Last year, the Utah legislature acted aggressively to cap 
its existing pension liabilities. We closed our defined benefit 
pension plans to new enrollees, creating a new retirement 
system for new public employees hired after July 1, 2011. The 
crux of our pension reforms are that the State will no longer 
have an open-ended guarantee to its public employees. Instead, 
we are saying affirmatively we will put a certain amount toward 
retirement, and that is what you get.
    Employees have the option to choose between a 401(k) style 
plan and also a defined benefit pension hybrid plan. But they 
are on the hook for the market risk.
    It is our hope in the State of Utah, as we have tried to 
manage all our liabilities and risks, that other States will 
follow suit. It is now time to act and make sure we are 
containing these liabilities, so we can move forward as a State 
and as a country. Thank you.
    [The prepared statement of Mr. Liljenquist follows:]



    
    Mr. McHenry. Ms. Prunty.

                   STATEMENT OF ROBIN PRUNTY

    Ms. Prunty. Thank you, Mr. Chairman, Mr. Ranking Member, 
members of the committee. Good afternoon. My name is Robin 
Prunty, and I am a managing director in Standard and Poor's 
Ratings Services business. I am an analytic manager in charge 
of the State ratings group.
    Standard and Poor's is a credit rating agency and as such 
conducts analysis and forms forward-looking opinions about the 
creditworthiness of debt and debt issuers, including among 
others, States and municipalities. I am pleased to appear 
before you today.
    Standard and Poor's believes that the difficulties faced by 
States and municipalities will give rise to very difficult 
budget and policy decisions, but not default for our rated 
universe in the overwhelming majority of cases. This is because 
State and municipal debt obligations are secured either by a 
specific pledge of the Government's full taxing authority or 
dedicated taxes, user revenues or fees. And there is often a 
priority status for debt relative to other obligations.
    Because States and in many cases local governments are 
required to balance their budgets rather than finance budget 
deficits solely through debt issuance, they are annually making 
choices to align revenues and expenditures. These actions, 
along with the Federal stimulus funding, contributed to 
relative credit stability for most U.S. public finance issuers. 
While credit downgrades have increased over the last 2 years, 
and we expect there could be further credit deterioration in 
2011, in the majority of cases, we believe that general 
obligation and other types of direct debts of State and local 
governments that we rate will continue to be retired as 
scheduled.
    Over the past 25 years, there have been 42 defaults for 
non-housing issues in U.S. public finance at Standard and 
Poor's. There has been observed default by a State in more than 
100 years. Although the number of defaults has been, relatively 
speaking, low, we do believe the securities issued by rated 
governments can still face meaningful default risks.
    Because of the slow progress of the recovery from the 
recession, S&P believes that the continued flat or slow revenue 
growth transfers State and local governments may add to strain 
on budgets and overall liquidity, especially in the short term, 
as Federal stimulus funds end. In addition, we believe that 
pensions and other post-employment benefit obligations 
represent material long-term risks to governments, and have 
long been factored into our criteria for rating State and local 
governments. Recent investment performance of the assets in 
most pension trust fund is well below historic trends and 
negative in many cases, which has contributed to weakened 
pension funding levels. Governments that are not funding their 
annual required contributions risk the most significant changes 
in their budget capacity in the future.
    Such concerns have given rise to pension reform movements 
in certain States, and we expect that this will continue. While 
we believe that liabilities to public employees represent 
genuine long-term pressures on government credit quality, they 
generally are not immediately competing for most governments' 
capacity to fund their debt service or meet other priority 
payment obligations.
    In general, we believe that the worst-case scenarios 
regarding pensions will likely occur only if governments are 
unable or unwilling to use their powers of adjustment. 
Notwithstanding the difficult policy choices facing State and 
local governments, S&P continues to expect that most issuers 
that we rate will continue to retain their strong capacity and 
willingness to meet their debt obligations. Moreover, there is 
little incentive for them to allow their debt obligations to 
default. This is in part because we believe that a defaulted 
debt service payment would likely result in a loss of access to 
the capital markets, which has been a significant source of 
funding for capital and infrastructure projects for both State 
and local governments.
    We have observed that governments have made many 
improvements to their budget structure, reserve policies and 
debt management during prior periods of budget stress, which in 
our view has generally enhanced their ability to manage through 
downturns. Reconciliation of structural revenue and expenditure 
misalignments may not be achieved in one fiscal year, but 
reform efforts are underway for many governments. We expect 
that this will continue through 2011.
    Effective financial management will be key to addressing 
these challenges. And governments have strong powers of 
adjustment. If governments do not manage or make adjustments, 
and instead rely heavily on debt and other one-time solutions 
in the hope that economic growth will balance their budgets, we 
believe that they could be setting themselves up for greater 
hardship in the near term.
    Throughout difficult economic periods, including during and 
after this most recent recession, we have generally seen on the 
part of governments what we consider to be a very strong 
commitment to their debt obligations, which for us has been an 
important credit consideration over time. While there are 
vulnerabilities in the public finance sector, our expectation 
is that the threat of default is generally not widespread among 
State and municipal issuers that we rate.
    I thank you very much for the opportunity to participate in 
this hearing, and would be happy to answer questions that you 
may have.
    [The prepared statement of Ms. Prunty follows:]



    
    Mr. McHenry. Thank you, Ms. Prunty. That was probably the 
most amazing use of time. Well done, thank you.
    Dr. Baker.

                    STATEMENT OF DEAN BAKER

    Mr. Baker. Thank you, Chairman McHenry and Ranking Member 
Quigley. I want to thank in particular Representative Quigley. 
I am also from Illinois, and my mother is one of those public 
employees who is dependent on the pensions there. So I 
appreciate your concern.
    I want to make three main points in my comments today. 
First off, that the financial strain facing State and local 
governments first and foremost originates in Washington, or 
perhaps I should say Wall Street. It is a problem of the 
economy, and that is where most of the difficulties stem from. 
Second, the problems that our pension funds face are 
manageable. And the third point is that the pension fund 
accounting is, for the most part, reasonable, that they are 
looking at expected returns on their pension funds. Requiring 
pension funds to use a risk-free rate of return in assessing 
their funds could lead to higher costs and possibly ending 
defined benefit plans altogether, which I would argue would 
mean higher costs for taxpayers.
    First point, the fact that the problems originate in 
Washington should be fairly straightforward. We are 3 years, 2 
months into a recession. The unemployment rate is still 4\1/2\ 
percentage points higher than it was prior to the downturn. If 
we compare that to the last serious recession, 1981, 1982, we 
already were back a the pre-recession level of unemployment. It 
is reasonable to expect State and local governments to prepare 
for downturns, but this is an extraordinary one, without 
precedence. This was due to mismanagement here in Washington, 
at the Federal Reserve Board, irresponsibility on Wall Street. 
This is not your run of the mill recession.
    And just an idea of how much difference that makes, we are 
currently 6 percent below potential GDP. If we assume that 
State revenues were 6 percent higher, a good first 
approximation, most of these States would have no problems at 
all balancing their budget. In the case of Wisconsin, which of 
course has been in the news lately, they would have $4 billion 
in additional revenue over the 2-year horizon, fully making up 
their shortfall, before even taking into account the savings on 
expenditures for programs like unemployment insurance, TANF and 
other expenditures that have increased during the downturn.
    So this is first and foremost a problem that originates in 
Washington. Not to say that all governments are responsible, 
but certainly the problems were enormously worsened by the 
severity of the downturn.
    The second point, oftentimes we scare people by using big 
numbers. The pension liabilities, however, estimated, are very 
big numbers. But if we calculate them relative to the size of 
the future economy, over a 30-year period, the normal horizon, 
we are looking at a shortfall that by my calculations is a 
little more than two-tenths of a percent of GDP. That is hardly 
trivial, but if we compare that, say, to the increase in 
defense spending from 2000 to 2011, that was 1.7 percentage 
points of GDP. So the amount of additional revenue, whether 
through tax increases or reduction in other spending, is about 
one-eighth as much as we found to increase our defense 
spending, defense budget, between 2000 and the present. Not to 
say that is trivial, but that it is very much a manageable sum.
