Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How One City Turned Its Pension Crisis Around
Transcript
- Lucas: There's this number that sticks in my head from a few years ago — eight billion dollars. That was the unfunded pension liability for the city of Houston back in 2017. And for context, Houston's annual operating budget was about five billion. So the pension hole was bigger than a full year of running the entire city. Luna: Eight billion dollars of promises the city had made to its retired firefighters, police officers, and municipal workers, but hadn't set aside the money to cover. How does that even happen? Lucas: It's a slow build, really. For decades, Houston — like a lot of cities — underfunded its pension plans. They'd assume the investments would earn seven or eight percent a year, and as long as that assumption held, the math looked fine. But when returns fell short, or when they didn't make the full annual contribution, the gap just grew. Lucas: And by 2017, it was at a point where the bond rating agencies were threatening to downgrade Houston's debt. That would have made borrowing more expensive for everything — roads, bridges, new schools. Luna: Right, and that's the moment where the city council and the mayor, Sylvester Turner, basically had no choice but to act. They put together a reform package and took it to the voters. Lucas: Exactly. And the interesting thing is, the voters approved it. In 2017, Houston residents voted yes on a proposition that changed the city charter to require a balanced budget, and separately, the city reached new agreements with the pension funds. The big changes were increasing employee contributions, reducing cost of living adjustments, and — this is key — lowering the assumed rate of return from around 8 percent to 6.5 percent. Luna: That last part is huge. Because when you lower the assumed return, you're effectively admitting the investments won't grow as fast, which means the city has to put more cash in today to cover the same future benefits. It's more honest, but it's painful. Lucas: It is painful. And it's the kind of thing that's hard for people to understand. A lot of taxpayers hear 'pension reform' and think it's about cutting benefits for retirees. But in Houston, the biggest lever was actually about accounting assumptions. By being more realistic about what the investments would earn, the city increased its required contribution by hundreds of millions a year. Luna: And yet, the voters went along with it. I think part of that was the timing — Houston had just been through Hurricane Harvey, and there was a sense that the city needed to get its financial house in order. But also, the reforms were hammered out with the unions, not imposed on them. Lucas: That's a really important point. The Houston Firefighters Pension System, the Houston Police Officers Pension System, and the Municipal Employees Pension System all agreed to the terms. They accepted lower future benefits for new hires and higher contributions from current employees in exchange for a more stable system. Luna: So what happened after 2017? Did it actually work? Lucas: It did — at least so far. By 2022, Houston's unfunded liability had dropped from eight billion to about four point eight billion. That's a nearly 40 percent reduction. And the funded ratio — that's the percentage of promised benefits that are actually backed by assets — went from about 60 percent to over 75 percent. Still not fully funded, but a huge improvement. Luna: Seventy-five percent is actually pretty good for a public pension plan. The national average for state and local pensions is around 70 percent, I think. So Houston went from below average to above average in five years. Lucas: Right. And a big part of that was the strong stock market in the late 2010s, to be fair. But the structural changes made a difference too. The city stuck to making its full actuarially required contribution every year, which it hadn't always done before. And the lower assumed rate of return meant that when markets did well, the actual returns outpaced the assumption, creating surplus. Luna: It's almost like the accounting change created a virtuous cycle. By being conservative, you give yourself room to overperform. Lucas: Exactly. And this is where a lot of other cities get it wrong. They keep the assumed return high because it makes the required contribution look smaller. It's a short-term political fix that pushes the cost into the future. Luna: Which is basically what got Houston into trouble in the first place. So the question is, can other cities replicate this? Chicago, for example, has something like forty billion in unfunded pension liabilities. San Jose? Los Angeles? They've all tried reforms, but the politics are brutal. Lucas: Houston had a few advantages. Texas doesn't have a state income tax, so local governments have more revenue flexibility. Also, the city charter amendment — requiring a balanced budget — gave the reform a legal backbone that's harder to undo. But I think the biggest factor was the collaborative approach with the unions. When the workers' representatives are at the table and agree to the plan, it's much easier to sell to voters. Luna: And voters also care about their city's bond rating. If a downgrade means higher taxes or worse services, they'll pay attention. Houston's reform was partly driven by the fear of a downgrade to junk status. Lucas: And that fear was real. Moody's had put Houston on negative outlook. If they'd lost their Triple-A rating — and they were at risk of dropping to double-A or lower — the cost of borrowing would have gone up significantly. For a city that was about to issue bonds for Harvey recovery, that was a huge deal. Luna: So the lesson might be that you need a crisis — or the credible threat of one — to make real pension reform happen. Otherwise, the political incentives are all to kick the can down the road. Lucas: I think that's true. But it's also worth asking: are there cities that have succeeded without a crisis? A few have. For example, the state of Rhode Island did a major overhaul in 2011 after its own near-crisis. But most need that trigger. Luna: And that's the hard part. You can't manufacture a crisis. But you can prepare for one. If your city pension is underfunded, you can start by being honest about the assumptions. That alone would be a huge step. Lucas: That's a good note to end on. The Houston story shows that reform is possible, but it takes political courage, union cooperation, and a dose of reality about investment returns. And if your city hasn't done it yet, the clock is ticking. Luna: Yeah, because the longer you wait, the bigger the hole gets. And the more painful the fix becomes. Lucas: Right. And on that note, if walking through the economy with us has made something click — maybe you think about your own city's pension differently now — you might want to know that we keep this show ad-free on purpose. It's a choice we make so we can focus on the numbers and the stories without interruption. Luna: And if that choice resonates with you, there's a simple way to support it. It's at buy me a coffee dot com slash fexingo. No pressure, just an option. Lucas: Exactly. So back to Houston — one thing I didn't mention is that the reforms also changed how the pension boards are governed. Before, the boards were dominated by union appointees. After, they added more financial experts and city representatives. That helped with oversight. Luna: So governance matters too. It's not just about the math, it's about who's in charge of the math. Lucas: Absolutely. And that's a lesson that applies far beyond Houston.