Government pension obligations the next fiscal crisis? State and local governments across the nation are suffering serious pension plan shortfalls and issuing bonds in desperate efforts to shore up their funds. CFOs need to prepare for this upcoming crisis.

• Author: Cheney, Glenn Alan
• Position: PENSIONS - Chief financial officers - Legislation

Are we looking in the face of the next financial crisis--the chronic, endemic underfunding of government pension plans? The problem is huge--so huge that, if it comes to a crisis, its ramifications will have a severe impact on companies throughout the United States.

A report issued this year by the Pew Center on the States, The Trillion Dollar Gap, reveals shocking numbers. As of the end of 2008, the shortfall for the nation's state and local government employee retirement funds was $1 trillion. In 2000, slightly more than half of states had fully funded pension systems. In 2008, only four were fully funded, and 21 states were funded below 80 percent.

In reality, the numbers are probably far worse than those in the report. Pension fund investments took a wicked blow when the recession hit, and many financial executives and analysts are questioning the validity of the financial statements that are the foundation. Orin S. Kramer--manager of the hedge fund Boston Provident Partners and chairman of the New Jersey Investment Council, which oversees that state's pension system--says the national total would be closer to S2.5 trillion if calculated under the more rigorous rules for corporate pensions.

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But corporate standards, too, are widely criticized as too lax. Kramer believes that if more appropriate corporate rules were applied to governments, states and cities would find their pension systems underfunded by $3.5 trillion.

That's a quarter of the U.S. gross national product. And that figure doesn't include other post-employment benefits, such as health care--another unfunded liability of $1 trillion.

The problem is already hitting some states hard. For example, California has made major cutbacks in services, and next year's deficit will be larger than this year's. And in New Jersey, in February, Gov. Chris Christie declared a fiscal emergency for the 2009-10 fiscal year, saying later said that the 2011 budget faced problems of even greater magnitude.

How could the country veer so close to crisis again so soon? Politics, it goes without saying, has a lot to do with it. But it's also in the accounting--how is money that isn't there yet actually calculated?

It's in the Math

The money that isn't there yet is an actuarial issue. Under Governmental Accounting Standards Board (GASB) rules, governments estimate how long their employees are likely to collect pensions and how well pension investments are likely to pay off over those hypothetical decades. Unlike the corporate practice of using actual market prices to project investment payoffs, the rules for governments allow pension planners to set their expected returns at whatever level they deem reasonable.

But reasonable according to whom? It varies, and sometimes it's at the whim of political pressure. North Carolina and...