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Remarks at Municipal Securities Rulemaking Board’s 1st Annual Municipal Securities Regulator Summit

Commissioner Daniel M. Gallagher

Washington, DC

May 29, 2014

Thank you, Lynnette [Kelly], for your very kind introduction.  I am honored to be today’s keynote speaker at the first MSRB Municipal Securities Regulator Summit.  The MSRB has always been an important institution, but never more so than now.  The statutory construct governing municipal securities regulation places the MSRB on the front lines of the federal oversight program for these vital markets and the participants therein.  And, thanks to more than half a decade of the Federal Reserve’s zero percent interest rate environment, the fixed income markets have taken on an increasingly important role in the financial planning of retail investors.

I’d like to speak to you today about some of the significant issues facing the muni markets, but before I do so, let’s briefly step back and take a look at the overall state of the non-Treasury U.S. fixed income markets.

Debt financing is a critical part of the U.S. capital markets, playing a central role in the operation and stability of both our public and private sectors.  The $3.7 trillion municipal bond market allows state and local governments to finance important infrastructure projects and provide a variety of public services.[1]  The $11.3 trillion corporate bond market provides cash for companies to run everyday operations and to grow their businesses through capital investment.[2]  The retail participation rate in both of these markets is very high:  72% in the municipal markets, and 46% in the corporate markets.[3]  But despite the importance of these markets, they are surprisingly opaque to investors.

If you ask an average investor to picture the equity markets, what comes to mind?  Perhaps traders rushing around the floor of the New York Stock Exchange.  But that image is now anachronistic, with the vast majority of today’s equities trading done on electronic venues.

Now ask that investor to picture the fixed income markets.  More likely than not, they’ll either call up another image of the floor of the NYSE or simply be stumped.  Maybe a good approximation of today’s debt markets are the scenes from the equity markets of 25 years ago as portrayed in The Wolf of Wall Street.  Although I do hope there is a lot less fraud, and at least a little less debauchery, than what was depicted in that film.  It is still common for investors to place corporate and municipal bond trades by calling their broker for a quote, without much insight as to whether they are receiving best execution and a fair price.

The fixed income markets, interestingly, have not always been this way.  In the early part of the twentieth century, there was an active market in corporate and municipal bonds on the New York Stock Exchange.  But by the late 1940s, municipal and corporate bonds had largely migrated to opaque, over-the-counter dealer markets.  While electronic trading is on the rise in the bond markets today,[4] corporate bond desks at some major Wall Street firms do indeed continue to execute trades primarily over the phone.[5]

So when people ask me how the SEC should respond to Michael Lewis’s Flash Boys—with its striking tales of high frequency trading in equities—my response is that we still need to respond to Lewis’s 1989 classic Liar’s Poker, and its vivid descriptions of the bond market structural issues that are still present today.

As the primary regulator for both the equity and the fixed income markets, the SEC needs to make sure its limited resources are properly allocated.  Currently, it’s a tale of two OMS units.  Our Office of Market Supervision—OMS—within the Division of Trading and Markets alone employs over a hundred staffers devoted to the oversight of the equity and options markets.  By contrast, the Commission only recently increased the staffing for the Office of Municipal Securities—also, of course, OMS—to 6 staffers.  Importantly, we also created a municipal securities specialty group in our Division of Enforcement, and they have been doing tremendous work for investors.  We still, believe it or not, have no staff focused solely on the corporate bond market—it’s covered by a loosely-knit, cross-divisional group of staff who spend some time as necessary on issues arising in that market.  These individuals are truly talented, but there’s only so much they can do to cover these significant markets.

So, to address these issues, where do we begin?  For municipal bonds, a good starting point would be the extensive work the Commission recently undertook to examine the municipal securities market.  In 2010 and 2011, the Commission held public field hearings regarding the state of the municipal securities market, which culminated in the Commission’s 2012 Report on the Municipal Securities Market.[6]  Some of the issues that the report highlights, such as pre- and post-trade price transparency, dealer pricing obligations, and disclosure practices, go to the heart of the SEC’s mission.  The Muni Bond Report is excellent, and I recommend those who have not read it to do so.  In fact, I believe the Commission should consider undertaking a similar effort with respect to the corporate bond market.

