Funding Pensions for Unionized Government Workers – It's Never Enough

Editor’s Note:  Here’s another government pension horror story coming from Chicago. If you think it can’t happen here, think again. California’s political system, state and local, is just as dominated by government unions as Illinois. At least in Illinois, Governor Rauner is using every legal and political weapon he can possibly muster to fight these unions. California Governor Jerry Brown, who knows better, is hoping incremental reforms combined with incessant tax increases will save the pension system. As Jon Coupal points out here, California’s taxpayers have one advantage – Proposition 13. Without the limits Prop. 13 places on property tax increases, California’s urban residents could easily end up facing what Chicago’s residents currently face, or what has already happened in New Jersey, where people living in modest homes pay annual property taxes of $15,000 or more to support – just like in Illinois, pensions for unionized public employees. First Detroit, then Chicago. One sustained market downturn, and Los Angeles will be next.

Chicago, Carl Sandburg’s “City of the big shoulders,” is about to find out just how heavy a tax burden homeowners are able to bear. Mayor Rahm Emanuel has revealed his plan for a massive property tax increase to pay for unfunded pension obligations. And for taxpayers, it isn’t pretty. The mayor wants a $543 million increase in property taxes to cover police and fire pensions, as well as additional taxes and fees to close a projected $745 million budget shortfall.

How much this will cost the average homeowner is not yet clear. Emanuel is seeking approval from the Legislature to exempt those homes worth less than $250,000 from the increase, meaning more valuable properties would absorb the entire burden.

The uncertainty may also be contributing to a decline in home values in recent months, as shown by the Case-Shiller Home Price Index. Buyers may not be so ready to cut a deal that will see them inheriting a massive property tax hike.

In order to illustrate the seriousness of the city’s fiscal crisis, and perhaps to make it easier to extort more from property owners, Emanuel is claiming that without the additional revenue, public safety will be decimated. Twenty percent of the police force and forty percent of firefighters will lose their jobs, he threatens.

Still, two years ago, the mayor foreshadowed the coming tax increase when he warned that in order to pay the mounting bill for government employee pensions — a bill that would triple in 2015 when a balloon payment comes due — property taxes could be forced to go up 150%.

This is a frightening scenario for homeowners, but not so much for homeowners in California. For us, notwithstanding equally daunting pension problems, the good news is Proposition 13. Although city mismanagement is also common to California – a number of cities have been forced to file for bankruptcy in recent years, largely due to exploding government employee pension debt – officials are prohibited by Proposition 13 from soaking property owners to cover up their dereliction. While Chicago homeowners are sitting ducks for higher property taxes, in California, increases are limited to two percent annually.

Add to the property tax limitations that Proposition 13 gives voters the final say on new local taxes and requires a two-thirds vote of each house of the Legislature to increase state taxes, and it becomes easier to understand why it is a target of so many Sacramento politicians, most of whom owe their election to their government employee union allies. If they can eliminate the impediments to tax increases established by Proposition 13, the politicians will be in a much better position to repay and reward their political benefactors.

Without Proposition 13 Californians could soon experience what it is like to live in Chicago without ever having to leave their homes. And it could be even worse. Chicago’s budget director has already gone on record as saying Mayor Emanuel’s property tax increase is not enough.

Jon Coupal is president of the Howard Jarvis Taxpayers Association — California’s largest grass-roots taxpayer organization dedicated to the protection of Proposition 13 and the advancement of taxpayers’ rights.

California's Pensions Are An Economic Burden, Not Benefit

Last month an article entitled “Pensions as Economic Stimulus” was posted to Fox & Hounds Daily. The author, Charles Beckwith, is a former CalPERS senior financial manager. Beckwith’s article, while thoughtful, invites a response. Because California’s pension systems may stimulate the economy in some ways, but equally significant ways, they are killing the economy.

Beckwith’s primary argument is this: California’s pension systems pay out over $3.0 billion per month to retired state and local government workers, who go out and spend this money, “at auto repair shops, home improvement centers, tuition for grandchildren, hair salons, rent, and at a thousand other small and large businesses.”

The problem with this reasoning rests on a fundamental assumption Beckwith makes, which is that all the money taken from taxpayers to fund these pension investments would not have created a similar economic stimulus if they had been free to spend it themselves. Mr. Beckwith goes on to extol the virtues of professional financial managers placing pension fund investments around the world, then pouring the returns back into California’s economy, but when he does this, he ignores the actual cash flows in and out of California’s state and local pension systems.

To dive deeper into the cash flows of California’s pension systems, unfortunately we must rely on the scandalously outdated, yet most recent available consolidated financial report for California’s pension systems, the Public Retirement Systems Annual Report for the fiscal year ended 6-30-2011, released over two years ago. But the proportions have probably not changed all that much in the last four years. And as can be seen on page xxii, figures 12 and 13, during that fiscal year taxpayers contributed $27.6 billion to California’s state and local government pension funds, and retirees collected $36.2 billion. This is a net benefit of $8.6 billion per year – IF you assume 100% of retirees still live in California.

A May 2015 analysis conducted by the Sacramento Bee on CalPERS retiree payments showed that 15% of their participants live outside California – if we assume that percentage is true for all California’s state and local government retirees, then that $36.2 billion shrinks to an in-state total of $30.8 billion. This more likely net benefit, $3.2 billion per year, represents a mere 0.14% of California’s $2.3 trillion economy.

That’s nothing, Mr. Beckwith. In the most recent year for which we have consolidated numbers, pension funds took $27.6 billion from taxpayers, then gave 30.8 billion back to retired government workers living in California. That’s $3.2 billion, net, that trickled down to private sector participants in an economy over 700 times larger.

With benefits come costs, and in this area, Beckwith, along with virtually every other defender of state and local government pensions, skirts the unpleasant realities. A California Policy Center study completed earlier this year, “California City Pension Burdens” used State Controller data to compile the employer pension contributions as a percent of total revenue from taxes and fees for every city in California. It estimated that pension fund contributions in 2015 for all California’s cities would amount to 6.9% of ALL revenue into those cities – including cities who run their own utilities – water, power, waste management. Equally significant, using figures provided by the pension systems, it showed that on average, these pension contributions would increase by 50% between now and 2020, to eventually constitute 10.3% of all revenues to California’s cities. These estimates do not take into account the current and projected funding for retirement healthcare, certain to add additional costs. Nor do they take into account the inadequate funded status of CalSTRS, or the many independent pension systems serving California’s counties, which are also supported by taxpayers in those cities.

In many cities, of course, pension burdens cost far more than 6.9% of all revenues. In San Jose, the total is 13.9% of all revenue. San Diego, 9.3%. And the already announced 50% increase to these employer pension contributions depends on a perilously weak assumption; that markets will continue to deliver 7.5% average annual returns on investment for the next several decades. Good luck with that.

At what percent of total revenue will everyone agree that funding public employee retirement benefits are “crowding out” other services and constitute the hidden agenda behind ALL proposed increases to taxes and fees? 10%? We’re already there. 20%? That’s reality already in many cities and counties. 30%? That’s where we’re headed.

Mr. Beckwith goes on to defend the defined benefit, writing that “the structure and strategy of a defined benefit plan cannot be debunked. It is a social benefit that should be available to all Americans in both private and public employment to assure a stronger American economy and social stability.” But he doesn’t explain what he means by “structure and strategy,” providing yet another frustrating example of why most reformers have given up on the defined benefit and almost universally advocate moving state and local workers onto individual 401K plans.

Constructive solutions to California’s state and local government worker defined benefit plans would include a “structure” that permits reductions to benefits – such as a suspension of retiree cost-of-living increases, or a reduction in rates of future annual benefit accruals – when market returns fail to meet expectations. And they might include a “strategy” that would return to the financially sustainable system that existed prior to Prop. 21, passed in 1984, which greatly loosened restrictions on investing in stocks, enabling much higher and much riskier rate-of-return projections, and before SB 400, passed in 1999, that started the process of retroactively increasing pension benefit formulas for what eventually became nearly all of California’s state and local government workers.

In an otherwise nuanced article, Beckwith’s one foray into demagogy was when he characterized investment setbacks as the result of the “Wall Street induced economic recession.” Because ever since Prop. 21 passed over 30 years ago, pension funds and “Wall Street” have been joined at the hip. When you’ve got nearly $4.0 trillion in state and local government pension funds chasing 7.5% annual returns, with no consequences other than to cut services and increase taxes to cover your shortfalls, you are indelibly part of the problem with financial special interests in America.

Pensions as they are today, Mr. Beckwith, are an economic burden to everyone in California who doesn’t have one, but has to pay for it anyway.

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Ed Ring is the executive director of the California Policy Center.

Median Total Compensation for Redwood City Firefighters – At Least $226,365

Back in February 2014 the California Policy Center publicly announced the Transparent California website, developed in partnership with the Nevada Policy Research Institute. An article covering this announcement was posted on the Forbes Magazine website, entitled “Hundreds Of California Government Employees Are Paid Over $400,000 A Year,” which a review of 2013 Transparent California data (2014 data is still being assembled) easily confirms. As a matter of fact, in 2013, total compensation in excess of $400,000 was paid to 1,292 public servants in California. A staggering 2,818 of California’s public employees collected total compensation in excess of $300,000 in 2013.

Some have argued that it is misleading to claim people are making, for example, over $400,000 per year, when in fact the $400,000 being referenced is total compensation, not regular earnings. We reject this argument categorically. It is incumbent on anyone who assesses compensation to treat total compensation as the only valid measurement both for comparative purposes and, especially, when considering employer costs. Total compensation represents the actual cost to the employer, and it represents the actual value earned by the employee. Every penny of total compensation, whether it’s to fund future retirement benefits or to pay for current benefits such as health insurance, is something a worker will have to pay for themselves out of their regular earnings, unless it is instead paid for by the employer.

When talking about how much we pay our public servants, we contend that it is misleading to reference anything but total compensation.

The Forbes article published in Feb. 2014 also cited examples of excessive pay from Redwood City, which raises another issue, which is the reliability of the data gathered. As it turns out, and as the city acknowledged, the data provided to Transparent California by the city was not intentionally misleading, but easily misunderstood. This lead to the author of the Forbes article claiming that “nine employees made over $400,000 in total compensation with a total of 33, mostly police and fire department employees, making over $300,000 in total compensation in 2012.” The city’s response:  “No Redwood City employee earned more than $400K. Furthermore, the correct number of employees earning more than $300K is 28, not 33 as stated in the op ed.” The city had put “exit incentive” payments into two data columns instead of just one and they got double counted by Transparent California’s researchers during the formatting process.

These are innocent mistakes. It’s worth noting that even the State Controller issues this disclaimer on all of their downloadable raw data spreadsheets showing public employee compensation – “the information presented is posted as submitted by the reporting entity. The State Controller’s Office is not responsible for the accuracy of this information.”

The real question, the real issue that isn’t going to go away, is how much should we be paying our public servants? How much can we afford to pay, and how much is fair both to these employees but also to taxpayers? So let’s take a look at 2013 data for Redwood City’s firefighters. We choose firefighters because the fire department in Redwood City, just as in nearly every other city in California, has the highest average pay and benefits of any major department.