    The last point I will make is that I would say that the 
pension funds are using appropriate accounting. They are using 
expected values. And I will say that I have been a critic of 
their accounting in years past, in the 1990's and the 2000's 
when you had very high price to earnings ratios. They were 
making assumptions about future stock returns that were clearly 
unrealistic. I said that quite openly at the time.
    Now that you have had a big fall in the stock market, going 
forward, the given price to earnings ratios and given growth 
projections from the Congressional Budget Office and other 
major forecasters, their assumptions on rates of return are 
very realistic.
    The alternative, if we are to insist the pension funds use 
a risk-free rate of return, we would have two stories we could 
tell. One is that they continue to invest in equities, but they 
assume a risk-free rate of return. This would, in effect, 
require pre-funding. This would be very perverse policy, it 
would mean more taxes or less spending in the current to have 
savings in the future. We might think that prudent in some 
sense, but I don't know of anyone who has recommended pre-
funding schools, pre-funding fire departments. That is not 
ordinarily the way we expect our governments to function.
    The alternative is to say, OK, they would just invest in 
bonds and get the lower risk-free rate of return. If we did 
that, pension fund would be more costly to State and local 
governments, which would mean a higher burden to taxpayers.
    The final possibility is we could end up eliminating them 
altogether, which as we know some States have done, some local 
governments have done. This again is a cost to taxpayers, if we 
think this through carefully. Defined benefit pensions are 
something that workers value greatly.
    The fact is that State and local governments can endure 
timing risks with the stock market, because they are 
essentially infinitely live entities. Individuals, of course, 
have finite lives. For individuals, it is a very, very big 
risk. By virtue of taking that risk, we are able to get either 
better employees for the same wages, or the same employees for 
lower wages. That is a benefit that workers get in exchange for 
other compensation.
    If State and local governments no longer take advantage of 
their indifference to risk, they end up losing that benefit. 
That will cost taxpayers more money. Thank you.
    [The prepared statement of Mr. Baker follows:]



    
    Mr. McHenry. Thank you, Dr. Baker.
    Mr. Kurtter.

                  STATEMENT OF ROBERT KURTTER

    Mr. Kurtter. Thank you. Good afternoon, Mr. Chairman, 
Congressman Quigley and members of the subcommittee.
    My name is Robert Kurtter. I am a managing director in the 
U.S. public finance group at Moody's Investors Service. I want 
to thank you for inviting Moody's to share our views as pat of 
today's hearings.
    My comments will focus on the credit risk of public finance 
bonds that are rated by Moody's. A significant number of public 
finance bonds are not rated by Moody's or any other rating 
agencies. Because unrated issuers and bonds may have quite 
different risk characteristics than rated ones, my comments 
should not be generalized to the entire universe of public 
finance bonds.
    I also want to be clear that Moody's opinions in this 
sector speak only to the likelihood that a Government-issued 
bond is likely to be paid in full and on a timely basis. While 
we take into account all of an issuer's major financial 
obligations, we do so in order to assess the likelihood that an 
issuer can and is willing to meet its payment obligations to 
bond investors. This means that when we use the term default, 
we are referring specifically to the failure to make payments 
to bondholders, and not a failure to fulfill any other 
obligations a State or local government may have, such as 
utility payments, salaries due to employees or pension 
liabilities.
    I will turn now to our views on the sector. All of us here 
today know that State and local governments are experiencing 
unprecedented financial strain. This is reflected in the 
negative outlooks Moody's has had on all major subsectors in 
this market. For State and local governments, our negative 
views are driven by four main factors.
    First, the overall economy is still fragile, even though it 
is recovering. Second, State and local governments are facing 
increased liabilities, such as pension and health care costs. 
Many commentators have recently focused on pension liabilities. 
Moody's has long factored these liabilities into our analysis 
and opinions. Growing unfunded pension obligations are creating 
challenges for these issuers. And we are monitoring the 
situation closely. We have taken and will continue to take 
rating actions where we believe an issuer's credit profile 
warrants it.
    Third, lingering fiscal pressures have required State and 
local governments to make severe budget cuts, use budget 
reserves and pursue other non-recurring solutions to solve 
their budget gaps. And finally, revenue sources have strained 
due to persistent high unemployment, sagging real estate 
prices, which lead to drags on taxes.
    Let me focus now specifically on the condition of the U.S. 
States. Most States are facing challenges with respect to both 
their liabilities and their revenues. The recovery is still 
fragile, unemployment is very high, and it is uncertain when 
sustained revenue growth will take hold. That said, Moody's 
does not see bondholder debt as a source of credit strain for 
most States. This is because annual bond debt service costs 
remain a relatively small share of overall expenditures.
    In addition, most States do not face refinancing or 
material rollover risks. We believe that we could see a few 
more States turn to deficit financings to fund operating 
expenses, or restructurings to produce budget savings in 2011. 
But we expect those States to be the exception rather than the 
rule. For these reasons, and because of the strong incentives 
they have to pay their bond debt, we believe it is very 
unlikely that any States will default on their bond obligations 
in the next 12 to 18 months.
    In the local Government sector rated by Moody's, we see 
unprecedented financial strain for the reasons I mentioned 
earlier. Further, the States can shift some costs to the local 
government level, which is likely to exacerbate the challenges 
there. However, we also expect that a majority of the 
individual local governments will make the tough decisions and 
the budget cuts needed to continue to make timely payments on 
their bonds.
    We do not expect widespread defaults by rated State and 
local governments. However, there have been situations in the 
past where the risk of default seemed imminent, even though it 
was ultimately averted. We saw this, for example, in 
Harrisburg, Pennsylvania. We expect there will be some 
additional cases of severe credit stress going forward.
    In summary, there is substantial credit pressure on the 
U.S. public finance sector today. Over the next 12 to 18 
months, we believe it is unlikely that any State will default 
on its obligations to bond investors. We believe the increase 
in bond defaults among local governments will be relatively 
small.
    Thank you again for inviting me to testify on this 
important matter. I look forward to answering your questions.
    [The prepared statement of Mr. Kurtter follows:]



    
    Mr. McHenry. Thank you, Mr. Kurtter.
    Dr. Biggs.

                  STATEMENT OF ANDREW G. BIGGS

    Mr. Biggs. Chairman McHenry, Ranking Member Quigley and 
members of the committee, thank you for offering me the 
opportunity to testify with regard to State and municipal 
finances and the role that public pension financing may play.
    It is my hope that State and local finances will avoid a 
severe disruption. Like a plane buffeted by turbulence, they 
will survive so long as they had sufficient altitude before the 
event. My greatest concern is not so much for this recession as 
the next one, which inevitably will come. If we enter that one 
in precarious financial position, State and local governments 
may not have sufficient room to maneuver.
    The rising costs of public sector pensions, while not the 
main driver of State and local financial problems, have gained 
increasing prominence in recent months. My work on public 
pension financing argues that if we wish to strengthen State 
and local government finances, we need an accurate assessment 
of the size of pension liabilities and the steps that will and 
won't help the governments reduce them. Current pension 
accounting methods unequivocally fail on this front.
    To be clear, the so-called market valuation critique of 
pension financing is not a criticism of the average returns 
that plans project for their investments. It does not say, for 
instance, that pension funds will yield 7 percent on average 
rather than the 8 percent average they claim. Rather, it says 
that because this 8 percent is a risky return, it is 
inappropriate to use that interest rate in valuing benefit 
liabilities that are guaranteed by State law or constitutions.
    Pensions current practice of discounting guaranteed 
liabilities using returns on risky assets runs counter to 
economic theory, the practice of financial markets and the 
accounting standards imposed on private sector pension plans.
    As the vice chairman of the Federal Reserve put it, ``While 
economists are famous for disagreeing with each other on 
virtually every other conceivable issue, when it comes to this 
one, there is no professional disagreement. The only 
appropriate way to calculate the present value of a very low 
risk liability is to use a very low risk discount rate.''
    Most economists believe that since pension benefits are 
guaranteed by governments, it is appropriate to discount them 
using interest rates derived from other government guaranteed 
investments, namely Treasury bonds. Using an appropriate 
discount rate, current unfunded pension liabilities are not 
$500 billion, as claimed, but over $3 trillion. Violating this 
rule, as public pension accounting does, leads to nonsensical 
results.
