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Public Employee Pensions and Municipal Insolvency
By Sean Myers
This paper studies how municipal governments jointly manage spending, credit market borrowing, and public employee pensions. I model governments as levered investors who must meet non-defaultable pension obligations and may value government spending more than citizens. I quantify the model using California city-level data, including a new record of fiscal emergencies, tax increases required to maintain essential services. After the financial crisis depleted pension funds, cities engaged in excessive risk-taking: the fiscal emergency option encouraged gambling for resurrection that kept cities vulnerable to shocks well into the recovery. Restricting risk-taking does not correct this problem, but a spending cap does.
Source @SSRN