To make this assessment, we used data provided to the State Controller for three years, 2011, 2012, and 2013. Here are the results:

Redwood City Compensation Analysis  –  Full Time Firefighters
20150601-UW-Redwood

As can be seen, during 2012 these firefighters earned significantly more overtime pay, probably because in 2012 full-time staffing was down from 2011, but then recovered again in 2013. It’s important to observe that the median total compensation is higher than the average. This is common when evaluating public safety pay and benefits in California, and refutes the claim that highly compensated executives skew the averages.

When evaluating the median total compensation of Redwood City’s full-time firefighters in 2013 of $226,365, it is necessary to consider what primary variables are driving that amount. The issue of overtime, for example, can be quite misleading. If you read the MOU in effect between Redwood City and IAF Local 2400, you will see that the 56 hour (fire suppression personnel who work 24 hour shifts) employees are apparently paid overtime when they work on any of the 12 paid holidays (MOU page 22, section 8.1). This makes sense, but if you assume these firefighters are, on average, earning 224 hours of vacation per year (10 years service, ref. MOU page 25, section 9.3), then their estimated actual 24 hour shifts per week are 2.32, an amount that includes only 3.9 hours of overtime. Holiday coverage is a sacrifice, to be sure, but apart from holidays, it does not appear that Redwood City’s firefighters are working significant amounts of overtime. Yet their median total compensation was $226,365 in 2013. Making these estimates is admittedly a fairly complex exercise and readers are invited to review the calculations on the “notes” tab of the downloadable spreadsheet “Redwood City 2013 – Firefighter Pay Analysis.xlxs,” a document that also shows all original SCO compensation data and the median/average calculations.

Another important variable affecting total compensation are pension contributions made by the employer. It is necessary to make two points on this topic with respect to Redwood City’s firefighters:

(1)  The Firefighter MOU grants a raise to cover every increase to their payroll withholding for pensions:

To fully appreciate this, read page 33, section 17.3 of the MOU, which covers the calendar years 2013 through 2017. In year 1 (2013), the employees begin to pay 2% towards their pension costs via withholding, and their pay is increased by 2%. In year 2, another 2% is withheld, and another 2% raise is granted. In year 3, another 2% is withheld, and another 2% raise is granted, and in year 4, another 1% is withheld, and a 1% raise is granted. In all, by 2017, Redwood City firefighters will be paying 7% of their pay towards their pensions. As a percent of regular pay, the city (the taxpayers) in 2013 made a 40% pension contribution. That’s 7% (eventually) from the employees to pay for their pension, and 40% from the city. That’s a nearly six-to-one employer match for retirement.

(2)  The city’s required pension contribution is going up, way up, no matter what. In February 2015 the California Policy Center published a study entitled “California City Pension Burdens,” compiling data and projections provided by the various pension systems, including, in this case, CalPERS. Here are some pension facts that confront Redwood City: Their estimated pension contribution in 2015 will be 6.61% of total revenue (all taxes and fees). Their pension contribution between 2015 and 2020 is assumed – according to CalPERS own projections – to increase by 54%, which, barring significant increases to employee withholding, means that instead of paying, on average $47,191 per firefighter (that is the 2013 number, the 2015 number is almost certainly higher), they will be paying $72,674 per firefighter. Just to fund their pensions. And barring pay decreases, that will elevate the median total compensation per full-time firefighter to at least $251,848.

All of these numbers are conservative, because in reality the increases to required pension contributions for firefighters will be more than what CalPERS projects for all of Redwood City’s employees, because firefighter pensions are far more expensive than those offered to miscellaneous employees. These numbers are also conservative because Redwood City is almost certainly not adequately funding their “OPEB” benefit (other post employment benefits), in particular, retirement health insurance (MOU page 49, section 19.2). And, of course, these numbers are grossly understated if you have any doubts regarding CalPERS’ ability to earn 7.5% per year through 2020 and beyond.

Asking whether or not California’s taxpayers should be paying firefighters roughly $250,000 per year is a question fraught with controversy. Clearly firefighters deserve a pay premium for the risks they take in their job. But firefighter unions have exploited the well-deserved respect firefighters have earned, and used that in conjunction with their dues revenue, to exert almost irresistible pressure on local politicians.

The rates of total compensation currently earned by Redwood City’s firefighters are by no means unique. Comparable levels of pay and benefits for firefighters are in place throughout California’s cities. When firefighter jobs that pay a quarter-million a year in exchange for slightly over two 24 hour shifts per week open up, literally thousands of people apply for them. The goal of public safety would be enhanced if we could hire more public safety personnel, firefighters in particular, for less money. But today there is no viable political coalition, anywhere, with the power and will to make that happen.

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Ed Ring is the executive director of the California Policy Center.

Aggregate U.S. Pension Data Shows Grim Outlook

Editor’s Note:  This analysis by economics blogger Mike Shedlock clearly shows why government employee pensions are taking an awful risk by continuing to forecast annual investment returns of 7.0% or more per year. In his first chart Shedlock points out how between 2008 and 2014 the aggregate value of state and local government worker pension system assets only increased 12.7% – a return of 1.9% per year. If one extends the horizon back to 2003 – i.e., if one backs up to include the stock market run-up from 2003 through 2008 – that annual return improves, to a still paltry 4.3%. The headwinds facing global investment portfolios include an aging population, which means there will be a higher percentage of retirees selling their assets which drives down prices and returns, as well as interest rates, everywhere, now at historic lows, which means that debt stimulated economic growth is more problematic than ever. What do the pension systems intend to do, if they can’t hit their 7.0% per year annual returns over the next several years? The answer to-date is to raise every tax and fee in sight to feed the pension systems, which along with incremental benefit adjustments is claimed to be sufficient. But only if 7.0% returns are forthcoming. What if they are not forthcoming? What then?

One of my constant themes over the past few years is the underfunding of state and local pension plans. Illinois is particularly bad, but let’s look at some aggregate data.

The National Association of State Retirement Administrators (NASRA) provides this grim-looking annual picture in their most recent annual update:

State and Local Defined Benefit Plan Assets at Year-End
2003-2014 ($ = Trillions)
20150831-UW-Shedlock1

Between the end of 2007 and end of 2014, pension plan assets rose from $3.29 trillion to $3.71 trillion. That’s a total rise of 12.76%.

Plan assumptions are generally between 7.5% to 8.25% per year!

S&P 500 2007-12-31 to 2014-12-31
20150831-UW-Shedlock2

In the same timeframe, the S&P 500 rose from 1489.36 to 2058.90.

That’s a total gain of 590.54 points. Percentage wise that’s a total gain of 40.22%. It’s also an average gain of approximately 5.75% per year.

Analysis

  • In spite of the miraculous rally from the low, total returns for anyone who held an index throughout has been rather ordinary.
  • The first chart is not a reflection of stocks vs. bonds because bonds did exceptionally well during the same period.

Drawdowns Kill!

To be fair, the first chart only shows assets, not liabilities, but we do know that pensions in general are still enormously underfunded, with Chicago and Illinois leading the way.

Negative Flow

Reader Don pinged me with this comment the other day: “Nearly all public pension funds have a negative cash flow, meaning they pay out in benefits each year more than they receive in contributions. For all public pension funds, the negative cash flow is approximately 3% of assets, which means an average fund needs to produce an annual return of 3% to maintain a stable asset value.

That’s fine if assets have kept up with future payout liabilities and plans are close to fully funded.

However, it is 100% safe to suggest that neither condition is true.

So here we are, after a massive 200% rally from the March 2009 low, and pension plans are still in miserable shape.

And plan assumptions are still an enormous 8% per year. Let me state emphatically, that’s not going to happen.

Stocks and junk bonds are enormously overvalued here.

GMO Investments Forecast

20150831-UW-Shedlock3

“The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forwardlooking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.”

Over the next 7 years GMO believes US stocks will lose money (on average), every year. Those are in real terms, but returns are at best break even, assuming 2% inflation.

Bonds are certainly no safe haven either. I strongly believe GMO has this correct.

Assume GMO Wildly Off

Even if one assumes those GMO estimated returns are wildly off to the tune of four percentage points per year, pension plans needing 8% per year will be further in the hole with 4% per year annualized returns.

Illinois Non-Answer

Illinois house speaker Michael Madigan and Chicago governor Rahm Emanuel believe tax hikes are the answer.

Both are sorely mistaken. Here are a few viewpoints to consider.

The only way out of this mess is a pension restructuring coupled with municipal defaults.

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Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

CalSTRS CEO Jack Ehnes Recommends 50% Increase to CalSTRS Retirement Income

Author’s Note: The original title of this post was “CalSTRS CEO Jack Ehnes Recommends 50% Increase to CalSTRS Pension Benefits.” That was inaccurate. What Ehne’s specifically recommended per the quote immediately below this note was “income replacement of 80 percent to 90 percent to maintain a similar lifestyle in retirement,” in reference to his assertion that presently “the median CalSTRS pension replaced less than 60 percent of final salary for the members who retired last year.” To be perfectly accurate, Ehnes’ is recommending a 50% increase in CalSTRS participant retirement income. While he does not specifically recommend increasing their pension benefit by 50%, in order for teachers to achieve a 50% increase in their retirement income, either some other employer paid form of compensation would have to increase – for example, supplemental 401Ks, fed by either greater teacher salaries or greater employer matching, or both, or something else – or teachers would have to live more frugally in order to save more retirement funds on their own without an increase to compensation. Which is it? While this note constitutes a retraction of the original title, and the author apologizes for the misconceptions that resulted, it is still necessary to wonder why pension fund executives are suggesting that 60% income replacement for a public servant is inadequate, when private citizens may consider themselves extraordinarily lucky to secure a retirement income anywhere close to that amount.

“The median CalSTRS pension replaced less than 60 percent of final salary for the members who retired last year. CalSTRS recommends income replacement of 80 percent to 90 percent to maintain a similar lifestyle in retirement. Public educators do not receive Social Security benefits for their CalSTRS service.”
– Jack Ehnes, Chief Executive Officer, CalSTRS, Introduction to CalSTRS Comprehensive Annual Financial Report 2014, page 11)

Here we go again – a recommendation for another 50% pension benefit increase. Will it be retroactive this time? That went well last time. Remember SB 400, quietly passed for CHP officers during a robust bull market in 1999, and by 2005 rolled out to nearly every state/local agency in California? No consequences whatsoever.

And, here we go again – somehow getting a CalSTRS pension instead of Social Security is a monstrous sacrifice!

Social Security recipients making roughly what veteran teachers make can expect to receive a benefit at age 68 that is roughly equivalent to 25% of their final year’s earnings. Twenty-five percent. The average teacher receives 2.5 times that much each year via their pension, starting about seven years earlier. Mr. Ehnes thinks that’s not enough. He ought to know better. If every Californian retiree got a pension equivalent to what a CalSTRS recipient currently gets, it would cost over $600 billion per year. Where’s that money going to come from, Mr. Ehnes?