    For instance, public pensions could erase all their 
reported deficits and even generate a surplus if only they were 
to shift all their investments to stocks and assume a 10 
percent rate of return. Note the plans actual benefit 
liabilities would be the same and the market value of their 
assets would be the same. But by adopting a more aggressive 
funding strategy and ignoring the risks of that strategy, they 
could magically generate $500 billion at the stroke of a pen. 
If this seems to make no sense, it is because it does make no 
sense.
    But even today, after the financial crisis and the market 
meltdown, many public sector pensions are effectively doubling 
down on risk. Having already doubled the share of their assets 
going to stock since the mid-1980's, public sector pensions are 
now the largest single investor in hedge funds and are also 
moving into private equity.
    There is no coherent funding strategy that would use these 
assets to fund fixed guaranteed benefit liabilities. This is 
particularly so when you note that the public sector pensions 
operate under a standard called inter-period equity, which 
dictates that every year, a plan should fully fund the benefits 
earned in that year and not pass on liabilities to future 
taxpayers.
    But when you fund a guaranteed benefit using highly risky 
assets, it is obvious that you are passing significant 
contingent liabilities on to future generations. The more risk 
you take, the larger these liabilities are.
    Using discount rates that economists deem appropriate, 
public pension unfunded liabilities are somewhere over $3 
trillion. The only way to reduce these unfunded liabilities 
would be to actually fund them. Most States currently devote 3 
to 4 percent of their budgets to pension funding. Using more 
accurate accounting, that would rise to over 10 percent, in 
some States significantly more so. Simply taking more 
investment risk won't do the trick, nor should it.
    We face difficult choices, but on one thing we should be 
clear. It is more important to get the numbers right before you 
have a crisis, when you still have time to do something about 
it, than to wait until a crisis has hit. It would be a sad 
irony if, even as we recover from a financial crisis driven by 
lax accounting and excessive risk-taking, that we lurched into 
a new one, driven by the same causes. Thank you very much.
    [The prepared statement of Mr. Biggs follows:]



    
    Mr. McHenry. I certainly appreciate your testimony. I will 
recognize myself for 5 minutes.
    Mr. Kurtter, in your testimony you affirm that combining 
both debt and pension metrics will improve transparency for 
investors. Can you please name specific measures that States 
can adopt to enhance transparency?
    Mr. Kurtter. Thank you, Mr. Chairman. We published a report 
recently, Combining Debt and Pension Metrics into one Metric, 
for purposes of providing increased transparency to the 
marketplace for purposes of evaluating credit risk. We did that 
because we were trying to conform with practices in other 
business lines, the way corporations are looked at and 
hospitals. Our goal is improved transparency for the investors 
who rely on our ratings.
    Mr. McHenry. What specifically could States do? In terms of 
public policy, what can we do to enhance disclosures for 
investors?
    Mr. Kurtter. We don't advise or make recommendations.
    Mr. McHenry. OK, then if that is your answer, that is your 
answer.
    Mr. Prunty, would you answer the same question?
    Ms. Prunty. We have looked at pension liabilities as pat of 
our criteria for many decades. I think that the challenge, when 
you look at public plans, is that the current governmental 
accounting standards allow for a range of actuarial assumptions 
when they are calculating those liabilities. So it is very 
difficult to do an apples to applies comparison among States 
and among local governments as well.
    So we do report those liabilities and have reported those 
alongside debt, and give them equal weighting when we are 
evaluating the debt and liability profile. But I think that 
some of the variability and the actuarial assumptions that are 
allowed definitely make it challenging to do that kind of 
comparison.
    Mr. McHenry. Would uniform disclosures assist in credit 
rating and transparency for investors?
    Ms. Prunty. I think there are current efforts underway with 
the Governmental Accounting Standards Board to look at that 
issue. We are obviously watching that closely.
    There are a lot of unique features, as you go from plan to 
plan. They are not uniform plans, government by government. So 
I think that the one size fits all solution is probably a 
little bit challenging there. But certainly, a little more 
uniformity would make it easier to make comparisons across 
governments.
    Mr. McHenry. Mr. Kurtter, would uniformity assist?
    Mr. Kurtter. Yes. We are in favor of more uniformity and 
consistency and transparency across the marketplace in terms of 
repotting this information.
    Mr. McHenry. Thank you. In comparison of the corporate bond 
market to the muni bond market, is there more disclosure in the 
corporate bond market than in the muni bond market? Ms. Prunty.
    Ms. Prunty. When we are assigning ratings, we are generally 
relying on the information provided by issuers. Based on our 
criteria, we are assuming that----
    Mr. McHenry. If you don't want to answer the question, it 
is fine. I don't have much time. Is there more disclosure, more 
transparency in the corporate bond market than municipal bond 
market? Yes or no.
    Ms. Prunty. Yes, I've been in public finance my entire 
tenure at S&P, so I am not familiar with the corporate.
    Mr. McHenry. Mr. Kurtter.
    Mr. Kurtter. General disclosure or pension disclosure, Mr. 
Chairman?
    Mr. McHenry. Both.
    Mr. Kurtter. Both.
    Mr. McHenry. Or either. Whatever you would like to answer. 
I am just trying to get an answer from you guys. And this is a 
beef. I have to be honest with you. This is a beef with the 
credit rating agencies, is you guys talk around the problem and 
actually not address it. This is the frustration that many of 
us have, and I think the marketplace has with this.
    Mr. Kurtter.
    Mr. Kurtter. Yes. In corporate disclosure generally, there 
is interim financial reporting and other types of more timely 
reporting. Municipal disclosure, the audits are typically often 
late, and there is no interim financial reporting. That said, I 
think it is important to recognize that in a public finance 
marketplace, there are many resources of publicly available 
information that are not available in the corporate world. 
Budget information, revenue reporting, things that are publicly 
available as a consequence of the budgeting process.
    Mr. McHenry. In terms of what has happened in Ohio, 
according to municipal bond strategists, upon the recent 
passage of Ohio State union reform legislation, the cost of 
borrowing reflected by the yield of the State's long-term 
general obligation bonds fell by a meaningful percentage, and 
dropped the cost of borrowing for Ohio, post-passage of this 
union reform legislation, basically the collective bargaining 
agreement.
    Mr. Kurtter, can you touch on this? Would you be willing to 
touch on that?
    Mr. Kurtter. The existence or non-existence of collective 
bargaining is not in and of itself determinative of budget 
balance or the likelihood that an entity will acquire large 
unfunded liabilities or large post-retirement liabilities. From 
our perspective, we look at the bottom line, it is whether the 
budget is balanced rather than how a budget is balanced.
    Mr. McHenry. But it has a meaningful effect on the 
marketplace, though it didn't create, change the rating, it did 
change the rate that people were paying, the State was paying.
    Mr. Kurtter. I don't track the pricing, so I trust that is 
correct.
    Mr. McHenry. With that, I recognize Mr. Quigley for 5 
minutes.
    Mr. Quigley. Thank you, Mr. Chairman.
    Dr. Baker, you are a little more optimistic on the overall 
picture than some. And on the overall picture, that is probably 
accurate. Wouldn't you concede that for six to eight States on 
the pension issue it is far more acute a problem and far more 
dramatic action has to be taken?
    Mr. Baker. Thank you, Ranking Member Quigley. I am usually 
not known for my optimism.
    You certainly do have several States, the ones you had 
mentioned on that list, that clearly have more serious 
problems. We have a number of States that, had we not gone into 
the downturn, their pensions would be pretty much fully funded. 
We had other States that faced problems even prior to the 
downturn, and certainly the situation was made considerably 
worse by the downturn.
    As you know, in your own State, Illinois, of course, they 
did have a substantial tax increase in part to deal with those 
problems. I suspect you will see comparable actions in other 
States.
    Mr. Quigley. But is that enough? Even Illinois is still 
borrowing a significant amount of money to meet those 
obligations. Are you suggesting, with all due respect, they 
could all be made up for with additional revenue?
