(WSJonline) The Government Accounting Standards Board has issued new rules that aim to crystallize government pension liabilities. It failed on that count, but it did succeed, albeit inadvertently, in making the case for defined-contribution plans.

GASB, as it's known in the trade, sets accounting guidelines for local governments. Since the board is run mainly by former public officials, its standards are often low. The board also usually takes several years to finalize rules, so it's often behind the times. Their new rules concerning how governments discount their pension liabilities are a case in point.

Financial economists have recommended for decades that governments calculate pension liabilities using so-called "risk-free" rates pegged to high-grade municipal bonds or long-term Treasurys. The argument goes that since pensioners are de facto secured creditors—even bankruptcy judges have been reluctant to slash retirement benefits—pensions are riskless and therefore the liabilities should be discounted at risk-free rates.

GASB's private cousin, the Financial Accounting Standards Board (FASB), began requiring corporations to discount their pension liabilities with high-quality fixed income assets in the 1980s. However, GASB let governments stick with their desired, er, expected rate of return, which is typically about 8%. Public pension funds have returned 5.7% on average since 2000. Achieving much higher returns over the long run would require markets to perform as well as they did in the 1980s and '90s. Would that be true. 

Governments have resisted climbing down from Fantasyland because using lower discount rates would explode their liabilities. When the Financial Accounting Standards Board introduced its risk-free rate guidelines, many companies shifted workers to 401(k)s because they didn't want to report larger liabilities. Such defined-contribution plans are by definition 100% pre-funded.

Prodded by economists and investors, GASB began considering modifying its discount rate rules a few years ago. Public pension funds, lawmakers and unions, however, pushed back hard against suggestions that governments use risk-free rates, which could more than double their liabilities. No surprise, the government troika won. 

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