There’s a lot to chew on for anyone trying to wade through CalSTRS most recent publicly available annual financial report. This additional gem, also coming from Mr. Ehnes himself, illustrates just how out of touch the pension bureaucrats have become:

“The funding approach in AB 1469 is predicated on the actuarial assumption that CalSTRS will earn a 7.5 percent annual rate of return throughout the life of the plan.” (CalSTRS 2014 CAFR, page 8)

Jack Ehnes is referring to California Assembly Bill 1469, passed in May 2014, which will phase in massive contribution rate increases over the next several years, mostly from taxpayers, so that CalSTRS will be fully funded by around 2047. That is, in exchange for even higher contributions from taxpayers, CalSTRS will get its financial house in order “in about 32 years.”

But what if “throughout the life of the plan,” CalSTRS is unable to earn a 7.5 percent annual rate of return? Does it matter at all that recently reported gains were logged during this latest bull market that’s running out of steam? Will even more massive contribution rate increases be the solution? According to the most recent data available, CalPERS is currently $73 billion in the hole, or only 67% funded. (CalSTRS 2014 CAFR, page 158)

The problem with seasoned financial professionals like Jack Ehnes fostering expectations like this – bull market returns of 7.5% for the next 32 years, and pensions for teachers that need to elevate from the current 60% of salary to “80 per cent to 90 percent” of salary, is that people who aren’t financial professionals actually believe them.

From professional government union supported PR firms, to the rank-and-file workers they assist to prepare op-eds, unrealistic expectations from people like Jack Ehnes are packaged into propaganda designed to destroy public support for pension reform.

For an example of this, look no further than the August 22 guest op-ed in the Sacramento Bee, “Another View: State pension funds are recovering,” purportedly written by Lydia Petitjean, a public school secretary and CSEA union official. Pettijean’s lead sentence is pure propaganda:

“Perhaps an oil slick is clouding the crystal ball of Stephen Eide of the Koch brothers-funded Manhattan Institute when he suggests that the effort to undermine the retirement security of millions of Californians – disguised as ‘pension reform’ – is gaining steam.”

This is sophomoric trash talk. It is vacuous, cynical drivel. The Manhattan Institute is a respected organization, Stephen Eide is a policy analyst with unimpeachable integrity and proven financial acumen, the Koch Bros have little if anything to do with the Manhattan Institute, and “oil slicks” is an image calculated to elicit disgust, but has nothing to do with pension reform. Nothing.

Anti-reformers like Lydia Petitjean base much of their rhetoric on a false premise – that big moneyed “Wall Street” special interests would like get their hands on all that pension money. This is patently false. As it is, the finance industry benefits immensely from government pension funds, because they have an enormous amount of money already invested on Wall Street – $4.0 trillion in assets nationwide. The pension funds relentlessly advocate, and then manage, benefit plans so generous that they are forced to invest in high-risk, high-return financial instruments that the financial industry is all to happy to invent and sell to them. Even better, when they don’t hit their numbers, the taxpayers bail them out. And even if every government worker’s defined benefit plan was converted to a 401K tomorrow, the same pension systems, CalSTRS and CalPERS and all the rest, would still be the administrators.

There’s nothing there, Ms. Petitjean. Not even “oil slicks.”

The reality is maybe pension reformers just want to prevent the pension systems and their government union allies from running every city and county in California into the ground.

Sooner or later, if public employees hope to keep their defined benefit pensions, they will have to accept lower benefit formulas. When the next market downturn hits, and it will, people like Jack Ehnes will have a lot of explaining to do, and people like Lydia Petitjean will have to make a tough decision:

Do they want to become oppressors of the private sector taxpayer in partnership with some of the most aggressive financial predators in the world, so they can enjoy retirement benefits several times better than Social Security recipients? Or do they want to share the same economic challenges as the people they supposedly serve, and work towards feasible solutions to retirement security in America for everyone?

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Ed Ring is the executive director of the California Policy Center.

CALIFORNIA POLICY CENTER PENSION STUDIES

California City Pension Burdens, February 2015

Estimating America’s Total Unfunded State and Local Government Pension Liability, September 2014

Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties, May 2014

Evaluating Public Safety Pensions in California, April 25, 2014

How Much Do CalSTRS Retirees Really Make?, March 2014

Comparing CalSTRS Pensions to Social Security Retirement Benefits, February 27, 2014

How Much Do CalPERS Retirees Really Make?, February 2014

Sonoma County’s Pension Crisis – Analysis and Recommendations, January 2014

Are Annual Contributions Into CalSTRS Adequate?, November 2013

Are Annual Contributions Into Orange County’s Employee Pension Plan Adequate?, August 2013

A Method to Estimate the Pension Contribution and Pension Liability for Your City or County, July 2013

Moody’s Final Adopted Adjustments of Government Pension Data, June 2013

How Lower Earnings Will Impact California’s Total Unfunded Pension Liability, February 2013

The Impact of Moody’s Proposed Changes in Analyzing Government Pension Data, January 2013

A Pension Analysis Tool for Everyone, April 2012

Government Union Assault on Taxpayers Continues in California

Editor’s Note:  This article discusses multiple proposals to raise taxes that are making the rounds in California’s government union controlled state legislature. Two in particular are mentioned, Senate Constitutional Amendment 5 that takes Prop 13 protections away from business owners, and Assembly Constitutional Amendment 4 that lowers the two-thirds vote requirement for local tax increases. On top of that they are considering transportation taxes, tobacco taxes, managed care taxes, new real estate transaction fees, and new “cap and trade” fees, to name a few. And this is happening at the same time as the government union spokespersons and their political puppets are crowing about a “six billion budget surplus.” Make no mistake about it. ALL of these proposed new taxes are to pay for excessive pay and obscenely inflated pension benefits for unionized government employees. Government workers should face precisely the same economic challenges as private sector workers. Only then will policies be crafted for the betterment of all Californians. As it is, California’s unionized state and local government workers are a privileged class, running the state’s economy and beleaguered taxpayers into the ground.

Although comparisons to actual wartime fighting should be used sparingly, California taxpayers can’t help but feel a bit like the 20th Maine Regiment at the battle of Gettysburg during the American Civil War. The actions of the 20th Maine, depicted in the Pulitzer Prize winning book “Killer Angels” by Michael Shaara, are well known to Civil War buffs.

Led by Joshua Chamberlain, who later became Governor of Maine, the 20th Regiment became famous for its defense of Little Round Top, a small hill on the flank of the Union forces. On July 2, 1863, the 20th Maine was positioned at the far left of the Union line with elements of the 44th New York, 16th Michigan, and 83rd Pennsylvania. As the Confederacy began its attack, Chamberlain was alerted that the enemy seemed to be pushing toward the regiment’s left. Chamberlain ordered a right-angle formation, extending his line farther to the east.

After an hour and a half under heavy attack and running low on ammunition, Chamberlain saw the rebels forming for another push and ordered a charge down the hill with fixed bayonets, which caught the enemy by surprise. During the charge, a second Confederate line tried to make a stand near a stone wall. The isolated group of Union soldiers, now in a position from which to provide the rest of the regiment with support, fired into the Confederate’s rear, giving the impression that the 20th Maine had been joined by another regiment. This, coupled with the surprise of Chamberlain’s bold attack, caused panic among the Southerners’ ranks.

The Confederates scattered, ending the attack on the hill. If the 20th Maine had retreated instead, the entire line would have been flanked and the Union likely would have lost Gettysburg. Most Civil War historians agree that holding the hill helped the Union win Gettysburg and turn the tide of the war.

What is notable about the 20th Maine was the number of direct assaults launched directly against its ranks. Time and time again, enemy forces assailed the small force made up of mostly farmers, woodsmen and fishermen. Chamberlain himself was no professional soldier, but rather the Professor of Modern Languages at Bowdoin College.

Like the constant attacks on the 20th Maine, which depleted both the energy and ammunition of its members, political forces in California are lined up against taxpayers ready to make a final push as the current legislative session enters its final few weeks. The question is whether taxpayers and their allies in the Legislature – mostly Republicans – can repel all the tax hikes being proposed.

The proposals are many, varied and all dangerous. Senate Constitutional Amendment 5 seeks to rip Prop 13 protections away from business owners, including tens of thousands of mom and pop stores. Assembly Constitutional Amendment 4 seeks to lower the two-thirds vote for local taxes which, if passed, will subject local citizens to massive new tax hikes. In a special session, which is not subject to the same time deadlines as the regular legislative session, there will be a huge push for new transportation taxes, slamming middle class working Californians who rely on their cars for both work and their family life.

Fortunately, there is plenty of ammunition taxpayers can use to counter the assault, starting with the argument that California is already a high tax state with a hostile regulatory environment that has driven many of its citizens and businesses to more friendly jurisdictions. Also, taxpayers will surely assert that, with a $6 billion surplus, the last thing we should be talking about is tax hikes. Finally, government waste in California continues to eat up tens of billions of dollars annually. All these contentions must be brought to the fore if taxpayers are to be victorious in stopping those who want even more money out of our pockets.

Jon Coupal is president of the Howard Jarvis Taxpayers Association — California’s largest grass-roots taxpayer organization dedicated to the protection of Proposition 13 and the advancement of taxpayers’ rights.

What Happens When Public Unions Control Everything for Decades?

Editor’s Note:  California and Illinois have a lot in common. Both have diverse, resilient economies, both are large states with most of the population concentrated in urban areas, and both have been controlled for decades by public sector unions. The crucial difference, of course, is that at least in Illinois, there is a reform minded governor who is standing up to the unions. But will it matter? In this article by Mike Shedlock, including commentary by Michael Bargo, it is clear that the depth of government union power in Illinois will be hard to overcome, even by a charismatic governor who is committed to reform. One of the most noteworthy quotes in this article comes from Bargo, who contends that literally 100% of the property tax proceeds paid by residents of Chicago are required to make pension payments. One analyst estimated the total per capita state and local debt for a Chicago resident at $88,000. But this debt wasn’t incurred to “help the working class and poor.” It is primarily to pay for pensions. California’s teetering pension systems are one market downturn away from facing a situation just as dire as Illinois. The hypocrisy of the government union controlled politicians in Illinois, and California, is only matched by their unwarranted power.

Here is my post from two weeks ago, Emanuel Fiddles While Chicago Burns; Public Schools Over the Edge; 9% Cloud Tax on Data Streaming; Emanuel Eyes Property Tax Hikes. discussing the sorry state of affairs in Chicago.

Michael Bargo, writer for the American Thinker, provides additional commentary on this topic.

Here is a  lengthy snip from Bargo’s recent, well-written article Public Pensions Prove Zero Sum Economics.

One of the major appeals in Democrat presidential campaigns  is to explain to voters that they need Democrats in office to take money away from the rich. And since the rich own big corporations, they will pay workers as little as possible. This idea is what Barack Obama had in mind in 2008 when he said he will redistribute money to the working class and poor.

But so far this analysis has only been applied to the private sector; the “rich” who own stocks or run corporations. If public sector workers, particularly pensioners who are not working, are taking significant amounts of money from taxpayers, then this may also be seen  as contributing to the shrinkage of middle class incomes.