    Mr. Baker. I don't mean to tell the States how they should 
deal with their shortfalls. But I will say one thing that is 
front and center, is the state of the national economy. If it 
were the case that we were somewhere near full employment 
today, Illinois and every other State would see both a much 
better overall budget situation and as well its pensions would 
likely look better, both because there would be more money 
flowing into it, regular money flowing into it. And then on top 
of that, I would anticipate the stock market moving back toward 
more normal levels.
    Mr. Quigley. Well, if we believe in collective bargaining, 
we should also believe in collectively solving the problems. I 
guess what I am trying to get you to is that it is not just the 
economy or additional revenues. There has to be some meeting in 
the middle. At least some of these pensions, you would agree, 
have been a little too generous, a little too out of synch with 
actuarials in terms of when people start collecting, how long 
they collect, how long they pay in, the COLAs that are 
involved.
    Mr. Baker. Well, a couple of points I would make on that. 
Pensions are part of an overall compensation package. There 
have been a number of studies, we have done some at my center, 
a number of other organizations around the country, academics 
have done studies, looking at public sector compensation in 
general. The conclusion of the bulk of these studies, I know 
Dr. Biggs has opposite conclusions, but the conclusion of the 
bulk of these studies is that public sector workers are paid a 
little less, taking into account their pension commitments, 
than private sector workers, adjusted for education.
    Now, having said that, are there cases where I think 
pensions are inappropriate, where maybe workers are allowed to 
retire too early, where they are perhaps structured 
inappropriately, it is common for pensions to just be based on 
the last 3 years or the last 1 year, I wouldn't do it that way. 
But again, I am not setting the laws for State pensions.
    Mr. Quigley. I agree. We are both in that situation.
    Mr. Prunty and Mr. Kurtter, you seem fairly confident that 
we are not in for a major default in the next year or so. But 
stranger things have happened when the experts haven't picked 
up. The issue that I am most concerned with is the impact on 
the market as a whole, even the bond market. Is there a 
contagion factor, if a major State had a major default?
    Ms. Prunty. Thank you. We do, our current rating would 
suggest that we don't see a default for Illinois, and actually 
their bond----
    Mr. Quigley. Or any State.
    Ms. Prunty. Yes, or any State. Illinois has actually, over 
the last year, during the last legislative session, put some 
protections in to ensure that there was sufficient special 
funds on hand in order to cover future years' debt service 
obligations, both short and long-term, and so have made some 
adjustments there in order to focus on that.
    Mr. Quigley. But the question still stands. Given a 
possibility in this country of a major default, is there a 
contagion factor? Or is this all isolated in terms of how you 
rate funds?
    Ms. Prunty. I think defaults historically, if you look at 
New York City back in the 1970's, there was a significant focus 
on the market and the impact there. I think that is why you see 
so many oversight mechanisms across States to prevent local 
government from being in a default situation for exactly that 
reason, that there would be concern that there would be 
implications for the broader market.
    Mr. Quigley. Mr. Kurtter, quickly.
    Mr. Kurtter. Yes, thank you. The markets clearly are very 
jittery right now. We don't believe there will be major State 
defaults. We don't believe that there will be more than a few 
small rated defaults among local governments.
    But clearly the markets are jittery, and any kind of a 
significant default would add to the nervousness of an already 
jittery market.
    Mr. Quigley. Thank you.
    Mr. McHenry. The gentleman's time has expired.
    Ms. Buerkle, for 5 minutes.
    Ms. Buerkle. Thank you, Mr. Chairman, and thank you to our 
panelists for being here today.
    My district is in upstate New York, so if you will indulge 
me, for my 5 minutes I would like to talk about the State of 
New York, and in particular because it is one of those 44 
States that the chairman spoke of in his opening remarks.
    Dr. Biggs, I would like to just direct my question to you, 
and then to Mr. Kurtter, and then if anyone else would like to 
comment on it. In 1975, New York City found itself in a crisis 
and had to make a decision between paying its debt or paying 
its employees. As you know, they paid their debt down.
    My question is, do you foresee New York State being in, 
facing such a choice within the next 5 years? And if you could 
comment on how dire you believe the situation is in New York at 
the present time.
    Mr. Kurtter. I know a little bit about New York State. My 
father is from upstate New York, near Schenectady, so I spent a 
bit of time up there. I would not claim to be an expert on New 
York State finances.
    Certainly in the recent history, it has not been 
encouraging there. New York State's pensions have been better 
funded than in many States of the country. But when you use 
honest accounting, that is being the top of a very bad heap. 
But still, the other costs the State government has to deal 
with are pretty significant.
    I have not followed closely enough the efforts of Governor 
Cuomo there to try to rein in some of the costs and to bring 
balance to the budget. If those are successful, certainly New 
York will be in better shape. I think because of New York's 
reliance on tax revenue from Wall Street, which is highly 
cyclical, they have a risk factor there that some other States 
may not have.
    So certainly I am hopeful and more hopeful now than I was 6 
months ago. But New York State has a long way to go.
    Ms. Buerkle. Thank you. Mr. Kurtter.
    Mr. Kurtter. Yes. Our ratings really speak to whether or 
not we expect the State to make good on its bond payments in 
full and on time. That said, of course, the State has had very 
difficult problems, as all States have, are facing tremendous 
problems of managing their revenue and spending. Our view is 
that the States have revenue and spending problems, but not 
really debt problems, because even in New York, their debt 
service is a relatively small portion of their overall 
spending.
    Right now, of course, because revenue is short, payments to 
the retirement system and all other expenses are competing with 
each other for scarce dollars. And the State is having to make 
difficult choices about meeting, balancing their budget within 
the constraints of weaker revenue.
    Mr. Baker. Let me just quickly add to that, just to remind 
the committee that first and foremost, the state of the economy 
will be the most important factor determining the ability of 
New York and every other State to meet its obligations.
    Ms. Buerkle. Thank you, Dr. Baker.
    Senator.
    Mr. Liljenquist. You asked the question whether or not New 
York is in a situation where they need to pay their debt or pay 
their employees. Utah is in that situation right now. As we 
ramp into 75 percent increases in our employer contribution for 
pension systems, that is going to pay for these losses. That is 
10 percent of our general fund that will not be available for 
wages or health care benefits for our employees.
    We fund things in this order in our State, and I think most 
States are similar. We fund pension benefits first, health 
benefits second, and whatever change is left over goes to wage. 
And our wages in the State have fallen behind as we have 
struggled to keep up with pension and health care costs.
    So as we looked at our reforms, we started calling it, 
maybe euphemistically, the wage liberation act. Because we 
said, look, you can't have a set bucket of money and having 
your benefits eat more and more of that bucket of money. You 
have no money left for wage.
    So we struggle to get the 24 year old, at the start of his 
career, because he or she is looking for wage, and benefits are 
less important. And we struggle to recruit, as a State. We 
think by affirmatively saying, and generous, our legislation 
says you get 10 percent toward your retirement, 10 percent of 
your wage. If you are public safety or fire, you get 12 
percent. So it is a generous amount, but it is set. And that is 
all we are doing. So hopefully over time, we can repair wages 
for our employees, which by our data in the State of Utah, 
their actual wage is lower because we are making this choice, 
do you pay this debt or do you pay the employees. And we are 
struggling with that right now, as a State.
    Ms. Buerkle. Thank you. I yield back my time.
    Mr. McHenry. Mr. Welch for 5 minutes.
    Mr. Welch. Thank you, Mr. Chairman.
    Senator, congratulations on your success in making some 
progress in dealing with this in Utah. You have to give us the 
magic potion so we can make some progress here.
    One of the things we are struggling with is our own 
deficit. And the new majority is, in my view, rightly focusing 
on that. But there are consequences to some of the policy 
decisions we make. I just want to ask, I will start with Dr. 
Baker, what is the impact on the States in their ability to 
address, among other things, this under funding of the pension, 
if we have $100 billion in cuts that include substantial 
revenues that the States have been depending on? Is there an 
impact?
