During the most recent year for which there is publicly available data, the fiscal-year-ended 6-30-2012, the California State Teachers Retirement System contributed a $1.1 billion payment towards paying off an unfunded liability of $71.0 billion. This fact, and much more, came out in a California Public Policy Center study released last week “Are Annual Contributions Into CalSTRS Adequate?”
Now let’s suppose you have borrowed $71,000, and you are paying a 7.5% interest rate on this borrowed money. Do you think you would ever have this debt paid off, if you only paid $1,100 per year? How would that work? Isn’t 7.5% interest on $71,000 equal to $5,300? Wouldn’t a mere $1,100 payment put you further in the hole by $4,200? Wouldn’t you owe $75,200 by the end of the year, more than the $71,000 debt you started with?
Multiply by a billion and you’ve got CalSTRS.
And this same disastrous, wishful thinking is playing out in nearly every “professionally managed” public sector pension fund in California. Every year, the combined unfunded liability for these plans grows by $10 billion or more. Why? Because they are employing graduated payment schedules that incur negative amortization, in order to avoid demanding that California’s already over-taxed citizens and bankruptcy challenged cities and counties give even more to the pension funds.
Where is $10 billion a year – or more – going to come from?
Pension finance is complicated. An unfunded liability is caused whenever the present value of the future pension costs, for all participants in the plan, exceeds the value of the assets currently invested. If you think the plan is going to do very well, you expect those assets to earn higher rates of interest. This lowers the unfunded liability. But the $71 billion shortfall is CalSTRS own number, based on their own optimistic projections. They claim they will earn 7.5% per year, on average, forever. Scarier, they believe they will earn 4.5% after inflation, on average, every year, forever. Don’t believe this? Go to page 56 of CalSTRS “Notes to Financial Statements.” See for yourself.
The point? $71 billion is the low number. Adhere to less optimistic forecasts, as recommended by GASB and Moody’s, and watch that $71 billion double. And you don’t need to be a certified pension actuary to know that paying $1.1 billion a year on a $71 billion liability will NEVER get you out of the hole.
Apparently, however, the public sector union machine that runs California wants to believe this party can go on forever. And backing them up are the pension bankers; the Wall Street speculators, the hedge funds, the private equity funds, the high frequency traders, the currency speculators – the entire corrupt apparatus of casino capitalism – addicted to $350 billion (or more) per year of taxpayers money pouring through U.S. government employee pension funds and into their firms to invest.
Public sector pensions are headed for a catastrophic clash with taxpayers. Because California’s taxpayers don’t have another $10 billion per year to rescue public sector worker pensions – and that’s the minimum, if they hit their numbers year after year.
To save CalSTRS, and the other defined benefit plans, the initiative proposed by San Jose Mayor Chuck Reed (ref. Pension Reform Act of 2014) is a good start. It will allow cities and counties to reduce pension benefits that haven’t yet been earned. But even that modest reform is being fought behind the scenes. Unions are putting contributors and businesses on notice – don’t support this initiative – or else.
Here’s what union spokesperson Steve Maviglio has to say about Mayor Reed in his recent essay “Reed’s Anti-Pension Drive Enrages Labor:”
“Perhaps Reed’s biggest dilemma is that the only money behind the measure is likely to come from right-wing ideologues. The state’s business community has little interest in changing the pensions of public employees.”
These unions are making a tragic mistake. Because if they don’t recognize the problem and start working with reformers, their plans could collapse entirely.
Saving defined benefits, using CalSTRS as an example, might require the following:
(1) Recognize that pension bankers are peddling the same sort of misleading, overly optimistic financial hogwash that lead to the housing bubble and great recession. Stop carrying their water.
(2) Reduce all pension benefits to the levels in place before the benefit enhancements began back around 1999. Do this retroactively and apply this to all active and retired participants.
(3) Establish a floor on pension benefits for participants so nobody collects less than they would have if they’d been enrolled in the Social Security system instead of CalSTRS.
(4) Establish a ceiling on pension benefits equivalent to twice the maximum Social Security benefit.
(5) For retirees and active employees with significant vested benefits, phase in the preceding benefit reductions by abolishing cost-of-living increases to pensions until the purchasing power of their benefits erodes to the specified levels.
(6) Establish one pension multiplier from now on, instead of awarding teachers escalating multipliers if they stay in the profession longer. Back-loaded multipliers keep bad teachers teaching, and discourage good prospects from entering the teaching profession at mid-career.
(7) Enroll ALL public employees in the Social Security system and adjust pension benefits further downwards accordingly.
It may come as a surprise to pension reactionaries that not all reformers are libertarian brutes, or “right wing ideologues,” who hope to someday reduce every citizen to island status in a Darwinian ocean. Social Security is a successful safety net that can be rendered permanently solvent with relatively minor adjustments. Similarly, defined benefit pensions can be saved if the benefits are reduced and the assets are invested in lower yielding, but far less risky assets.
Maviglio suggests that “the smart money in the state sees it [pension reform] as a sure loser.” Maviglio may be right that nobody in their right mind dares to fight California’s unionized government. But he is wrong regarding the facts about pensions. Absent major reform, CalSTRS, CalPERS, and nearly every other government employee pension plan in California is headed for shoals. When they run aground, they are going to wipe out public sector solvency, and, ironically, foster a wave of privatization in response.
* * *
Ed Ring is the executive director of the California Public Policy Center.