Of course, Illinois is not the only state dominated by high Democrat taxes and public sector spending but it serves as a good case study of what Democrats do when they have total control of budgets for decades.

The results are startling. Today, Chicago’s public sector unions are underfunded, according to the City itself, by $26.8 billion. This is just the City of Chicago. When the state debt is added, the total amount of debt owed by each Chicago household to the city and state rise, according to the Illinois Policy Institute, to $61,000. SEC Commissioner Gallagher stated the number is $88,000.

Pension payments to Chicago public union employees have become so high that today all the property taxes paid by the households of Chicago go exclusively to pensions. The operating expenses are paid by additional taxes on things from packs of cigarettes, to gasoline, sales tax, and cable TV bills. Given these facts about how Chicago’s property taxes are used, it’s not surprising that its new Republican governor wants to freeze property taxes to rescue the middle class’s paychecks from Democrats.

Illinois Democrats have indentured the taxpayers of the state to turn over historic amounts of their incomes to government, shrinking Illinois’ middle class.

All public debt creates taxation and the effects have an impact, sooner or later. The more time allowed for debts to go unpaid, the greater the amount of taxes eventually wasted on interest payments.

Chicago is now the slowest growing of all major cities. In 2014 Chicago only gained 82 people in population. Residents are fleeing Illinois, taking their purchasing power with them. Illinois is also the slowest state to recover from the recession.

Chicago households will have to pay, through taxes, muni bond and unfunded pension debt for decades to come. Far into their lifetimes, and the lifetimes of their children. Zero sum theory is true, but the lion’s share of the proof shows that government spending, not private sector investing, takes money from average Americans.

Zero sum theory has been used by Democrats as nothing but a rhetorical tool used to exploit voters’ emotions of envy and greed. But in the end, the greed is exercised by Democrats while taxpayers in Illinois find themselves deep into a hole of government-created debt.

The private Illinois Policy Institute has uncovered most of the facts used here, and often had to file FOIA requests. In some cases, they had to take state agencies to Federal court to find out how much they were earning, and how much debt they had accumulated. This is all planned, it is a strategy used by Democrats to con taxpayers into putting them into office; saying they want small class size and to help the elderly; while all along they were secretly passing huge public pension contracts and dumping the cost onto average middle class and poor taxpayers.

These facts show two things. One is that these payments are so high that all Chicago households are under a crushing debt burden that takes many thousands per year away from their household budgets. And secondly, these figures provide an opportunity to measure whether this transfer of wealth from households to public pensioners negatively impacts economic grow. Illinois has the most public debt, the lowest credit rating, and the slowest growth.

Who Really Runs Illinois?

Little or no legislation passes through the Illinois legislature without the approval of Michael Madigan.

Wikipedia notes Madigan has been a House member since 1971, and Speaker in all but two years since 1983.

Chicago Magazine named Madigan the fourth-most-powerful Chicagoan in 2012 and second in 2013 and 2014, calling him “the Velvet Hammer—a.k.a. the Real Governor of Illinois.

Rich Miller, editor of the Capitol Fax Illinois political newsletter, wrote “the pile of political corpses outside Madigan’s Statehouse door of those who tried to beat him one way or another is a mile high and a mile wide.

Taxes Not the Answer

The results of Madigan’s tenure as the long-serving “real governor” of Illinois are as follows:

  • Pension holes in the hundreds of billions of dollars
  • Budget deficits
  • Corruption
  • Business exodus
  • Private taxpayer exodus
  • High taxes
  • Shrinking middle class

Tax hikes are clearly not the answer. Illinois has a spending problem, not a revenue problem.

Unfortunately for Illinoisans, other than kowtowing to public union demands, raising taxes is about the only thing Madigan knows how to do.

The results of Madigan’s tenure speak for themselves.
Isn’t it time to try a new tack?

Here’s Where to Start 

  1. Bankruptcy legislation to allow municipal bankruptcies
  2. Pass Right-to-Work legislation
  3. Scrap prevailing wage laws
  4. Property tax freeze
  5. Freeze defined benefit pension plans
  6. Pension reform
  7. Fair redistricting
  8. Reform worker’s compensation laws

That’s a big list of things that needs to be done, and Madigan is on the other side of every one of them.

As I said at the top,  Emanuel Fiddles While Chicago Burns.

And at the state level, Madigan Fiddles While Illinois Burns.

About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

CalPERS Spends $50 Million on Investment Advisors, Underperforms Market by 67%

The California Public Employees’ Retirement System (CalPERS) spent nearly $50M on their investment advisors in 2014, despite producing a dismal 2.4% investment return – 67% lower than what the market returned over the same time, as measured by the S&P 500. CalPERS’ 275 investment officers and portfolio managers cost taxpayers $49.27 million, with chief investment officer Theodore H Eliopoulos’ $856,000 compensation package topping the list.

The California State Teachers’ Retirement System (CalSTRS) also missed its 7.5% target, returning only 4.8%, but spent significantly less on their investment advisors in the process. CalSTRS spent roughly $18 million on their 100-plus investment officers and portfolio managers. Their chief investment officer, Christopher J Ailman, received a $674,000 compensation package.

To put these returns in perspective, an index fund that tracks the Dow Jones Industrial Average (DJIA) returned 7.1% and the S&P 500 fund returned 7.4%.

calstpres

After adjusting the total cost spent on investment advisors against actual investment results, CalPERS’ performance looks even bleaker. CalSTRS spent roughly $3.75 million per percentage point of returns on investment advisors, whereas CalPERS spent nearly six times as much at over $20 million per point. These costs are only for employees of their respective retirement system and do not include the billions of dollars spent on fees for external funds and the unknown carried interest fees associated with CalPERS’ private equity investments.strsvspers

One of the added benefits of utilizing the appropriate, lower discount rate in the 4-5% range is that public pension funds would be able to save billions of dollars on fees. For example, the New York Times reported that CalPERS paid $1.6 billion in fees to external funds managing their global equity portfolio in 2014. By contrast, the comparable fees for investing in the S&P 500 index ETF would have been $154 million, for a savings of nearly $1.5 billion.

Naturally, given the size and current investment objectives of both CalPERS and CalSTRS, investing in a single index fund is implausible. Yet, it does illustrate the degree of savings that would come from using a risk-free discount rate in which long-term AA-rated bonds and a basket of index funds were used in lieu of an aggressive investment strategy and the fees that accompany it.

The argument against such a conservative strategy is that it would reduce the potential for investment gains that a more aggressive strategy would provide. Yet, neither CalPERS nor CalSTRS has been able to beat the market over the past 20 years, despite spending millions of dollars each year on investment advisors, at taxpayer expense.

While both CalPERS and CalSTRS tout their 7.8% returns over the past 20 years as being indicative of their investing prowess, this is significantly less than the 9% achieved via an index fund that tracks the S&P 500. As such, it is hard to justify the millions spent on investment advisors internally, not to mention the billions spent on investment fees externally.

Many defenders of the status quo attempt to impugn the motives of those advocating for pension reform as being de facto lobbyists for big bankers and investment managers on Wall Street, claiming that a shift to defined contribution plans would line the pockets of fund managers on Wall Street. In reality, California’s public pension systems consistently send billions of dollars each and every year in fees to Wall Street.

A shift to a defined contribution plan would give individuals greater access over their own accounts and dramatically reduce the fees being paid to Wall Street, as individual investors are free to choose low-cost mutual funds or exchange-traded funds (ETFs) that have dramatically lower fee structures than what CalPERS and CalSTRS pay, yet have outperformed both pension funds over the past 20 years.

Robert Fellner is the Director of Transparency Research at the California Policy Center.

Why Pension Reform is Inevitable, and How Reforms Can Benefit the Economy

“The six-year bull market is admittedly long in the tooth.”
CalSTRS Chief Investment Officer Chris Ailman, Sacramento Bee, July 17, 2015

If what Mr. Ailman really means is equity investments may not be turning in double digit returns any more, that makes the recent performance of CalSTRS and CalPERS all the more troubling. Because according to their most recent financial statements, CalSTRS only earned 4.8% last year, and CalPERS only earned 2.4%. That leaves CalSTRS 68.5% funded, and CalPERS 77% funded.

Are we at the top of a bull market? Take a look at this chart:

S&P 500, Last Twenty Years Through June 21, 2015

20150721-UW-pensions1

The S&P index, which reflects U.S. equity trends reasonably well, enjoyed a five year bull market that crested in mid-2000, then another one that ran five years from September 2002 to October 2007, then this current bull market, which began 6.5 years ago. The bull market ending in September 2000 saw a 170% rise in the S&P, the one that peaked in October 2007 rose 90%, and this current one has yielded a 188% rise. So far.

Is today’s bull market “long in the tooth”? It sure looks that way.

There’s more to this, however, than the new reality of globalized, largely automated equity trading that condemns stock indexes to unprecedented volatility – or the graphically obvious fact that we’re at another peak.

There’s something stock traders call “fundamentals,” in this case creating economic headwinds that all the high-frequency trading and hedges in the world can’t avoid. About the same time that CalSTRS and CalPERS announced they missed their earnings targets, Reuters published this: “Calpers chief looks to cut volatility as fund enters negative cash-flow era.”

In plain English, this “negative cash-flow era” means that CalPERS has crossed a big line financially. They are now going to be selling more investments each year than they buy. They are going to be net sellers in the markets. While the superficial explanation for this is “baby boomer retirements,” that is incorrect. Government staffing is not directly driven by population demographics. In government, new hires replace retirees and headcounts trend upward. The real reason CalPERS is entering a negative cash flow era is because the retroactive pension benefit enhancements that started in 1999 and rolled through agency after agency for the next six years or so are now translating into large numbers of people retiring with these enhanced pensions, replacing earlier retirees who had modest pensions. Meanwhile, new hires are, increasingly, accepting more realistic reduced retirement promises, and paying proportionately less into the funds.

If CalPERS were the only pension fund becoming a net seller in the market, it wouldn’t really matter. But all the major pension funds, everywhere, are becoming net sellers. That’s nearly $4.0 trillion in assets under management in the U.S. that suddenly are shedding assets faster than they’re acquiring them. When supply rises, prices drop. This is a headwind.

There are other headwinds. If government staffing doesn’t directly reflect population demographics, the general population obviously does. Between 1980 and 2030 the percentage of Americans over 65 will rise from 11% to 22% of the total population. And ALL of these seniors will be net sellers of assets.

If that weren’t enough, there is the small matter of the United States – along with most of the rest of the world – arguably in the terminal phase of a long-term credit cycle. Total market debt as a percentage of GDP in the United States is over 300%, higher than it was in 1929. When interest rates fall to zero, playing the debt card to stimulate economic growth doesn’t work anymore. And when interest rates rise, asset values fall and debt service becomes untenable. We’ve painted ourselves into an economic corner.

In the face of this reality, unconcerned and all-powerful, the government union band plays on. Today the Los Angeles based City Watch published an early version of what will become an irresistible torrent of propaganda opposing the proposed Reed/DeMaio pension reform initiative. The title says it all “Measure of Deception: Initiative Would Gut Retirement Benefits for Millions of Californians.”

