Former Los Angeles Mayor Richard Riordan, who has been a prescient critic of current state and local pension plans, published a piece earlier this week in the New York Times with former journalist Tim Rutten proposing a federal bailout of state and local pension plans. No doubt the Times was happy to get a prominent Republican former mayor to sign on to its campaign for bailouts of fiscally irresponsible cities and states, but before other Republicans (and Democrats in states and cities that don’t have these pension problems) sign on to the Riordan plan, they should think carefully about the path we seem to be heading down. 

Riordan and Rutten propose a tradeoff, based on an idea floated by Stanford finance professor Joshua Rauh, in which the federal government would provide lending guarantees to states and cities so they could finance badly underfunded pension systems in exchange for basic reforms the states and cities would have to agree to in their pensions.

One big problem, however, is that once you open the door to a federal bailout, it becomes easier to negotiate away the proposed ‘reforms’ until they become more or less meaningless, and what we are left with is really only a federal bailout.

Riordan and Rutten propose reforms that are already less onerous (and more expensive) then those originally proposed by Rauh and research partner, Robert Novy-Marx, in this 2010 piece in the Economists Voice. In that piece the economists argue that states and cities that need a bailout would have to freeze their current pension systems and create new, defined contribution plans for new workers, ending the endless risk that taxpayers face from the current system of defined benefit plans.

Riordan’s big reform is a universal discount rate imposed on public pension funds so that states can’t use high projected future investment returns to make their pensions seem better funded then they are. While that’s a nice idea, the devil is in the details (how would the number be determined? who would do it?  what would we wind up with?). It still leaves a system in place that can be gamed more easily than the Rauh proposal for shifting workers to defined contribution plans.

In a recent blog entry, Rauh points out that while Riordan and Rutten try the same ‘carrot-and-stick’ approach that he suggests, their plan involves a bigger carrot. They want the federal government to ‘guarantee’ the debt. Rauh suggests only providing tax advantages that might lure investors to borrowing that would be used to refinance these pension systems.

Rauh estimates his own plan would cost the federal government about $75 billion, but the Riordan-Rutten plan would be significantly more expensive. Even more to the point is that Riordan’s plan would create yet another federal insurance plan that might wind up being far more costly to taxpayers than we can imagine now.

Yes, it’s true that Riordan’s reforms might be more palatable to unions in places like Chicago or Los Angeles. But these folks are hardly in a strong negotiating position right now. They desperately need federal money because they simply can’t afford to fix their pension problems on their own without steep cuts to benefits.

And we’re still a long way from any pressure on a Chicago or Los Angeles, even in the wake of Detroit, creating some widespread financial ‘contagion’ that would bring down the whole financial system.

It makes no sense to imagine that those who are in desperate straits should dictate the terms of their bailout, or that we should be hesitant to propose thorough and effective reforms for fear the insolvent will reject them.

Crossposted at Public Sector Inc.