Building on the work of the Muni Bond Report, I would like to focus today on three secondary market issues that I view to be particularly important:  riskless principal markups, post-trade price transparency, and best execution.

Riskless Principal

Riskless principal transactions take place when a dealer who has received a customer order immediately executes an identical order in the marketplace, while taking on the role of principal, in order to fill the customer order.[7]  By doing so, the dealer takes on very little risk that the market will move against it.  Conceptually, this is little different than the dealer trading on an agency basis.[8]  In fact, I have yet to hear a convincing argument to support the alleged distinction between riskless principal and agency trading.

The SEC focused on this issue in the Muni Bond Report, recommending that the MSRB consider requiring dealers “to disclose to customers, on confirmations for riskless principal transactions, the amount of any markup or markdown.”[9]  The report noted that while MSRB Rule G-15 generally requires municipal bond dealers acting as agents to disclose any remuneration to be received from the customer, there is no comparable requirement for dealers acting as principals—even in a riskless environment.

Given that “riskless principal” is basically just a fancy name for “agency,” there is no real reason to perpetuate this dichotomy.  Disclosure of the markup or markdown in riskless principal transactions would enable customers to assess the fairness of the execution prices.[10]  I encourage the MSRB to review whether amendments to Rule G-15 to accomplish such disclosure would be appropriate.

Post-Trade Price Transparency

Price transparency is a hallmark of fair and efficient markets.  The MSRB and FINRA have helped improve fixed income market transparency through the creation of systems designed to centralize the collection and dissemination of post-trade price information.

In 2002, FINRA implemented its Transaction Reporting and Compliance Engine, or “TRACE,” which now provides investors with access to bond transaction and price information free of charge and on a near real-time basis for a significant portion of U.S. corporate bond market activity.[11]

Similarly, building on its existing Real-Time Transaction Reporting System, the MSRB launched the Electronic Municipal Market Access, or “EMMA,” web site in 2008.  I am proud to have worked on that project when I was counsel to Chairman Cox.  EMMA now provides investors with free access to transaction and price information on a near real-time basis for the majority of municipal bond trades, and hosts important municipal disclosure documentation.  In fact, in the past few months, the MSRB enhanced the design and organization of the EMMA website to make it easier for investors to find key information.[12]  If you have not seen the revised website, I encourage you to do so—once you’ve finished reading the Muni Bond Report as I suggested earlier, of course.

Best Execution

Despite these advances in post-trade price transparency, retail investors continue to face headwinds in the bond markets.  The opacity of the markets, especially given the lack of a centralized collection and continuous dissemination of bid/ask quotes—that is, pre-trade price transparency—makes it difficult for retail investors to feel confident that they received the best execution.

MSRB rules require that municipal bond dealers trade with customers at “fair and reasonable” prices and exercise diligence in setting the market value of municipal securities; MSRB rules also address the reasonableness of dealers’ compensation.[13]  One of the recommendations in the Muni Bond Report was for the MSRB to consider a best execution standard for municipal bond dealers.[14]  In February of this year, the MSRB proposed establishing, for the first time, a best execution rule for municipal securities transactions.[15]  The draft rule would require brokers, dealers, and municipal securities dealers to use reasonable diligence in seeking to obtain for their customer transactions in municipal securities the most favorable terms available under prevailing market conditions.  This is an important, aptly-named step forward, and I hope the MSRB will be able to finalize it soon.

* * *

In addition to the trading issues I have just discussed, the Commission must recognize, as laid out in the Muni Bond Report, that there are major issues we need to address in the muni offering area.