Take a look at the average full career CalPERS pension per former employer. Bear in mind the average public sector retirement age is 61, and that the average Social Security benefit is around $15,000 per year. Is there no middle ground between “gutting” and restoring financial sustainability?

Restoring pension systems to financial sustainability in the face of economic headwinds will require two major changes in policy. First, pension benefit plans would need to change in the following ways: (1) Increase employee contributions, (2) Lower benefit formulas, (3) Increase the age of eligibility, (4) Calculate the benefit based on lifetime average earnings instead of the final few years, and (5) Structure progressive formulas so the more participants make, the lower their actual return on investment is in the form of a pension benefit. Finally, enroll all active public employees in Social Security, which would not only improve the financial health of the Social Security System, but would begin to align public and private workers to share the same sets of incentives. Taking these steps will repair the damage caused by SB 400 in 1999, which set the precedent for retroactive pension benefit increases.

Second, completely change the investment strategy of public pension systems to return to lower risk investments. Along with choosing, say, high-grade corporate bonds over global hedge funds, these lower risk investments could include investment in revenue producing civil infrastructure. A thoughtful article recently published in Governing, “How Public Pensions Are Getting Smart About Infrastructure,” explores this possibility. Not only would massive investment by pension funds in revenue producing infrastructure create millions of jobs, repair neglected public assets, and constitute a low risk investment, over their life-cycle many of these projects actually produce excellent returns. Moving to lower risk investments will repair the damage caused by Prop. 21, narrowly passed in 1984, that “deleted constitutional restrictions and limitations on the purchase of corporate stock by public retirement systems.”

Given the financial headwinds they face, it is going to take courage and creativity to save defined benefits for public sector workers. But depending on what direction these reforms take, they have the potential to greatly benefit the overall economy.

*   *   *

Ed Ring is the executive director of the California Policy Center.

CALIFORNIA POLICY CENTER PENSION STUDIES

California City Pension Burdens, February 2015

Estimating America’s Total Unfunded State and Local Government Pension Liability, September 2014

Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties, May 2014

Evaluating Public Safety Pensions in California, April 25, 2014

How Much Do CalSTRS Retirees Really Make?, March 2014

Comparing CalSTRS Pensions to Social Security Retirement Benefits, February 27, 2014

How Much Do CalPERS Retirees Really Make?, February 2014

Sonoma County’s Pension Crisis – Analysis and Recommendations, January 2014

Are Annual Contributions Into CalSTRS Adequate?, November 2013

Are Annual Contributions Into Orange County’s Employee Pension Plan Adequate?, August 2013

A Method to Estimate the Pension Contribution and Pension Liability for Your City or County, July 2013

Moody’s Final Adopted Adjustments of Government Pension Data, June 2013

How Lower Earnings Will Impact California’s Total Unfunded Pension Liability, February 2013

The Impact of Moody’s Proposed Changes in Analyzing Government Pension Data, January 2013

A Pension Analysis Tool for Everyone, April 2012

San Ramon Fire Protection District Pay and Governance Exemplifies Union Power

In a democracy, the assumption is that civilians exercise the ultimate authority over their government. The citizens elect representatives who will act in the public interest. But what happens when government agencies are disbursed over thousands of jurisdictions, and the people who run these local agencies are virtually unknown?

Even citizens who follow politics and vote diligently are challenged to make an informed selection when considering the many candidates vying for obscure boards and commissions and special district elected positions. In some cases they will know about a particular obscure race, but in most cases they will not. So they either don’t select a candidate, or select a candidate almost randomly based on the brief ballot description, “small business owner,” “retired teacher,” whatever.

Only one group of voters consistently makes informed choices in these elections to supposedly minor elected positions. The people who these elected officials are going to manage and negotiate with over pay, benefits, and work rules.

The problem with dismissing these bottom-of-the-ballot elections as inconsequential, of course, is that these “minor elected positions,” in aggregate, represent thousands of agencies in California, managed by multiple thousands of elected officials, spending hundreds of billions of taxpayer dollars. And the problem is compounded because that small minority of voters who really care about the outcome of these elections, the public employees these politicians are going to manage, are represented by powerful, taxpayer funded, politically sophisticated labor unions.

Government unions have little in common with private sector unions, who cannot elect their own bosses and who have to negotiate in good faith with business owners who will go out of business if they are too generous with pay and benefits. Government unions, on the other hand, promote carefully selected candidates to their members, and relentlessly fight to elect them. Against this machine is virtually nothing comparable. Local activists and reformers, along with their donors, are volunteers who come and go, their efforts rising and falling with the urgency of the issues. That is how it should be in a democracy. But not the government unions. They are perennial powerhouses, employing full time professionals, using taxpayer funds, always active, playing the long game.

In California, an example of government employees receiving pay and benefits exceeding any reasonable market norm would be urban firefighters. Unlike police departments which sometimes struggle to find qualified recruits, California’s fire departments typically have hundreds, if not thousands, of applicants every time there is an open position. Yet firefighters consistently are the highest paid among public safety employees in California. This would be inexplicable, except for the power of the firefighters’ unions.

The San Ramon Fire Protection District is managed by a five member elected board. Last November two board seats were up for election. And as reported in the San Jose Mercury on November 4, 2015, “Union-supported candidates Donald Parker and Chris Campbell cruised to victory against fiscal reformer Dale Price and incumbent Glenn Umont in the San Ramon Valley Fire Protection District race.”

If you view the current members of the San Ramon Fire Protection District Board, you will see that these two union backed candidates join another union backed director, Gordon Dakin, to create a 3-2 majority on the board. When Dakin won his election in 2012, the Contra Costa Times reported “Dakin, an Alameda County fire captain, is the vote leader capturing 51 percent of the vote. His campaign had the backing of the San Ramon Valley Firefighters Association International Association of Firefighters Local 3546.”

This may be democracy, but it isn’t representative. Government unions elect the people they negotiate with. What could possibly go wrong?

For starters, pay and benefits rise well beyond what is necessary to attract and retain qualified people. The average full time firefighter working for the San Ramon Fire Protection District in 2013 – the most recent year for which data is available – made $283,457 per year. Including overtime, and taking into account vacation benefits but not sick time, veteran full-time firefighters worked 2.7 days per week (24 hour shifts) to make this much money. [Download compiled SCO data on spreadsheet, view individual complensation incl. part-time.]

Donald Parker, one of the recently elected directors, is a retired firefighter who in 2013 collected two pensions, $110,587 from the Oakland Fire and Police Retirement System, and another $74,069 from CalPERS for his service as a firefighter with Vallejo (these figures do not include other retirement benefits, which the pensions systems did not disclose). Chris Campbell, according to the Contra Costa Times, is a firefighter for the City of San Francisco.

According to their website, the San Ramon Fire Protection District had revenue in FY 2012 of $52.9 million. According to Wikipedia, their budget in 2013 was $53.0 million. According to the State Controller, they spent $40.7 million on pay and benefits in 2013, 77% of their total budget. They spent $12.5 million on employer payments for pensions, that is, 24% of their entire budget went to pay for pensions. And without additional reforms, that percentage will rise in the coming years.

Those of us who look at these statistics over and over again get sensitized to the figures. Step back. Think about this:

44 of these full-time firefighters, 37 percent of them, made over $300,000 in total compensation in 2013.

75 of these full-time firefighters, 63 percent of them, made over $200,000 in total compensation in 2013 (but less than $300K).

1 of these full-time firefighters, ONE OF THEM, made less than $200,000 in total compensation in 2013 – that person made $179,025.

This cannot be financially sustained. Rates of pay and benefits this high have a real cost in terms of higher taxes and reduced services. And there is currently no viable political coalition, anywhere, capable of standing up to these unions. Businesses and wealthy people get out of the way. They’d rather stay on the good side of the local governments, who approve their permits and inspect their projects, and these local governments are run by unions.

To summarize – because of the power of local government unions, barring fundamental legislative or judicial reforms, the political battle is lost. With rare and fleeting exceptions, California’s cities and counties and special districts will continue to be run by union backed elected officials, and they will continue to allocate every budget dollar they possibly can to pay unionized public employees. The San Ramon Fire Protection District is a case in point. And it is the norm.

*   *   *

Ed Ring is the executive director of the California Policy Center.

University of California Hikes Tuition to Fund Soaring Pensions of up to $350,000 a Year

The University of California (UC) is implementing major changes to their retirement system to address its $12.1 billion unfunded liability, which has been cited as the driving factor behind recent tuition hikes.

The proposed changes include a cap on pension benefits and the possibility of offering a 401(k) defined contribution plan to new hires.

Looking at how UC got here is instructive. In 1990, the plan enjoyed a healthy funded ratio of roughly 135%. The decision was then made to stop making any contributions – employee and employer – and rely on investment earnings to keep the fund afloat going forward.

This continued for two decades. UC only resumed contributions in 2010 when over $6 billion in unfunded liabilities had accumulated and the plan was heading towards ruin, should they fail to act.

The fiscal irresponsibility, first in suspending contributions, and then failing to reinstate them until the very last moment, is staggering. As Moody’s declared, “employee and employer contributions are the bedrock of any defined benefit pension plan.” The American Academy of Actuaries (AAA) concurs, noting that contributions “should actually be contributed to the plan by the sponsor on a consistent basis.”

It should be noted that the spectacular decline in the health of UC’s retirement system occurred despite UC realizing an average annual investment return of 9% over those same 20 years, significantly higher than their assumed 7.5% annual return. Clearly, Moody’s and the AAA understand what is needed to keep pension systems in sound financial shape, while public pensions’ emphasis on investment returns over annual contributions is fundamentally flawed.

So why did UC behave so recklessly? Quite simply, public institutions have the exact opposite incentives necessary to manage a defined benefit system appropriately. The decision makers who authorized the funding holiday in 1990 are all long gone, and none of them will bear any of the cost for their actions. In fact, they all directly benefited from their profound mistakes.

UC regents and plan trustees, all being members of the retirement plan themselves, all saw their take home pay immediately rise as a result of their contributions dropping to 0%. Further, UC administrators saw millions of dollars flow back into their general budget, no longer designated for funding the retirement system.

Pete Constant, Senior Fellow at the Reason Foundation, finds that public pension systems are “actually a perverse system in which there is a win for the entire membership when pension board trustees are wrong!”

He notes that, “The risk associated with not meeting actuarial assumptions is borne entirely by the taxpayers…unfunded liabilities are generally amortized over long periods of time, spreading the associated costs across generations.”

This point is driven home by looking at the several recent UC retirees who are collecting base pensions of over $300,000 a year for life. While these former UC employees were fortunate enough to pay nothing, for at least 20 years of their careers, for such lucrative pensions, the cost is now being borne by an entirely new generation of students and taxpayers.

Further, current UC employees have seen their annual contributions rise dramatically, and new hires will be under a substantially reduced pension system themselves. In short, virtually everyone but the employee who received the benefits, or those who received that employee’s services, are now paying the cost.