    Dr. Baker. I certainly expect there to be an impact, to 
some extent. These are revenues, as you say, that would be 
committed to the States. But I think probably the bigger impact 
is that there have been a number of estimates, Mark Zandi and 
Moody's and Goldman Sachs came up with estimates that this 
could lead to loss of as many as 700,000, 800,000 jobs. This 
means more people unemployed, slower Economic growth, less tax 
revenue to the States. I think that actually is likely to be 
the bigger impact, due to the impact on the economy, than sort 
of direct impact in terms of cutting money to State 
governments.
    Mr. Welch. Thank you.
    Mr. Kurtter, how about you? And again, these are policy 
choices we have to make. There is not endless money. We here in 
Congress have to bring us back to fiscal balance. But I also 
think we have to be clear-eyed about the impact of some of 
these cuts, when it is revenue that goes to the States, and 
then how that impacts their ability to deal with their own 
fiscal problems. Do you have a comment on that question?
    Mr. Kurtter. States are beginning to face the fiscal 
dilemmas that they are challenged with right now. They are 
making very difficult spending and revenue cuts, touching 
programs that in prior years were off limits. These are tough 
choices elected officials have to make.
    With regard to pension obligations, they are also beginning 
to address some of those issues, too, by increasing employee 
and employer contributions as well as addressing the benefit 
side of the equation.
    Mr. Welch. Ms. Prunty, how about you?
    Ms. Prunty. Yes, I think it is fair to say that the budget 
climate is still very difficult for States. If there were any 
reductions in revenue sources, be it Federal or other tax 
sources, it would add additional difficulty to the current 
budget challenges. Particularly because Medicaid is a very 
large portion of State spending, and that is the primary 
Federal flow of revenue to States. So yes.
    Mr. Welch. Thank you.
    Dr. Biggs, I think you made a very compelling point in 
terms of the investment models and what is realistic. You can't 
have a pie in the sky kind of projection.
    But on the other hand, is it equally questionable as to 
whether there should be this so-called risk-free model that 
imposes what historically I think is a much lower rate of 
return, where there are consequences to State budgets if you 
have a so-called risk-free model where you can give yourself 
the, perhaps satisfaction that you ``guaranteed'' to have that 
return, but on the other hand, there is a consequence with 
respect to how much then has to be put in to fund it. It may be 
more.
    Mr. Biggs. Sure. Well, I think it is important to repeat 
that the use of a riskless or a risk-adjusted discount rate is 
the way you value your liability. It doesn't restrict the plan, 
if it wishes to invest in equities or invest in more risky 
assets. And the plan will benefit from those investments if 
they pan out. If they invest in stocks and the stocks generate 
higher returns, then they actually have more assets on hand 
than they otherwise would have.
    The objection is to essentially assume that those assets 
will generate 8 percent returns going forward without taking 
any risk into account. If you go back to the 1980's, up to 
the----
    Mr. Welch. Let me just get clarification, because I think 
this is quite important. If you have a riskless model where you 
are saying it has to be the T-bill rate, let's say, where there 
is some, we hope the Federal Government is good for it, that 
can have a depressing impact on the ability of a State to meet 
many of its other legitimate obligations, including what the 
Senator was talking about, trying to bring up the wage scale.
    Mr. Biggs. Sure. If you value your liabilities correctly, 
the liability is what it is. How you fund a liability is an 
entirely distinct question from what the liability is. Plans 
today, State pensions generally take an aggressive funding 
strategy, which means they invest in stocks and hedge funds, 
things like that. The higher expected return means they can 
make a lower contribution today. And people like that. It 
leaves more money for other things.
    But because the benefit is guaranteed, it means a higher 
contingent liability on future taxpayers. That is inconsistent 
with the standards that GASB lays out that says, you should try 
to fully fund your benefits as they accrue and not pass 
contingent liabilities. Well, what we are finding out today, 
again going back to the mid-1980's, before then you had a high 
level of funding into State pensions, but conservative 
investments to go into them. They would invest mostly in bonds 
and things like that.
    That meant you had to put a lot of money away. You didn't 
have a large contingent liability. Since then, they went more 
aggressively into stocks, which essentially cut their funding 
levels in half. For many years, you had good times. The stocks 
returned well, they increased benefits, they had funding 
holidays. Today we are seeing the flip side of that strategy.
    So you can't take an aggressive, risky strategy and expect 
that you are never going to have to deal with the downside. 
That is currently what we have.
    Mr. McHenry. The gentleman's time is expired.
    Mr. Meehan of Pennsylvania, for 5 minutes.
    Mr. Meehan. Thank you, Mr. Chairman.
    Thank you to each of the panelists for your articulation of 
a lot of details on a very, very challenging issue, certainly 
for those who struggle at the local level. I often think about 
these things in the context of municipalities, not just the 
States, where there is a greater capacity to handle these, but 
a lot of local obligations that have been undertaken for 
everything from funding local economic development to other 
kinds of programs.
    I am thinking about the implications that are going to be 
sort of bleeding down, particularly as we aren't able to 
predict yet what States are actually going to be doing with 
their budgets. But the implication is that much of it is going 
to be pushed down to the local level as well.
    I think Ms. Prunty and Mr. Kurtter, you discussed this 
issue, which I don't clearly understand, which is the role of 
accounting in municipal finance, which may be different from 
what we do with a publicly traded company. And the fact that we 
may be understating the risk, because of the method of 
accounting. Can you explain to me what the difference is 
between municipal accounting and accounting that is done, say, 
for a corporation, and their tax filing?
    Ms. Prunty. I think on the Governmental Accounting 
Standards Board side, there is a different government, I think 
there is a recognition that they are different from 
corporations, because they are going concerns, and it is 
unlikely that they will be out of business going forward. So 
the Governmental Accounting Standards board does allow a 
different set of assumptions to be used for public pension 
accounting. And that has been the case. There is significant 
discussion underway at the Governmental Accounting Standards 
Board to look at that and determine if that is still 
appropriate, given market performance of the last decade.
    But I think that the accounting differential really 
recognizes the fundamental difference between governments and 
corporations.
    Mr. Meehan. Is it exclusive to pensions, or does it involve 
other kinds of general obligation bonds as well?
    Ms. Prunty. The Governmental Accounting Standards Board 
also covers the annual financial statements or financial audits 
that governments provide. So there is a differential in 
accounting standard there, also, recognizing some of the 
differences between corporations and governments.
    Mr. Meehan. If it is understated, and that was the 
testimony, I believe it was you or Mr. Kurtter, was there 
somebody that testified today that local, there is sort of an 
understatement of the problem? Dr. Biggs, you did. Would you 
then answer my question?
    Mr. Biggs. The standards used by the Governmental 
Accounting Standards Board [GASB], allows States or 
municipalities to discount their liabilities at the expected 
rate of return of any assets they have set aside to fund their 
liabilities. So if they think their assets are going to return 
8 percent, they can discount the liability at that. That 
applies mostly to pensions. It would apply in some limited 
cases to retiree health care. Some States pre-fund their health 
care obligations. Most don't.
    So in the private sector, a private sector pension plan 
could discount its pension liabilities at the rate of return or 
the yield on corporate bonds, which are currently around 5\1/2\ 
percent. So the effect of the differences in the discount rates 
is really very, very large between the private sector and the 
public sector.
    Mr. Meehan. Thank you for that explanation.
    I just have one remaining question. Mr. Kurtter, let me ask 
you this one. In my review for this hearing, there was a 
discussion about the fact that the Federal Reserve looks as if 
they are going to decrease their participation in the purchases 
within the bond market. Do you have any sense as to what impact 
that is going to have on the interest rates, and a prediction 
about how high those interest rates may go?
    Mr. Kurtter. Yes, Mr. Congressman, that is really something 
that is really outside my area. I am a State and local 
government analyst, and I don't really have an opinion on these 
kind of larger macro issues.
    Mr. Meehan. OK. Is there anybody on the panel that does 
have a feeling on that issue?
    Mr. Baker. Well, the consensus, if you look at the 
Congressional Budget Office, and just about every other 
forecaster out there, is that the interest rates will head 
upward. They are extraordinarily low levels today. Assuming 
that we do see some sort of economic recovery, it is reasonable 
to expect that they will get to more normal levels.
    Mr. Meehan. Thank you.