One of the biggest issues facing muni investors, I believe, is the failure by issuers to disclose the true extent of pension and other post-employment benefit, or OPEB, obligations.  Trillions of dollars in liabilities—reflecting amounts promised to state and local government workers—are not appropriately reflected on government books, thereby seriously misleading investors about the riskiness of their investments in municipal securities.[16]

Pension and OPEB Liabilities Are a Serious Threat

Even according to their own optimistic estimates, state and local pension plans are underfunded by $1 trillion.[17]  However, many believe that the true number is substantially higher—over $4 trillion[18]—placing it in the range of the much more well-known $6.5 trillion unfunded Social Security obligation.[19]  To fully fund these public pension shortfalls, every household in the U.S. would need to pay $1,400 per year for the next 30 years.[20]

The problem, however, is not evenly spread across all households in the U.S.  For example, in one particularly profligate jurisdiction, each household is responsible for over $88,000 in unfunded pension liabilities, split between city and state underfunded pension plans.[21]  This is nearly double the median city household income of $47,400.[22]

The severity of these unfunded pension obligations and their potential impact on investors are not merely academic issues—they are being played out right now in Detroit’s bankruptcy proceedings.  While Detroit’s pension funds were originally set to receive the same haircut as other contractual obligations,[23] the current bankruptcy plan, if approved, would result in pensions escaping nearly unscathed.[24]  Pensions will be protected through an infusion of cash gained by the sale of Detroit’s art collection,[25] while limited-tax general obligation bondholders will receive only a 10 to 13 percent recovery.[26]  It’s not clear how an expected $100 million in federal blight relief funds—which would essentially be an indirect federal bailout of Detroit—will be applied.[27]  But if, as it appears will happen, Detroit proves that bankruptcy courts will favor underfunded pension funds over bondholders, it is imperative that bondholders know with precision the size of the potential pension liabilities of the entities in which they are investing.  And yet, they do not.

The Threat Has Been Hidden From Investors

This is because, for years, state and local governments have used lax governmental accounting standards to hide the yawning chasm in their balance sheets.

To explain why, first we need to do a bit of pension math.  If you’re one of the few audience members still listening, particularly after I said “pension math,” I thank you.  Basically, expected future cash inflows from return on investment plus contributions from plan sponsors must meet or exceed expected future cash outflows from payments to retirees.

To calculate future inflows, a sponsor must assume the fund’s future rate of investment return.  Here, state and local pension plans have generally been over-optimistic:  many assume a 7.5 to 8% return, when a rate in the mid-6% range would be more realistic.[28]  Striving to meet this artificial and inflated goal may cause funds to reach for yield, exposing them to increased investment risk and potentially exacerbating the problem.[29]

Even worse, pension plans also have valued their expected outflows based on this same expected return on assets, discounting their future liability to a present value using that 7.5–8% number.[30]  This is contrary to fundamental tenets of financial economics:  liabilities should be valued at a rate that reflects their risk, not the risk of the assets that are expected to cover the liabilities.[31]

The riskiness of a pension obligation depends on state law.[32]  If pension obligations have the same preference as general obligation debt, then the municipality’s own municipal bond yield (generally around 5%) would be the proper discount rate.[33]  Or, if as we’ve seen from Detroit, pensions will be saved before all else, then we should use a default-free measure to discount the liability:  specifically, the Treasury zero-coupon yield curve.[34]  This would result in a discount rate in the low 3% range.

Obviously, the higher the discount rate, the lower the present value of the liability.  The difference between a discount rate in the range of seven percent and one in the range of three percent is in large part responsible for the hidden $3 trillion in unfunded liabilities that are currently going unreported.

This lack of transparency can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees,[35] or not to make the promises in the first place.

In the private sector, the SEC would quickly bring fraud charges against any corporate issuer and its officers for playing such numbers games.  And, we would also pursue and punish the so-called fiduciaries who recklessly seek yield to meet unrealistic accounting assumptions.  We should not treat municipalities any differently.