UC’s decision to consider shifting new hires to a defined contribution plan is long overdue. In addition to the perverse management incentives and issues of intergenerational inequity outlined above, a shift to defined contribution plans would eliminate the long term liability to taxpayers, while offering greater flexibility and portability to employees.

As UC President Janet Napolitano said, “Pension reform needs to happen. It’s the responsible thing to do.”

Robert Fellner is the Director of Transparency Research at the California Policy Center.

Strike by Santa Clara County Workers Averted

Everyone should breathe a sigh of relief. Or should they?

Santa Clara County’s nurses, librarians, janitors, dispatchers, and assorted other workers belonging to SEIU Local 521 will not be going on strike after all. At least not yet. Late night negotiations have produced a deal that’s being sent back to the members.

The exact terms of this latest deal are not clear. But according to sources at the San Jose Mercury, the level of pay and benefits was only one of the issues being negotiated. Another key issue was work conditions – in particular, excessive overtime and excessive workloads.

The issue of pay and benefits is directly connected to the issue of overtime and workload, of course, because when employees are paid more than the budget can accommodate, it is impossible to hire more employees. Here is a look at how much key members of this union are making:

Santa Clara County Public Employees
Average Total Compensation by Select Job Title, 2013
20150630-UW-santaclaracomp1

Unfortunately, this data, which comes from the California Office of the State Controller’s “Government Compensation in California” database, has not been updated yet for 2014, so it is possible that the situation has changed. But using these numbers, a few things are immediately apparent:

(1)  These workers are very well paid. The average nurse collects a compensation package worth $183,822 per year. The average janitor collects a compensation package worth $76,309 per year. By comparison, according to the U.S. Census Bureau, the median annual earnings for a full-time, year-round civilian employed worker in Santa Clara County in 2013 was $68,586, one of the highest in the nation.

(2)  These workers are not working extreme amounts of overtime. The 2nd to last row on the above table is calculated based on overtime pay, divided by 1.5x (some overtime is paid at 2.0x so this is, if anything, understated), divided by base pay (some overtime rates are calculated on base pay plus other pay, so this is also understated). The group that works the most overtime are the dispatchers, who, in a 40 hour week, on average are turning in an extra 6.0 hours of work. That equates to 72 extra minutes a day, i.e., zilch from the perspective of any start-up entrepreneur.

(3) The cost of pay and benefits are making it difficult to hire more workers. These workers are typically receiving a 2.5% at 55 pension, meaning, for example, if the average nurse retired after 30 years making $128,117 (it would be more than that since that figure represents the average, not the final – again, we’re understating), at age 55 they would get a starting pension of 2.5% times 30 times $128,117 = $96,088, with annual cost-of-living increases, for the rest of their lives. The employer’s health insurance payments, over $15,000 per year, are roughly the same across job categories regardless of average income. This means the benefits overhead for the relatively low paid employees, the janitors, is a staggering 58%. In the case of the nurses, who are the highest paid among these four groups, it is still 28%. For dispatchers, who have to work a measurable amount of overtime, benefits overhead is 42%.

Without having more detailed knowledge of the situation in Santa Clara County, it isn’t fair to indulge in excessive editorializing on this specific case. But the unions who represent Santa Clara county workers, and all government workers, have become accustomed to comparing their rates of pay to each other. In Santa Clara County, the unions representing miscellaneous workers see how much money is going to unionized public safety employees and they become resentful. The public safety unions continuously identify cases where, somewhere, a local government agency is paying their police and firefighters more than they’re making, and they foment resentment that leads to politicians granting pay increases to achieve parity. And the circle goes round and round. And pay goes up and up.

Meanwhile, in the real world of private sector work, the idea of an employer paying $15,000 per year or more to cover an employee’s health insurance plan is almost unheard of. In the world of salaried employment, the idea of working a mere 40 hour week (and accruing 4+ weeks a year of paid vacation) is almost unheard of. And the idea of retiring at age 55 with a pension (with cost-of-living adjustments) that starts at 75% of one’s final year’s earnings is preposterous.

California’s government workers, especially those in the Silicon Valley, point to the wealth being created by start-up companies who make it big, minting dozens if not hundreds of multi-millionaires, and somehow they think that’s the norm. But it isn’t the norm. The norm is a median private sector worker income of $68,586 per year; a median household income of $91,702 per year. The norm is an employer paid benefits overhead of around 15% (9.0% Social Security and Medicare, at most another 6% for health insurance and a contributory 401K). Not 28%. Not 41%. Not 42%. Not 58%.

California’s government workers deplore the excessive cost of living, especially in the Silicon Valley. But instead of fighting for more wages and benefits for themselves, they might find the vision, the courage, and the selflessness to identify and fight for policies that would lower the cost of living for everyone. Nobody can afford a home, because environmentalists have successfully declared all open space to be sacred. Ordinary workers struggle to pay for gasoline, electricity and water, because development of these resources has been excessively restricted for decades. Across almost every critical household expense, add education and healthcare to the list, ordinary workers pay far more than they would have to in a more competitive economy.

The aspirations of unionized government workers are understandable; the rhetoric of their union leadership is compelling. But these government union leaders don’t live in the real world, and worse, they don’t appear to even care about the real world. Because unlike private sector unions, government unions negotiate with bosses they elect, for a share of taxes that are taken from citizens, not precariously earned by a private company. And they use their unique power to exempt themselves from the economic challenges facing the rest of the citizens they are supposed to serve.

When that is fixed, we may truly breathe a sigh of relief.

*   *   *

Ed Ring is the executive director of the California Policy Center.

Over 8,000 LA County Retirees Made at Least $100K in Pension Pay as Taxpayer Cost Soars

Last year, 8,088 retirees in the Los Angeles County Employees’ Retirement Association (LACERA) received yearly pension and medical benefits packages worth at least $100,000, a more than 11% increase from the previous year, according to Transparent California’s recently published 2014 pension data.

At the same time, the employer’s annual required contribution – the cost borne by taxpayers – hit a record high 20 percent of payroll, more than double the 8.9 percent paid in 2001.

Topping the pension list was former Los Angeles County Sheriff, Leroy Baca, who is collecting a yearly pension and benefits package worth nearly $340,000.

The next three highest compensated members were:

  1. Larry Waldie, retired from the Sheriff’s Department in 2011, received $333,009.
  2. Thomas Tidemanson, retired from Public Works in 1994, received $332,200.
  3. Michael Judge, retired from the Public Defender’s Office in 2010, received $325,078.

The average pension and benefits package for a retiree of the Fire Department with at least 25 years of service was $128,729 and the average for a retiree of the Sheriff’s Department was $106,299. For all other members who had retired with at least 30 years of service, the average pension and benefits package was $74,568.

Current LACERA members are able to include a variety of supplemental pay items as part of their pensionable compensation – which is their highest single year of pay that will be used to calculate their pension benefit. Additionally, LACERA allows employees to sell back any unused vacation, holiday, or sick leave and counts that as part of their pensionable compensation.

While the Pension Reform Act of 2012 sought to ban “abusive practices used to enhance pension payouts” and calculate pension benefits “based on regular, recurring pay” only the practice of selling back unused leave was banned, and only for employees hired after January 1, 2013.

LACERA’s unfunded liability has more than doubled over the past 10 years – rising from $5.6 billion in 2004 to $13.3 billion in 2013, despite having hit their investment target over that same time period.

A Moody’s Investment Services report calculated LACERA’s adjusted net pension liability at nearly $40 billion. They also found that the rules governing public plans inappropriately emphasize investment returns over yearly contributions, resulting in shortfalls even under ideal investment conditions.

Moody’s also cautioned against the increased risk public pension portfolios have taken. When comparing LACERA’s most recent investment portfolio they found a higher allocation of riskier investments such as private equity and hedge funds, as compared to prior years.

This “increases the risk of sharp asset declines” and, consequently, increases the likelihood that taxpayers will be required to pay substantially more to keep the system afloat.

A recent paper published in the Journal of Retirement found that many public pensions will remain underfunded, even if they hit their investment goals, because they rely on flawed actuarial assumptions that understate the true cost of benefits.

Pete Constant, Senior Fellow at the Reason Foundation, observed that there are strong incentives for pension boards to adopt assumptions that are wrong. Doing so directly benefits both the pension system and its member agencies – which now have more tax dollars at their disposal – while the costs are borne by future generations.

To view the complete 2014 pension report in a searchable and downloadable format, visit TransparentCalifornia.com.

Robert Fellner is the Director of Transparency Research at the California Policy Center.

 

Public Sector Union Reform Requires Mutual Empathy

Sorry but you would all be crying like a little b**** if the cops and firefighters that earn every penny they get in retirement were not there when your perfect make believe world falls apart so shut the f*** up. Until you do the job you have no idea what you are talking about.
–  Comment on Facebook.com/CalPolicyCenter post, June 3, 2015

This comment, made by a California police supervisor onto the Facebook page of our organization, graphically encapsulates what is entirely understandable resentment on the part of public servants to a new reality – their pay and benefits are being exposed to public debate. It would be easy to dismiss this comment as inappropriate, or to merely characterize it as an example of public sector arrogance. But that would be a huge mistake.

Compared to the lives most of us are privileged to lead, public safety employees endure unrelenting stress. While it is important to be honest about rates of police and firefighter mortality and job related disabilities, the fact that many other jobs carry greater risk of death or injury does not change the fact that public safety employees endure unique stress. It is unique not only because it can occur at any time, but because it is the very nature of their work. They face hostility and mayhem as part of their job description, and because they do that, we are enabled to feel secure in our so-called “make believe” lives.

There is a compensation premium we owe public safety employees that appropriately should exceed the premium we’ve paid in the past to those who risk their lives to protect us. Because we now live in a society where overall safety and security has never been greater. Crime rates remain at historic lows in the United States. Based on empirical data, the quality of services we receive from public safety agencies has never been higher. Better service merits higher pay.

Public safety employees deserve a premium over historical rates of pay for another reason. Crime has morphed into areas unimaginable even a generation ago – cybercrime, global terrorism, financial crimes, gangs, international criminal networks, foreign espionage, asymmetric threats – the list is big and gets bigger every year. At the same time, our expectations regarding human rights and police conduct have never been higher. Police officers today need to possess skills well beyond what sufficed in the past. This also means they should be paid more.

Which brings us to the difficult conversation that we still have to have regarding compensation. The person who made this comment was reacting to our recent post that exposed a retired firefighter – and current official for a firefighter union – who was attacking pension reformers, while collecting a pension that during 2013 (not including benefits) was $183,690. It is neither fair nor affordable to pay anyone a government pension that big. The average full-career pension and benefits for recently retired public safety employees in California is over $100,000 per year, and the average retirement age is under 60. Using conservative assumptions, a starting pension of $100,000 per year, awarded that early, is worth at least $2.5 million. Factoring in cost-of-living adjustments, it’s worth even more. This is an impossible level of retirement benefit to sustain. It prevents us from hiring more public safety employees, and it drains funds from other worthwhile government programs including not only general services, but crucial infrastructure development.