    Mr. McHenry. With that, I yield the full committee ranking 
member, Mr. Cummings, 5 minutes.
    Mr. Cummings. Thank you very much, Mr. Chairman.
    I want to thank our witnesses for your testimony.
    Dr. Baker, one of my concerns in having been now in State 
legislature for 15 years and been here on the Hill for 15 
years, you see a lot of times folks trying to deal with a 
problem as if that problem is going to last forever. And they 
deal with it, and then things get better.
    When I listen to a lot of the discussion, I am worried 
about folks who, when the economy comes back, we try to make 
these changes, and it will be hard to reverse it. Do you follow 
me? Is that one of your concerns, too?
    Mr. Baker. Absolutely. Again, I was on the other side of 
this argument a few years back, because I did feel that given 
price to earnings ratios in the stock market in the 1990's, 
particularly when we had the bubble, that pension funds, both 
on the private and public side, were being hugely over-
optimistic. Now, we have a serious downturn. Much of the 
pension fund shortfall likely will go away when we get future 
year valuations, because of course, the market has recovered 
much of its lost ground.
    I am not saying it is going to go away 100 percent. But we 
are looking in many cases at funding periods that were very 
near the trough of the market. Now, there is averaging, so it 
is a little more complicated than that. But we are in many 
cases looking at funding periods that were near the trough of 
the market. The market has recovered much of its value. I don't 
have a crystal ball, so I can't tell you it will recover all of 
its value. But it is almost certainly going to be the case. 
They will look better simply from that recovery.
    Again, if we had the economy back on its feet, if we were 
back near 5 percent unemployment, we would be looking at a much 
better situation in general for State and local governments. So 
the idea that we are going to be in perpetual crisis, I can't 
roll that out. But I think that is going to be more determined 
by the situation of the macroeconomy than the finances of State 
and local governments themselves.
    Mr. Cummings. That leads me to my next question. Probably 
the most poignant example of how politicians use pensions and 
public employees as their scapegoat is the battle that has 
transpired in Wisconsin on this issue. As a February 22, 2011 
Huffington Post article explains, it says, ``While Governor 
Scott Walker has painted a dire picture of his State's pension 
obligations, Wisconsin's pension fund for public employees is 
among the Nation's strongest, according to a report by the non-
partisan Pew Center. The Pew Report issued last year concluded 
that Wisconsin is a national leader in managing its long-term 
liabilities for both pension and retiree health care.''
    Dr. Baker, according to that same article, Governor Walker 
used his State's pension obligations to argue for a need to 
revoke collective bargaining rights of State employees. I am 
just wondering if you had an opinion whether such a drastic 
step was necessary, or was that an example of a scare tactic 
that you have discussed in your report of February 2011, 
entitled The Origins and Severity of the Public Pension Crisis?
    Mr. Baker. I won't claim to be an expert on either 
Wisconsin's funding or Governor Scott's motives. But I will say 
from what I know of its funding, it is very close to fully 
funded. They have been very responsible. And I will point out 
that again, just to be as clear as I can here, pension is part 
of the overall compensation. There have been analyses 
specifically of Wisconsin's compensation packages. Jeff Keefe, 
at Rutgers University, looked at it and found that public 
sector workers receive somewhat less total compensation than 
comparably educated, experienced private sector employees.
    If you are to cut the pensions in some way, you could no 
doubt in the short term save some money. But workers expect 
comparable pay. If you are reducing public sector compensation, 
you could either say, well, maybe we won't get good workers in 
the future, or alternatively, maybe you will have to make that 
up in other pay. And again, the defined benefit is very 
important. Workers value that certainty. And again, this gets 
back to this issue Andrew was raising, that States can bear the 
risk. If you have a downturn and there are 2, 3, 4 years where 
the market is down, where things look bad, States can get 
through that risk, as long as they have in general been 
responsible.
    If you or I retire and the stock market is down, we are out 
of luck. There is nothing we can do about that. So by virtue of 
taking that risk, that is a very big benefit for workers, that 
they are willing to give up other compensation for. We would 
lose that if we end defined benefit plans.
    Mr. Cummings. One of the things, when you talk to workers, 
particularly ones in my district, they tell me that when they 
were voting for various, during union negotiations, that they 
took less pay because they were worried about the benefits when 
they retired.
    Mr. Baker. It is very common. Public sector workers have 
lower pay by almost every measure than private sector workers, 
straight wages. But they have somewhat better pensions and 
health care benefits.
    Mr. Cummings. Thank you, Mr. Chairman.
    Mr. McHenry. The gentleman's time is expired. And with 
that, I recognize the full committee chairman, Mr. Issa of 
California.
    Mr. Issa. Thank you, Mr. Chairman. Thank you for holding 
this important hearing.
    Dr. Biggs, we have a constant debate, it seems, on public 
and private sector activities, union, non-union. The ranking 
member went on quite a bit acting as though it is a scapegoat. 
Don't we have basically a difference between unionized private 
sector workers and public workers, particularly in that, in the 
private sector, a unionized worker is in Social Security, while 
in the public sector, at all the State levels, virtually, they 
are in a system that has their high pay opted out of Social 
Security and often Medicare, which means they are out of a 
system and into their own system, which is not fully paid for.
    As I think Dr. Baker made very clear, they have this safety 
net, which is current overseers, the elected officials and/or 
the elected representatives, can make a deal that ultimately 
they know cannot be kept in the future without unrealistic 
expectations of growth in their bonds. Typically in California 
they were assuming a growth that you could not find in any 
index, but you could find it for a short time in PERS and 
STERS. Would you like to give us a little insight into that 
part of the problem we are dealing with in these pensions?
    Mr. Biggs. Well, this I think is an important issue, 
because one question, how you resolve some of these pension 
financing issues, comes down to your perceptions of how well or 
how poorly paid public sector employees are. You are right that 
many public sector employees don't participate in Social 
Security. That is sometimes pointed out as though they are 
losing something in that regard. I don't want to downplay the 
important protections that Social Security provides. But as a 
general deal, public sector pensions are a far better deal for 
them. Social Security would pay them on average a rate of 
return of around 2 percent of their contributions. Under the 
typical public sector pension, they are effectively guaranteed 
a rate of return around 8 percent. Compound that over your full 
career, and it is an enormous difference.
    You also tend to get, in the State and local sector, 
retiree health care, which can be very generous, and often that 
is not included in the private sector. Congressman Cummings was 
just mentioning employees in Wisconsin. I know Milwaukee 
teachers, for instance, receive retiree health care that is 
worth around 20 percent of their pay. The sort of pay studies 
we have heard about today saying that State and local employees 
are underpaid, it doesn't include retiree health care. It also 
tends to undercount the pension benefits they get.
    So we want to get a good feel for where things stand. We 
have to compete for workers with the private sector. If you are 
in any low level of government, you don't want to underpay 
people. But it takes careful analysis to be able to tel whether 
they are being fairly paid or not.
    To touch on your last point, the assumptions that go into 
the pension financing and things like this, I focused on the 
assumed rate of return, and that is the most important one. 
There are many other things that can be jimmied around. 
Illinois had some problems where they would cut benefits for 
workers that haven't even been hired yet and book those savings 
today. There have been examples in Washington State where their 
actuary said, you have to better account for the longer work 
lives of people, and the board said, no, we are not going to do 
it.
    Mr. Issa. And I am going to cut you off, I apologize. It is 
a good train of thought, and certainly in San Diego, we have a 
scandal where that has been well codified in criminal 
prosecutions.
    Dr. Baker, I saw you startled when I talked about the 
unrealistic expectations of the growth in PERS and STERS and so 
on. I heard you say earlier, with the ranking member that, 
well, the markets have come back. But isn't it true that if you 
were broadly invested, you in fact over the last 3 years had 
effectively net zero? And net zero is 24 percent compounded 
less than the anticipated amount that these contributions were 
based on. Can you sit here today saying that anyone on this 
side of the aisle should have confidence in these retirement 
plans, if they assume 8 percent growth rather than, let's just 
say, inflation plus 1 or 2?
