In 1762, political philosopher Jean Jacques Rousseau published The Social Contract, a concise statement on the relationship between the citizen and the state. Rousseau established his opening assumption with the famous line, “Man is born free; and everywhere he is in chains. One thinks himself the master of others, and still remains a greater slave than they.” Yet Rousseau was no cynic; indeed, he believed that there was an alternative to the social order of the mid-eighteenth century.
He framed the solution in response to what he considered the essential question of the day. He wrote that, “The problem is to find the form of association which will defend and protect with the whole common force the person and goods of each associate, and in which each, while uniting himself with all, may still obey himself alone, and remain as free as before.”
Since Rousseau’s time, the world has witnessed and benefitted from the evolution of representative democracy, yet the essential tension that he so eloquently described is undiminished. Across almost every policy area—law enforcement, emergency services, health care, education, infrastructure, defense, finance, housing, environment—the core pragmatic and philosophic debates distill down to two essential questions:
- What responsibility does the State have to its citizens?
- What responsibility do the citizens have toward the State?
Few in America have had to work so hard at actively managing this tension as America’s most current governors and treasurers. They bear tremendous responsibility to prudently guide our 50 states, yet little control over the factors that influence the success of those they lead. In almost every state, whether decisions are made in the legislature or via direct voter initiatives (as in California and Colorado), voters generally demand more from the state, yet generally wish to pay less to the state; thus the pressure to cut others people’s services or increase other people’s taxes.
Imagine for a moment that you were State Treasurer of your state of residence (apologies to our friends in California and Illinois, both with credit ratings of “A-,” on par with Libya). How would you address the critical questions below that have little to do with the headline grabbing policies, yet everything to do with proper stewardship of state funds?
1. What are prudent investments for investing State funds (reserves, pension funds, etc.)?
Would you err toward a conservative stance and potentially face the opportunity cost of lost upside, particularly when there are so many budget gaps to fill and there is so much ground to be made up? Or would you favor a moderate stance with greater potential return (in lieu of higher taxes or cut services), yet in so doing subject state funds to once again potentially experiencing a major loss, pushing the state further into the red? What risk management tools would you use?
2. What is a reasonable return assumption when budgeting the State’s defined benefit (Pension) obligations?
The funding of defined benefit Pension Plans relies on three variables: 1). Contributions into the Plan; 2). Net investment return on assets in the Plan; and, 3). Benefits paid out of the Plan. Let’s assume many state Plans are poorly positioned to meet their future obligations. Requiring higher contributions from the state would increase taxes or cut funding to other state funded programs, a good way to alienate voters and stifle growth and employment. Meanwhile, cutting the benefits hurts citizens in the Plan, breaks a compact with them, and can certainly be unpopular with key voting constituencies. So the pressure is on you and other elected officials to boost the net investment return assumption, whether or not such an assumption is reasonable. What would you do in that situation? Would you defer hard decisions by assuming higher returns today, hoping that other solutions or other decision-makers would enter the picture down the road?
3. With whom would the state do finance-related business?
Many municipalities lost tens and even hundreds of millions of dollars due to failed derivatives, swaps, repurchase agreements, securities lending agreements, structured notes and individual securities. Some municipalities are pursuing legal action against the investment banks, broker-dealers, and insurance companies that profited handsomely from creating and/or distributing these products; however, the disclaimers in the offering documents and the regulatory framework that govern the industry will protect most financial firms from providing any relief or accepting any responsibility. Now, many of these same financial services firms have been hired by the same municipalities to underwrite—at a premium no less—Build America Bonds and to otherwise advise on refinancing their liabilities. If you were Treasurer, would you allow your state to do business with those same firms? Would you re-engage a firm that had already cost your state millions of dollars by misrepresenting its risk management products? What about a firm that did that to other states? Would you focus instead on doing business with local firms, or with firms that had been better partners with your state all along? What if the only bankers or traders that you deem qualified (or that contributed to your campaign) work at firms that have wronged the state in the past? What business ethics would you demand from the state’s financial vendors?
4. How do we educate our citizens about the State’s finances?
In America, one way or another, the State’s finances serve as an expression of the will of the people. We pool our desires and our resources and voila! Decisions are made. If enough bad decisions are made and if the finances get ugly enough, we can always move to a more sensible state—but not the Treasurer. The Treasurer has to work with the decisions made by the citizens regardless of the wisdom of those decisions. So if you were Treasurer, what would you do to educate citizens about finance, to instill a sense of responsibility so that over time, the collective expression of the peoples’ will would be a more rational, more sustainable expression?
The State is one big kitchen table, with hundreds of thousands of people collectively budgeting, together spending their money, their neighbor’s money, their children’s’ money and even that of their children’s’ children. In a sense, we should all think like we were State Treasurer, bound by high moral and professional obligation, unable to declare bankruptcy or simply walk away from our liabilities like corporations and individuals can; we collectively have not approached municipal finance this way in the past and our states are the poorer for it. For now, people can leave California or Illinois, New York or New Jersey for greener pastures; but the same equations are playing out nationwide. The sooner we sharpen our pencils and answer the tough questions, the sooner we all are in a better state.