Recent Reforms Have Improved Pension Disclosures

The Governmental Accounting Standards Board, or GASB, began its efforts to fix this problem approximately eight years ago.  Unfortunately, its standard-setting project proved hugely controversial.[36]  And so, while the resulting standard is a step in the right direction, there is more that needs to be done.

Specifically, the new GASB standard partially addresses the discount rate issue.  Rather than discounting all pension liabilities using an unrealistic rate of return on assets, municipalities are permitted to use that rate only for “funded” liabilities—liabilities covered by existing and expected future assets.  Unfunded liabilities must be valued using the high-yield, tax-exempt 20-year general obligation bond rate of the governmental sponsor.

Applying this new methodology, the funded percentage reported by plans themselves should drop from 73% to 60%.[37]  This would be a good step toward reflecting reality, but the new methodology is not without its own issues.  For example, because “funded” liabilities includes liabilities covered by expected future assets, it can be far too easy for a state legislature to commit to achieving full funding in 35 or 40 years, perhaps by using a back-weighted contribution schedule.  This would allow state and local plans to use the rate of return on assets to discount 100% of the expected liability, thereby continuing to hide the true extent of underfunding.  The new methodology also does not fully solve the “burning cash” and chase-for-yield problems that using a rate of return to discount liabilities can produce.[38]

The new GASB standard also does away with the annual required contribution, or “ARC.”  The ARC was the amount plan sponsors had to pay to amortize unfunded liabilities over a maximum 30-year period.  Every plan was required to disclose the ARC, and so it was a well-defined, easy-to-use measuring stick to determine whether plan sponsors were meeting their funding obligations.[39]  While I understand the need to divorce the technical nature of accounting for pension promises from the political nature of funding those pension promises through the state budgetary process, removing the ARC will diminish transparency on this important issue.  But GASB standards are a disclosure floor, not a ceiling.  Nothing is preventing entities from re-creating, and using, the ARC—and I would encourage them to do that.

Additional Steps Need To Be Taken To Fully Inform Investors

To be clear, I believe that GASB has done a tremendous service to investors by bringing some much-needed transparency into accounting for public pensions, and I applaud GASB’s Chairman and board members for that.  And, as SEC staff has made clear, we will be closely monitoring compliance with the new GASB standard.[40]

But reform in this area is an iterative, incremental process, and I hope that GASB will revisit the discount rate and ARC issues in the coming years.  In the interim, I believe we should insist on supplemental disclosure to help bridge the informational gap.

Specifically, municipalities should follow the new GASB pension accounting standards.  In fact, I believe all municipalities should be held to that standard.  But in addition, there should be a common disclosure baseline against which all municipalities can be compared.  First, entities should value and disclose their liability using a risk-free discount rate, for example, the treasury yield curve, applied to all benefit liabilities.[41]  Second, entities should calculate and disclose a baseline plan contribution—the amount actuarially necessary to fully fund the plan—based on those conservative liability assumptions, along with a conservative estimate of return on investment.[42]  Investors would then be able to readily compare financials calculated using GASB standards and disclosures about the current level of plan funding against this common baseline.  Entities would be free to explain to investors why the differences exist.

Moreover, I agree with Lynn Turner’s suggestion that we should require disclosures similar to those required of companies that are faced with an auditor’s going concern opinion.[43]  Specifically, where a plan’s solvency is threatened, for example by a legislature’s failure to make adequate contributions, specific disclosure of the existence of the threat, and plans to address it, should be required.

Finally, while I’ve focused heavily on pension obligations, those are not the only post-retirement obligation that state and local governments have.  Accounting for OPEB obligations, including post-retirement health care, life insurance, and long-term disability, was improved significantly in 2004, when these obligations were moved on-balance sheet, to the tune of $1.5 trillion.[44]  Just yesterday, GASB voted to issue exposure drafts proposing further improvements to OPEB accounting requirements.  I am thrilled that the GASB is working to improve transparency on this important issue, and its work should be finished as soon as practicable.  Liabilities resulting from promises to pay health care or other benefits to retirees should be as clear as pension liabilities.[45]  If they are not, supplemental disclosures should be required here as well.