Public safety employees deserve all the respect we can give them for the jobs they do. They deserve our appreciation and our thanks. But that courtesy should not extend to routinely conceding the debate over how much they should be paid, or, for that matter, whether or not they should have so much political influence, or, to get down to the crux of it, whether or not they should be allowed to even form unions and bind local governments with collective bargaining agreements. There is NO connection between our debate over public employee compensation or related public policies, and how much we respect public employees.

Finally, the respect that citizens ought to feel towards public safety employees can be taken too far. We should respect all workers, including those whose jobs are indeed more dangerous than police work or firefighting, and including those whose jobs are tedious, laborious, dirty, and underpaying. All work is valuable. All workers deserve dignity and respect. And while the deaths of police and firefighters are always tragic, all deaths are tragic. About 2.5 million Americans die each year, and about 1.0 million of those deaths are untimely – usually from fatal accidents or terminal disease that strikes before someone is elderly. Our collective empathy must extend well beyond what we rightly owe public safety employees, or we cannot keep their sacrifices in perspective.

*   *   *

Ed Ring is the executive director of the California Policy Center.

Volcker Sounds Alarm Over States' Budget Gimmicks and Pension Assumptions

The Volcker Alliance, founded by former Fed chairman Paul Volcker has sounded an alarm over budget gimmicks. The alliance seeks Truth and Integrity in State Budgeting.

In the report, the Volcker Alliance examines in detail the budgeting practices of California, New Jersey and Virginia, assessing the effectiveness of each state’s practices.

The report highlights the need for effective and transparent budgeting practices by “shining a spotlight on opaque and confusing practices and by identifying more appropriate approaches” when creating state budgets and fiscal policy.

Executive Summary

EVEN AS THE REVENUE OF STATE GOVERNMENTS in the United States recovers from the longest economic downturn since the 1930s, many states continue to balance their budgets using accounting and other practices that obscure rather than clarify spending choices. These practices make budget trade-offs indecipherable, lead to poorly informed policy – making, pass current government costs on to future generations, and limit future spending options. Further, they weaken the fiscal capacity of states to support the cities and counties that depend on their aid.

In 49 states, “balanced budgets” are required by constitution or by statute; Vermont, the sole exception, follows the practice of its peers. In truth, however, there is no common definition of a balanced budget, and many states resort to short-term sleight of hand to make it appear that spending does not exceed revenue. The techniques include shifting the timing of receipts and expenditures across fiscal years; borrowing long term to fund current expenditures; employing nonrecurring revenue sources to cover recurring costs; and delaying funding of public worker pension obligations and other postemployment benefits (OPEB), principally retiree health care.

While these actions temporarily solve budget-balancing challenges, they add to the bills someone eventually has to pay. Yet few states include information about these long-term spending obligations in the budgets that governors propose and state legislatures debate. This precludes accurate, informed consideration of policy trade-offs.

A primary aim of this preliminary study is to lay the groundwork for a common approach toward responsible budget practices in all 50 states. A continuing comparative analysis should provide a framework for a scorecard with respect to budgeting and financing practices. By shining a spotlight on opaque and confusing practices and by identifying more-appropriate approaches, we hope to provide incentives for officials to clarify financial issues and encourage debate on basic policy choices.

We invite and encourage governors, budget officers, and legislators to commit to work with us in developing useful approaches toward effective financial policies. Recent experience demonstrates the need. Mounting fiscal stress in Illinois, the bankruptcy of Detroit, and the impending financial crisis in Puerto Rico all indicate the relevance of the initiative that the Alliance has undertaken.

Preliminary Budget Report Card

20150615-UW_Shedlock

Many Pensions, Many Standards

While the Governmental accounting Standards Board (GASB) provides recommendations for public employee pension funds’ reporting, comparing liabilities between states is difficult because they are based on actuarial assumptions and calculation methods that differ from one plan to another.

The actuarial assumption that has received the most attention over the past 15 years is the investment return. Any change in this assumption has a substantial impact on the calculation of liabilities. For example, when Utah shifted to a 7.75 percent from an 8 percent assumption in 2008, its funding level dropped to 95 percent from 101 percent. If it had raised the investment rate assumption to 8.5 percent, the funding level would have risen to 113 percent.

Of the three states studied by the Volcker alliance, the Virginia retirement System assumes a 7 percent rate of return. New Jersey’s public employee and teachers’ systems use a 7.9 percent rate of return; and both the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ retirement System (CalSTRS) use 7.5 percent.

A number of independent experts have questioned whether the pensions’ assumptions are higher than justified by existing circumstances and future probabilities. These and other calculations need to be considered when looking at the plan’s calculations of its unfunded liabilities.

At the end of 2013, the state portion of the New Jersey pension system was 54 percent funded;  the Virginia Retirement System was 65 percent funded. In California, the public employee portion of CalPERS was 75 percent funded, 24 while CalSTRS was 67 percent funded.

Cash Accounting

States should move away from strictly cash budgeting and toward the type of accounting, used in their audited comprehensive annual financial reports, that shows the true present value of future spending obligations. The use of cash-based fund accounting methods by most states and localities creates the temptation as well as the capacity to shift the costs of today’s services onto coming generations by ignoring future spending for which taxpayers are already obligated.

For example, Virginia, California, and New Jersey have failed to make their recommended contribution, as determined by actuaries, for full funding of public employee pension systems. Yet the states’ enacted budgets show only the amount governors and legislators chose to appropriate for each fiscal year or biennium studied. In addition, New Jersey and California, particularly, have amassed billions of dollars in obligations for public workers’ retirement health care benefits.

The three states have substantial deferred long-term infrastructure maintenance needs that are not reflected in their budgets, and California and New Jersey have failed to reflect the cost of future obligations for K-12 spending required under statutes or judicial orders.

California

Once tied with Illinois for America’s lowest state general obligation credit rating, California now stands out as a budget reformer. Since 2013, its general obligation bond debt has garnered multiple upgrades from Moody’s, S&P, and Fitch.

California has also taken steps to improve teachers’ pension funding, though this is being accomplished in part by pushing the costs from the state to local school districts. Risks remain for California. The state is still saddled with $94.5 billion in bond debt supported by tax revenue, and it has amassed another $195 billion in unfunded promises to pay pension and other retiree benefits. Its revenue remains highly dependent on capital gains taxes, which means the state is hostage to the vagaries of the stock and real estate markets. Further, California has a $64.6 billion shortfall in deferred infrastructure maintenance, according to the California Five-Year Infrastructure Plan of 2014. It remains too early to tell if the state’s fiscal culture has changed permanently or if California will revert to its previous tactics in the next economic or stock market downturn.

Status of Pension and OPEB Funding

California is carrying a total of $131.1 billion in unfunded pension liabilities and $64.6 billion in unfunded retiree health benefits for state workers, teachers, and local school administrative personnel. The combined amounts equal more than 9 percent of the state’s $2.1 trillion economy, a burden of about $5,100 per resident.

There is much more in the 60-page report.

I side with the independent experts in regards to pension plan assumptions.

The California pension assume 7% returns. I suggest there will be -2 to +2% percent returns over the next seven years. For further discussion, please see Seven Year Negative Returns in Stocks and Bonds; Fraudulent Promises.

Such returns would devastate California and crucify Illinois. Sadly, there have been no reforms at all in Illinois.

About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

Retiree with $183,690 Annual Pension Attacks Pension Critics

“Critics of public employee retirement benefits are engaging in hyperbole and pointing to potholes as evidence that millions of elderly Californians should be stripped of their retirement savings.”
Brian Rice, president, Sacramento Area Fire Fighters, Sacramento Bee, June 2, 2015

Notwithstanding the possibility that saying pension reformers want to see “millions of elderly Californians stripped of their retirement savings” is itself “hyperbole,” Brian Rice’s recent Sacramento Bee submission requires a detailed rebuttal. Rice’s piece, entitled “Pensions aren’t being paid at expense of filling potholes,” was in response to a study written by Stephen Eide and released by the Manhattan Institute entitled “California Crowd-Out, How Rising Retirement Benefit Costs Threaten Municipal Services,” published in April 2015.

Rice leads off by attempting to link the Manhattan Institute to the supposedly infamous Koch Bros., despite offering zero evidence that the Koch Brothers contribute to that organization. And, of course, he is relying on this unsubstantiated link to discredit Eide’s work, apparently because if the Koch’s funded the work, then the author had to come up with data and conclusions that fit their agenda, instead of the facts and logic.

We’ll get to facts and logic in a moment, but first it is necessary to consider Brian Rice’s agenda. Because there is virtually no comparison between California’s urban firefighters and the “working class,” “minority, low-income and rural communities,” to whom Rice makes reference in his article, and for whom unions are more legitimately challenged to represent. Brian Rice, who retired in 2011 after 28 years of service, collected a pension in 2013 of $183,690, NOT including other benefits which probably add at least another $10,000 to his total retirement package.

Here’s pension data for Brian Rice. Notice how during retirement his pension still increases each year.

Here’s pension data for Rice and his fellow retirees from Sac Metro Fire – and Rice isn’t even in the top ten. The top spot is held by James Eastman, who collected a modest pension of $231,428 in 2013.

Rice writes: “Public employees have traded off other compensation in order to have a secure retirement.”

Really? Here’s payroll and benefits data for Sac Metro Fire’s active employees. Eleven employees made over $300,000 in 2013, 195 made over $200,000 in 2013, and 408 made over $150,000 in 2013. The Sacramento Bee recently published an analysis of average pay, not including benefits, for Sacramento firefighters. The data shows the average firefighter makes $122,677 per year, NOT including current benefits such as health insurance, and not including the employer’s pension contribution. Add those and the average goes up to $194,083. And no, that average does NOT include captains, who average $163,040 before benefits.

Quite a trade off. Modest pay in return for a secure pension. No hidden agenda there, right? No motive to engage in “hyperbole” when you encounter critics?

Back to potholes. A California Policy Center study published in February 2015, “California City Pension Burdens,” documents the average employer pension contribution for California cities in 2013 at 7% of total revenue. CalPERS is increasing their required pension contribution by 50%, meaning the average will become over 10% of total revenue. And that assumes the markets don’t correct downwards. Many cities are in far worse shape. Is it really necessary for 10% of every dollar in local tax revenue go to pay pensions that average over $100,000 per year for public safety employees who retire early and whose pensions get annual cost-of-living increases?

The “crowding out” effect is real, and it affects more than potholes. Rice is perhaps at his most hyperbolic when he writes “each year, the $13 billion that much-maligned CalPERS pays Californians in pension payments creates $30.4 billion in economic activity. The California Public Employees’ Retirement System also invests in big infrastructure projects for the state, and makes capital available to minority, low-income and rural communities.”

Bull. Bull. And Bull. To wit:

(1) The $13 billion creating $30.4 billion in economic activity is known as a “multiplier.” As Rice puts it, “They spend it on housing, food, gasoline, other necessities, gifts for the grandkids and more – which drives economic activity, creates jobs and increases tax revenues.” We hate to break it to you, Mr. Rice, but if we had been able to keep that money, instead of paying higher taxes so you can have your $183,690 per year pension, we would have also been able to “spend it on housing, food, gasoline,” etc. No net benefit there.