    Mr. Baker. I don't think there is anyone who has been more 
critical of overly optimistic returns in the stock market than 
I am. And I base that on price to earnings ratios. They were 
very high in the 1990's. They were still somewhat high in the 
last decade. They have fallen a great deal. Future returns 
depend on current price to earnings ratios. Now that the price 
to earnings ratio is considerably lower, if you look out over a 
20, 30 year horizon, then yes, I could look to your side of the 
aisle and say yes, I think those returns are very reasonable, 
and have done the arithmetic.
    Mr. Issa. OK, well, I hope you are right. Let's do another 
half of this. Dr. Biggs, back to you for a second. We have 
historically low interest rates today. We have a huge, 
ballooning Federal deficit, but my own State of California and 
many others have built up a lot of debt. What happens if we 
return to, if you will, somewhere between where we are today 
and where we were in the 1970's? What happens to both the 
Federal and the States' ability to meet pension obligations?
    Mr. Biggs. The Federal budget, and to a degree, the State 
budgets, have benefited from the fact that our financing 
crisis, our budget problems, have coincided with significant 
financial problems overseas, which has pushed capital from 
foreign countries into the United States. That has helped keep 
our interest rates low. We are very advantaged by virtue of 
that.
    If interest rates start rising back to normal levels, or if 
they go even further, if markets are not convinced of our 
ability to get on top of our deficits, then all of this process 
starts cascading and it happens much, much sooner than we 
otherwise anticipate. The history of financial crises, whether 
you are talking about currency crises, banking crises, is they 
can continue going on normal. But when they happen, they happen 
very, very quickly.
    So I think it is very good and we are very lucky to have 
low interest rates today. We should not be complacent because 
of that.
    Mr. Issa. Thank you. I yield back.
    Mr. McHenry. Thank you, Mr. Chairman. I will now recognize 
Mrs. Maloney for 5 minutes.
    Mrs. Maloney. First of all, I want to thank the chairman 
for holding this, and the ranking member.
    We are going to the floor shortly on a budget vote to 
continuing resolution. And in the budget proposals that have 
come forward for fiscal year 2012, practically every, 42 States 
have proposed to spend less on education and health care than 
they spent in 2008 after inflation. States are proposing these 
cuts, despite the fact that the costs associated with their 
services will be higher.
    So given that backdrop, I would like to ask Mr. Baker, why 
is it important at this time not to cut Federal funding for 
State and local governments?
    Mr. Baker. Again, I would say there are two reasons here. 
One, perhaps the more important, is the macroeconomic reason, 
that at this point the Federal deficit is supporting the 
economy. If we were to radically roll back the Federal deficit 
in 2011, we would see less demand. I don't know of any story I 
could tell whereby if we cut back spending, laying off public 
employees, we are going to see retail stores, hospitals, 
whoever it might be, go out and hire more workers. I don't know 
a story of an economy that works like that, at least not when 
you are in the middle of a downturn.
    So the macroeconomic picture is very important. The other 
part of the story is, obviously, many of these programs have 
the character investment, we are talking about education. If 
our kids don't get adequate education, because we have 1, 2, 3 
years of economic slump, they are not going to be able to make 
that up. Some of the cuts are in regulatory programs, like the 
Securities and Exchange Commission, I would think people would 
be very sensitive to that, recognizing that we clearly had 
problems of inadequate regulation. We were talking about fraud 
in the public sector or at least questionable accounting. There 
clearly was a serious rash of that in the private sector as 
well. I would think that Congress would be very sensitive to 
that.
    So I think we could pay a big price for it.
    Mrs. Maloney. Well, isn't it true that proposed GOP cuts to 
Federal funding for State and local governments will force some 
States to impose higher taxes and to cut vital public services, 
actions that will hinder economic growth? Could you comment on 
that?
    Mr. Baker. Most States in the country are facing serious 
budget shortfalls. They are making cutbacks in a wide range of 
areas, and many of them are raising taxes as well. One could 
argue as to how vital those are. But clearly, they are making 
important cutbacks, and I think most, even the Governors that 
have been aggressive in supporting those cutbacks I think 
regret many of them in the sense that they feel they are 
cutting back services that have real merit. And again, this is 
not the time, I would think, that you would want to see 
cutbacks in programs that, say, provide health care for the 
poor. Because there are more poor now, and it is very hard to 
argue that they could simply go out and get a job, when we have 
close to 25 million people unemployed or under-employed.
    Mrs. Maloney. And Mr. Baker, how will State and local 
governments balance their budgets, without this much-needed 
Federal funding? Many States have budget gaps that are huge, 
including my own State, including the great State of California 
and others. So how in the world are they going to balance their 
budgets?
    Mr. Baker. Well, nearly every State has requirements that 
they balance the budget. There is always some room around that. 
But in most States, this will mean serious cutbacks in spending 
and/or increase in taxes, which again, this is not the sort of 
thing you want in the middle of a downturn. If we were in a 
situation where the economy were at normal levels of output, we 
were operating near 5 percent unemployment, you could say, OK, 
fine, the private sector will pick up the gap. But I don't 
think credibly can tell that story, given where the economy is 
today.
    Mrs. Maloney. I want to thank you for your testimony and 
just conclude by saying that State and local governments have 
eliminated 426,000 jobs since August 2008, and State budget 
cuts have eliminated additional jobs in the private sector. In 
fact, at least 13 of 42 States who have released budget 
proposals for fiscal year 2012 have proposed layoffs and cuts 
in pay for public workers, and 8 States have proposed measures 
such as extending expiring tax surcharges, repealing tax 
credits or deductions and broadening the base of some taxes, 
and raising rates. We have been called for a vote, on that sort 
of depressing note.
    Thank you all for your testimony and for being here today. 
Thank you.
    Mr. McHenry. Thank you for yielding back. With that, I 
recognize Mr. Ross for 5 minutes.
    Mr. Ross. Thank you, Mr. Chairman. I will try to be brief.
    I am trying to get my hands around this. It appears even 
though we have had a reduction in work forces, both federally, 
State-wide and in municipalities, there still exists an 
unfunded mandate, or an unfunded liability out there, with 
regard to the defined pension plans. Ms. Prunty, what I am 
trying to understand is, at some point, as a financial rating 
organization, you have to look at these pension plans and say, 
it is too good to be true. You have to look at the investments 
that they are making in order to fund these, correct?
    Ms. Prunty. When we are analyzing pension, we do include 
pension in our review. It is part of our criteria and has been. 
We look at all of the underlying assumptions, we look at the 
liabilities, and it is factored into our rating. You will see a 
differential, for instance, Utah is a triple A rated State. 
They have very proactively managed those liabilities and looked 
at their assumptions. You do see us factoring in----
    Mr. Ross. They have looked at it and made adjustments 
moving away from defined benefit plans, is that correct?
    Ms. Prunty. That is part of the solution in Utah. But that 
is not universal across governments. Most of the pension plans 
do remain defined benefit.
    Mr. Ross. In your statement you say, in general, we believe 
worst case scenarios regarding pensions will occur only if 
governments are unable or unwilling to use their powers of 
adjustment. What would you recommend to be their powers of 
adjustment in order to avoid the worst case scenarios?
    Ms. Prunty. I don't think we would have a recommendation on 
what the power of adjustment is. But I think history has shown 
that they have the ability to either manage the liability side 
of the equation or increase contributions or make other 
adjustments to the overall program and plan. So those are 
really policy choices that each individual State or local 
Government will make.
    Mr. Ross. Moving from a defined benefit plan to a 
contribution plan would be a step in the right direction, would 
you not agree?
    Ms. Prunty. I think that we would say that those are, 
again, policy decisions that each government is going to make 
on, and we will look at the overall impact on the liabilities.
    Mr. Ross. But from your perspective, from your financial 
rating perspective, it would be more advantageous to a better 
rating if it was a contribution plan?
    Ms. Prunty. I think proactively managing liability is 
certainly very positive. And making a strong commitment to 
funding the pensions has historically been consistent with a 
high rating level.
    Mr. Ross. Mr. Kurtter, I want to go to you for one quick 
second, because you also are in the financial rating business. 
If, as the title of today's hearing implies, bailouts on 
private and public programs, if there were ever to be a 
bailout, would that not be an assumption, then, that a 
financial rating service would have to take into consideration 
when giving a rating, once the precedent is set?