I believe these disclosures are necessary to make financial statements prepared using GASB standards not misleading.

* * *

Thank you for giving me the honor of kicking off this important, inaugural conference.  I wish you all an enjoyable and educational day.


  [1]         Data is extracted from the most recent FRB Flow of Funds Report and the SIFMA website. The values entered are as of Q4 2013.

  [2]         Id.

  [3]         Id.  The 72% retail participation in the municipal bond space is comprised of 44% direct and an additional 28% indirect, while the 46% retail participation in the corporate bond space is comprised of 25% direct and an additional 21% indirect.

  [4]         For example, NYSE Bonds is the largest centralized corporate bond market in the U.S.; it launched in 2007.  Per NYSE Bonds, there are 6,612 CUSIPs eligible to be traded on the platform as of May 27, 2014.  While approximately 85% of all bond volume could therefore trade on NYSE Bonds, the percentage of actual trading volume is, by all accounts, much lower.

  [5]         See Will Rhode, Retail Liquidity: The Evolution of Fixed Income (Apr. 22, 2013), at

  [6]         U.S. Securities and Exchange Commission, Report on the Municipal Securities Market (2012), at 5 [hereinafter Muni Bond Report].

  [7]         For example, a dealer may receive a “buy” order, from a customer, go into the market and buy the security for the dealer’s own account, and then immediately turn around and sell that security to the customer, thereby acting as principal rather than purchasing the security in the market on the customer’s behalf as an agent.

  [8]         Muni Bond Report at 19.

  [9]         Id. at 148.

  [10]       Id. See also Commissioner Michael S. Piwowar, Speech, Advancing and Defending the SEC’s Core Mission (Jan. 27, 2014), available at (noting that “while commissions on agency transactions must be disclosed, the same is not true for markups and markdowns on riskless principal transactions, even though the trades are economically equivalent,” and characterizing that as “low-hanging fruit” that could be picked to enhance the fixed-income markets).

  [11]       Importantly, however, mandatory reporting to TRACE under FINRA Rule 6720 only applies to entities registered with FINRA.  See FINRA Rule 6710.  So trades conducted by other entities (for example, banks not trading through FINRA-registered broker-dealer subsidiaries) would not be captured in TRACE.  The regulatory authority to require banks to report such trades to TRACE is vested in bank regulators, who have thus far chosen not to require banks to report this information, impeding the ability of TRACE to provide a comprehensive picture of the corporate bond markets.

  [12]       See EMMA Electronic Municipal Market Access at

  [13]       Muni Bond Report at 149.

  [14]       Id.

  [15]       See MSRB Regulatory Notice 2014-02 Request for Comment on Draft Best-Execution Rule, Including Exception for Transactions with Sophisticated Municipal Market Professionals, available at

  [16]       Muni Bond Report at 85–91.

  [17]       State Budget Crisis Task Force, Final Report (Jan. 14, 2014) at 16, available at (data as of 2011 fiscal year) [hereinafter Task Force Final Report]; Donald J. Boyd & Peter J. Kiernan, Strengthening the Security of Public Sector Defined Benefit Plans (Jan. 2014) at vii (“They are underfunded . . . by $1 trillion using measurement practices virtually unique to the public sector pension industry”).

  [18]       Robert Novy-Marx & Joshua Rauh, Public Pension Promises:  How Big Are They and What Are They Worth?, Journal of Finance v.66(4) (2011) ($3.1 trillion) [hereinafter Novy-Marx & Rauh]; Thomas J. Healey et al., Underfunded Public Pensions in the United States:  The Size of the Problem, the Obstacles to Reform and the Path Forward, Harvard Kennedy School Faculty Working Paper No. 2012-08 (Apr. 5, 2012) (citing Rauh’s updated figure of $4.4 trillion, reflecting the depressed Treasury yield environment) [hereinafter Harvard Working Paper]; Philip Coggan, Money to Burn:  The muddle-headed world of American public-pension accounting, The Economist (May 4, 2013) (citing “best estimate of the shortfall” as “more than $4 trillion”).