    Mr. Kurtter. Our ratings don't assume that the Federal 
Government will bail out States. We do assume that----
    Mr. Ross. But let's assume that it is done, that a bailout 
is actually done.
    Mr. Kurtter. What we do consider is that the Federal 
Government has always and by law assumes the cost of emergency 
response in the event of natural disasters and other man-made 
events. We do build that into our ratings.
    Since the role of the Federal Government in providing 
bailout, if a State were to need assistance, is uncertain, we 
don't embed that in our ratings, because we don't have enough 
precedent to reliably know that investors could depend on that.
    Mr. Ross. It would seem to me, though, that once a 
precedent is set, then it would have to be considered as a 
potential assumption in making your ratings.
    Mr. Kurtter. A precedent is situationally based, and may be 
a relative particular circumstance that may not be something we 
could rely on in the future.
    Mr. Ross. Dr. Biggs, one thing real quickly. Mr. Kurtter 
points out we do not expect any States to default on their bond 
obligations in the next 12 to 18 months. Do you agree or 
disagree with that statement, and why?
    Mr. Biggs. I wouldn't want to overstate my confidence in 
this area, because it really depends on State by State 
knowledge. It is also extremely difficult to predict low 
probability events. If we had defaults every year, we would 
have very good models for knowing what leads to a default. At 
this point, they are so infrequent it is hard to say. So I 
think I would agree, but it is certainly not something I would 
be complacent about.
    Mr. Ross. OK. And Senator, last question. Given the bad 
results of many revenue bond projects, should such highly risky 
projects benefit from tax exemption?
    Mr. Liljenquist. Pardon me?
    Mr. Ross. On municipal bonds, should we continue to have 
tax-exempt municipal bonds, or should Congress come into play 
and say, hey, wait a second, these things are so risky, there 
is such a high rate of default, we are incentivizing the sale 
of them with tax exemption, should we as Congress step back and 
say, you know what, maybe we should readdress the tax-exempt 
status of these things?
    Mr. Liljenquist. I think that is a good question. I think 
the challenge we have more with our municipalities is having 
them over-extend themselves, because of the free ability of 
credit. We are addressing that in our State ourselves, trying 
to make sure that our cities aren't over-extending themselves. 
We end up being the catch-all for them, so that is something to 
consider.
    Mr. McHenry. The gentleman's time is expired.
    With that, I am going to recognize the vice chair, Mr. 
Guinta from New Hampshire, for 2 minutes, and then Mr. Walsh 
for 3\1/2\ or 4 minutes, depending on the time for the votes on 
the floor. Mr. Guinta.
    Mr. Guinta. Thank you, Mr. Chairman. Thank you all for 
being here. I will be very brief, because we do have to go over 
to vote.
    A question for Dr. Baker. First of all, do you feel, 
generally speaking, that the Federal Government should be 
backing the loans that States are asking for and demanding for 
their borrowing?
    Mr. Baker. I am afraid I am not sure which loans you are 
referring to.
    Mr. Guinta. The Build America bonds program.
    Mr. Baker. Oh, I am sorry.
    I think a program like that is a reasonable program. One 
could construct different contours to it, sure. But I think 
given the situation where we are in the economy, I think it 
does make sense for the Federal Government to encourage States 
to engage in infrastructure spending, stimulus of different 
types. We do need to boost the economy.
    Mr. Guinta. And for the edification of the committee, what 
is your opinion as to where the Federal Government gets that 
money from?
    Mr. Baker. Given that we are in a downturn right now, that 
would mean borrowing. I don't think there is any doubt about if 
you were to raise taxes, it would be self-defeating.
    Mr. Guinta. OK, so the Federal Government is borrowing the 
money to give to States so they could borrow to pay whatever 
obligations they have. I hope that they are not doing it for, I 
would accept that it would be capital-based projects and things 
of that nature. But I have seen some States borrow to pay their 
operating costs, which is obviously not a good thing to do, but 
I have seen it.
    I guess my question would be, this Build America Bonds 
program is expiring, correct?
    Mr. Baker. That is correct.
    Mr. Guinta. Does that have a negative or a positive effect 
on, from a rating agency perspective, for the States that are 
using, that have used that program?
    Mr. Baker. Did you want me to answer that question?
    Mr. Guinta. Sure.
    Mr. Baker. If they reduce their borrowing, if they are no 
longer borrowing because the program is not there, I imagine it 
would be pretty much neutral.
    Mr. Guinta. Would Ms. Prunty or Mr. Kurtter agree with 
that? Where is there an effect, now that this program is 
lapsing?
    Ms. Prunty. The Build America Bond program has, the 
expiration has hit the end of the year. So I think that the 
Build America Bond program was helpful in expanding the market 
for municipal bonds. But it wasn't a direct credit issue for 
State and local governments.
    Mr. Guinta. OK, thank you.
    Mr. McHenry. With that, I recognize Mr. Walsh.
    Mr. Walsh. Thank you, Mr. Chairman.
    Dr. Biggs, I was going to ask you a few questions about my 
home State of Illinois, but we have to vote, so I won't. Let me 
just ask you one quick big picture question. It has been 
suggested by the other side, I think, that Government spending 
cuts, maybe even cutting some public sector jobs at the State 
and local level, might do some harm to the economy, might do 
some harm to the private sector economy. Just give me your 
view. Does that make sense to you?
    Mr. Biggs. There has actually been a range of studies that 
have been done by international organizations, like the IMF, 
the World Bank, the OEC, that have looked at countries that 
have successfully balanced their budgets. There are some who 
have tried and failed, some who have tried and succeeded. The 
countries that tried to balance their budgets and succeeded in 
reducing deficits and debt did it principally on the spending 
side, I guess around 85 percent on average spending, only 
around 15 percent tax increases. And those countries tended to 
focus on reductions in transfer spending and reductions in what 
is called the government wage bill, which is the size and pay 
of the government work force.
    One thing that these studies have found, and there is some 
debate, but the worst case they found was that these sorts of 
steps tend to be neutral with regard to the economy. Tax 
increase they founded tended to hurt the growth of the economy. 
Some studies have found that these steps could even improve 
economic growth because of the confidence factor they build in. 
The individuals and businesses and financial markets see the 
government getting on top of these tough problems. And even if 
they are long-term solutions, they feel better today and that 
helps get the economy going again.
    Mr. Walsh. Great, thank you. Just one other quick question.
    Senator Liljenquist, what is one quick takeaway? What can 
the rest of the country learn about Utah, if you can bestow one 
lesson on all of us?
    Mr. Liljenquist. I think the lesson would be that reality 
is not negotiable. If you can look forward and see what are 
bearing as a State, which is what we did on pension problems, 
it didn't pass the smell test. We looked at every scenario. And 
that was 95 percent of the battle, as we went person by person 
in our legislature, and sat down with them and showed them the 
data.
    We are burying far more risk than we ever dreamed. And I 
think that is the message, that reality is not negotiable. You 
have to do something.
    Mr. Walsh. Great, thank you.
    Mr. Chairman, I yield back.
    Mr. McHenry. I appreciate the gentleman yielding back. I 
certainly appreciate the testimony today.
    Mr. Kurtter, in particular, thank you for being 
forthcoming. Your analysis, that is very helpful. We wanted to 
have that from the credit rating agencies.
    I appreciate everybody taking the time to travel to 
Washington. I know it is not easy to go before a committee like 
this, but thankfully it was brief in comparison to some other 
hearings, because we have been called to the floor for votes.
    We certainly appreciate your analysis. This is certainly an 
ongoing series, and we want to have feedback on what is 
necessary for us to have accurate transparency and disclosure 
in the marketplace, so that, actually, those participating, 
those lending money to States, will have the transparency they 
need to actually make an accurate decision and price risk. That 
was obviously the center part of this hearing. We certainly 
appreciate your testimony. We understand there is a challenge 
out there, the magnitude of which, there has been a little 
debate. But there is a problem, and we have to tackle that.
    Thank you for your testimony. This meeting is now 
adjourned.
    [Whereupon, at 3:11 p.m., the committee was adjourned.]

                                 
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