  [19]       Harvard Working Paper at 13.

  [20]       Id. at 15 (citing Novy-Marx & Rauh, The Revenue Demands of Public Employee Pension Promises).

  [21]       Id.

  [22]       In case you were wondering, this fiscal nightmare is Chicago.  See U.S. Census Bureau, State and County QuickFacts:  Chicago (city), Illinois, at (Median household income, 2008-2012).

  [23]       See Monica Davey et al., Detroit Ruling on Bankruptcy Lifts Pension Protections, N.Y. Times (Dec. 3, 2013) (“The judge [presiding over the Detroit bankruptcy case] made it clear that public employee pensions were not protected in a federal Chapter 9 bankruptcy, even though the Michigan Constitution expressly protects them.”); Micheline Maynard, Detroit Is Eligible For Bankruptcy, And City Pensions Are At Risk, Forbes (Dec. 3, 2013) (“Judge Rhodes ruled that Detroit’s pensions would be treated the same as any other contract in bankruptcy, meaning that benefits could be cut.”); Alana Semuels, Detroit bankruptcy plan includes deep pension cuts, L.A. Times (Feb. 22, 2014) (noting 10% cut to police and firefighter pensions, and 34% cut to all other city employee pensions).

  [24]       Monica Davey, Detroit and Retirees Reach Deal in Bankruptcy Case, N.Y. Times (Apr. 25, 2014) (describing a deal for no cuts to police and firefighter pensions, and 4.5% cuts for all others).

  [25]       Stephen J. Lubben, Pensions vs. Art in Detroit’s Bankruptcy, N.Y. Times (May 12, 2014) (reporting on the “art deal” that would provide a “$816 million cash infusion into Detroit’s pensions in exchange for transferring title to the works in the Detroit Institute of Arts”—which is “basically a sale of the art, in exchange for money to help avoid deeper cuts to the pensions”).

  [26]       See id. (noting that “Detroit’s bondholders are a bit sore that they won’t receive the same deal”); see also Maria Chutchian, Detroit Plan Threatens Muni Bond Market, SIFMA Says, Law 360 (May 12, 2014) (reporting on SIFMA’s court filing that the “10 to 13 percent recoveries for limited-tax general obligation bondholders being offered by the city flies in the face of what investors reasonably expect when they sign on to fund a municipality’s GO bond” and that the plan, if approved by the court “will have a devastating impact on the municipal bond market”).

  [27]       See David Shepardson, U.S. Treasury chief to visit Detroit, Detroit News (Apr. 21, 2014) (describing potential diversion of up to $100 million in federal foreclosure relief funds into blight reduction in Detroit, which will allow state and local funds earmarked for blight relief to be redirected to “soften the blow of pension cuts and other financial issues”).

  [28]       See, e.g., Arthur Levitt & Lynn E. Turner, Pension Shell Games Threaten Market:  Arthur Levitt, Lynn Turner, Bloomberg (Sept. 22, 2010); State Budget Crisis Task Force, Illinois Report (Oct. 2012) at 20 (highlighting Illinois’ pension systems’ use of an 8% assumed rate of return/discount rate, and noting that “many believe that this assumed rate of return is overly optimistic,” particularly in light of the financial crisis and subsequent risks to economic recovery); Dunstan Prial, Public Pension Funds Rethinking Investment Return Rates, Fox Business (Apr. 17, 2014) at (citing a deal reached between Detroit city officials and retirees to set rate at 6.75%, and noting a rate of around 6% would not be “outlandish”).

  [29]       See, e.g., Boyd & Kiernan, supra note 16, at 8–9.

  [30]       To be sure, this measurement was appropriate under then-effective GASB standards.  See, e.g., Novy-Marx & Rauh.  Under new GASB standards adopted in 2012 and currently taking effect, it is not appropriate.

  [31]       E.g., Boyd & Kiernan, supra note 16, at vii (“The proper way to value future cash flows such as pension benefit payments is with discount rates that reflect the risk of the payments.  This is separate from the question of the rate pension funds will earn on their investments.”); Novy-Marx & Rauh (“Discounting liabilities at an expected rate of return on the assets in the plan runs counter to the entire logic of financial economics:  financial streams of payment should be discounted at a rate that reflects their risk . . . .” (internal citations omitted)).

  [32]       But cf. Task Force Final Report at 17 (noting that the Detroit bankruptcy has raised the question of whether federal bankruptcy law might preempt even state constitutional protection for worker pensions).

  [33]       Specifically, the zero-coupon yield corrected for the tax preference on municipal debt.  Novy-Marx & Rauh.

  [34]       Id.

  [35]       See Task Force Final Report at 16 (“If estimates of funded ratios based on low-risk discount rates were available, the funded status of virtually very plan would look noticeably worse . . . . Using earnings assumptions to value liabilities can make systems appear better funded than they are, making it easier for governments to avoid hard choices to shore up funding and potentially encourage changes to benefits or contributions in ways that would reduce future funding levels.”).

  [36]       E.g., Nanette Byrnes, Little-known U.S. board stokes hot pension debate, Reuters (July 10, 2012).

  [37]       Alicia H. Munnell et al., The Funding of State and Local Pension: 2012–2016 (July 2013) at 5 (applying new GASB rules to past funded ratios).

  [38]       See Daniel Fisher, Want To Make That Public Pension Look Healthier?  Burn the Cash, Forbes (Feb. 10, 2013) (describing Novy-Marx’s hypothetical).  Basically, take two plans, with identical liabilities, and identical assets in stocks.  But one has extra money in Treasuries.  The one with the Treasuries should be seen as better-funded, because it has more money, in a low-risk investment at that.  But the plan with the Treasuries will assume a lower rate of return after averaging the stock and bond returns together, thus decreasing its assumed rate of return in the future, and increasing the present value of the liability.  That combined effect can outweigh any benefit to the funded percentage derived from holding the extra cash.  Realistically, the fund would probably shift all that money to stocks—the chasing yield problem.  But Novy-Marx makes the point that simply burning the cash would also perversely increase the plan’s funded percentage.

  [39]       See, e.g., Cory Ecualitto, State Budget Solutions, GASB’s ineffective public pension reporting standards set to take effect (June 5, 2013).

  [40]       See Paul A. Beswick, Remarks at the AICPA 2013 Conference on Current SEC and PCAOB Developments (Dec. 9, 2013), available at

  [41]       Cf. Society of Actuaries, Report of the Blue Ribbon Panel on Public Pension Plan Funding (Feb. 2014) at 23 (recommending disclosures of a comparison of “1) the plan liability and normal cost calculated using its actuarial funding method and assumed earnings rate, to 2) the plan liability and normal cost calculated using a risk-free rate (e.g., the U.S. Treasury yield curve), based on the plan’s actuarial funding method and demographic assumptions”).

  [42]       Id. (“Therefore, the Panel recommends the disclosure of a ‘standardized plan contribution’ that would be compared to the recommended contribution to help users assess the adequacy and reasonableness of the plan’s contribution.  The ‘standardized plan contribution’ would be calculated by all plans using the same discount rate and funding methodology (but their own demographic assumptions).”).

  [43]       See Financial Reporting Codification § 607.02.

  [44]       See e.g., David Zion & Amit Varshney, Credit Suisse, You Dropped a Bomb on Me, GASB (2007).  This was, unsurprisingly, also controversial.  For example, Texas passed a law, H.B. 2365, giving municipalities an option to ignore GASB standards and follow statutory standards instead.

  [45]       Cf. Chris Cox & Bill Archer, Cox and Archer:  Why $16 Trillion Only Hints at the True U.S. Debt, WSJ (Nov. 28, 2012) (describing less than transparent federal accounting practices).

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