(2) Rice claims $13 billion is paid out annually by CalPERS to pensioners. Actually last year it was $17.7 billion (ref. CalPERS CAFR 6-30-2014, page 24). But Rice neglects to mention that 15% of those pensioners have moved out of California. And Rice ignores the other side of the equation, which is that based on their asset allocation to-date, 91% of the $12.6 billion paid into CalPERS last year was invested out-of-state. CalPERS has $301 billion in assets, and ninety-one percent of that money is invested out-of-state. As it stands today, California’s citizens, their cities, and the overall economy would be a lot better off if CalPERS, and every other pension system in California, did not exist.

(3) When it comes to infrastructure, not only is CalPERS investing a ridiculously minute portion of their portfolio, but the primary reason there isn’t money for infrastructure is because cities, counties, and the state are too busy allocating all of their financial resources to overcompensated public employees. And if CalPERS and the other pension systems were willing to invest for reasonable rates of return, instead of speculating on global markets, they could take their roughly $700 billion in assets and finance revenue producing civil infrastructure such as dams, upgraded water treatment to allow reuse of waste water, desalination plants, aqueduct upgrades, port expansions, road and freeway upgrades, bridge repair – the list is endless.

Despite Mr. Rice’s hyperbole, most pension reformers do not want to abolish defined benefit pensions for public employees, if these pensions could be made fair and financially sustainable. That would require returning to the conservative investment guidelines in place until Prop. 21 was passed in 1984, and it would require returning to the modest and fair benefit formulas that were in place until SB 400 was passed in 1999. Taking these steps would not only save defined benefit pensions, but enable massive investment by the pension systems in revenue producing civil infrastructure.

There’s a lot of middle ground between someone collecting a pension of $183,690 per year, and being “stripped of their retirement savings,” Mr. Rice.

*   *   *

Ed Ring is the executive director of the California Policy Center.

Look Out For These Pension Gimmicks

State public pension plans are the future, and often current, greatest liabilities that state governments must tackle. Promises made to employees in the past, and politicians kicking the problem further into the future have made the problem spiral out of control. Economists agree that the current discounting of liabilities leaves much to be desired. State Budget Solutions has long been an advocate for using fair market valuation.

But it isn’t just discount rates that cause these pension liabilities to climb. Here is our guide to some of the other popular tricks used by politicians and actuaries that hide the true cost of delaying pension reform.

Outdated Life Expectancy Assumptions
When public pension funds were first established, the average life expectancy was much lower than it is today. The problem is that some pension funds have not adjusted for this change. The calculations for determining liabilities take demographics into consideration. If this is not updated, it means that the pension fund is planning to pay out benefits to retirees for a shorter time. TheInternational Monetary Fund recognized this issue, concluding that “if everyone lives three years longer than now expected–the average underestimation of longevity in the past–the present discounted value of the additional living expenses of everyone during those additional years of life amounts to between 25 and 50 percent of 2010 GDP.”

  • California: CalPERS has been assuming that government employees, especially police and fire personnel, are more likely to die on the job. This allowed the system to require smaller contributions into the system. But it isn’t true, because government has expanded that definition to include several causes of death that are not directly related to the job, such as heart attack. The result is that CalPERS actuaries are now asking for a 10% increase in contributions to make up the difference for the faulty assumption.
  • New Study: How Will Longer Lifespans Affect State and Local Pension Funding?

Inflated Discount Rates
The discount rate is used to determine the amount of funding necessary in a public pension fund today in order to reach the predicted funding needed in the future to provide retiree benefits. Most public pensions use the expected investment rate of return as the discount rate. This rate is often 7-8%, and sometimes higher. This means that pension fund managers must be willing to take greater risk in order to match the discount rate and ensure that there is sufficient money in the fund at a later date. This also requires that the necessary contributions are made every year, and also requires that all actuarial assumptions are accurate. Pension benefits, however, are considered guaranteed assets to the retirees who are vested in the system and therefore must be paid. This obligation puts taxpayers on the hook for trillions of dollars if the discount rate is not met.

A study by Moody’s Investor Services showed that from 2004-2012, the top 25 public pension funds were “on-target” for rate of returns but still accrued nearly $2 trillion in unfunded liabilities. This is because using the rate of return in lieu of a market-valued discount rate is not a proper reflection on the liabilities. The discount rate should reflect similar liabilities, such as those paid out in government bonds yields. The State Budget Solutions annual report on public pensions showed that if public pension funds used a more appropriate discount rate, the collective unfunded liability of all state plans would be $4.7 trillion.

Overly Aggressive Investment Assumptions
Legislators are tempted to assume a higher annual rate of return on investments, meaning that they can put fewer dollars into pensions in the current budget. Although related to inflated discount rates, this issue is an independent problem.

Underfunding Pension Contributions
An underfunded state pension plan has more liabilities than assets. By continually underfunding pensions, pension accounts become less stable, and there is less assurance that the state can effectively cover distribution amounts when pension benefits become due. The Annual Required Contribution (ARC) is the amount of money required to sustain the pension fund based on the discount rate and other assumptions. When the ARC is skipped, or even reduced, that means that pension funds will need to make up for the lost expected growth, as well as the actual contribution in today’s dollars. This compounds the unfunded liabilities.

  • New Jersey: Governor Chris Christie has made a habit of underfunding the state pension fund, repeating the sins of many of his predecessors. Most recently, Christie’s administration is arguing that its own reforms to the pension system, which required full contributions each year, are unconstitutional. Courts have said that he must follow the 2011 law.

Pension Obligation Bonds
As more states recognize the whopping unfunded liabilities in public pension funds, some policymakers have opted to borrow money now in order to make up the difference. When interest rates are low, the logic follows that if a state borrows money today at a lower rate, it can invest that money, have a greater rate of return, and be able to pay off the bond debt and also assist in paying down unfunded liabilities. But this maneuver also allows the state to automatically assume that this new funding will hit the higher rate of returns, often at 7-8% annually. That means that even less money needs to be put into the pension funds now, or at least according to this accounting trick. Another challenge is when a state issues pension obligation bonds, they underfund the annual required contribution in the budget and in some cases (i.e. Illinois) use the pension obligation bonds to “balance” the current budget and thus not put the money into pensions.

  • Kansas: Kansas has approved a $1 billion pension bond that will put cash directly into the coffers of the system to be used for investment. Because of the investment assumptions, the state has also decided to lower the contribution to the pension plan by $64 million over two years, which will help “balance” the budget.
  • Illinois: “In just ten years, the Illinois General Assembly pushed the burden of billions in government spending onto Illinois’ future generations. Official estimates put Illinois’ unfunded pension liability at $85.6 billion. But that amount does not take into account the $25.8 billion in pension obligation bond (POB) payments still outstanding, which have a net present value of approximately $17.2 billion”

Rolling Amortization and Smoothing
In order to make the contributions by the employer–the government–more stable and predictable year over year, pension funds engage in actuarial gimmicks that allow contributions to remain low. The spirit of this idea is admirable, as it intends to ignore the potential volatility on Wall Street and still ensure proper contributions into the pension fund. In reality, the result has been the opposite. This tactic has allowed pension funds to ignore their incorrect assumptions on investment returns and discount rates and maintain contributions that do nothing to meet the true liabilities.

Liberal Vesting Requirements
In order to receive a pension benefit, government employees must meet certain requirements regarding their employment, including length of service. In some cases, state and local governments have made it easy for employees to meet those requirements, known as “vesting.” If vesting is easy, then too many retirees will be receiving benefits in the future, straining the system. Vesting requirements may also be expanded by the courts, adding greater liabilities to the pension plans. These liberal vesting requirements also make reforms more difficult. The more employees that are considered to be vested while employed, the more limited the reforms can be as it is often the case that vested employees may not have their benefits altered.

Not Planning For The Future
It is so easy for legislators to promise benefits tomorrow but not pay for them today. This is the essential flaw in the current public pension system that allows for defined benefit plans. Those who control the levels of benefits are politicians who must worry about re-election. This is not a system that rewards future planning over present results. If politicians were divorced from the process and employees and retirees had control over their retirement, a good number of these gimmicks would not be necessary to have a sustainable system.

*   *   *

About the Authors:

Joe Luppino-Esposito is the editor and general counsel of State Budget Solutions. Joe’s current research focuses on public employee pensions, Medicaid expansion, state debt, budget gimmicks, and many other state budget reforms. Prior to joining SBS, Joe was a researcher for Berman and Company, and previously served as a Visiting Legal Fellow at the Heritage Foundation, specializing in criminal and constitutional law.

Bob Williams is President of State Budget Solutions. He is a former state legislator, gubernatorial candidate an auditor with the U.S. Government Accountability Office (GAO). Bob is a national expert in fiscal and tax policies, election reform and disaster preparedness. Because of his unique experience and expertise, Bob is a frequent guest on talk radio and at public forums. His commentary on state budget solutions appears frequently in newspapers, journals and online publications.

This article originally appeared on the website of State Budget Solutions and is republished here with permission.

Pension Reformers are not "The Enemy" of Public Safety

“You will find that powerful financial and investment institutions are the ones promoting the attacks on your pensions. Firms like Berkshire-Hathaway and the Koch brothers are backing political candidates and causes all over the country in the hopes of making this issue relevant and in the mainstream media. Why? Because if they can crack your pension and turn it into a 401(k), they will make billions. Your pension is the golden egg that they are dying to get their hands upon. By the way, it was those same financial geniuses that brought about the Great Recession in the first place. After nearly collapsing the entire financial system of western civilization, they successfully managed to deflect the blame off of themselves and onto government employee pay/benefits.”
– Jim Foster, Vice President, Long Beach Police Officers Association, posted on PubSec Alliance website

These comments form the conclusion to a piece published by Foster entitled “What does “unfunded liability” mean?,” published on PubSecAlliance.com, an online “community of law enforcement associations and unions.” If you review the “supporters” page, you can see that the website’s “founding members,” “affiliated organizations,” and “other groups whose membership is pending” are all law enforcement unions.

In Foster’s discussion of what constitutes an unfunded pension liability, he compares the liability to a mortgage, correctly pointing out that like a mortgage, an unfunded pension liability can be paid down over many years. But Foster fails to take into account the fact that a mortgage can be negotiated at a fixed rate of interest, whereas a pension liability will grow whenever the rates earned by the pension system’s investments fall short of expectations. When the average taxpayer signs a 30 year fixed mortgage, they don’t expect to suddenly find out their payments have doubled, or tripled, or gone up by an order of magnitude. But that’s exactly what’s happened with pensions.

Apart from ignoring this crucial difference between mortgages and unfunded pension liabilities, Foster’s piece makes no mention of the other reason unfunded pension liabilities have grown to alarming levels, the retroactive enhancements to the pension benefit formula – enhancements gifted to public employees and imposed on taxpayers starting in 1999. These enhancements were made at precisely the same time as the market was delivering unsustainable gains engineered by, as Foster puts it, the “same financial geniuses that brought about the Great Recession in the first place,” and “nearly collapsing the entire financial system of western civilization.”

This is a huge failure of logic. Foster is suggesting that the Wall Street crowd is to blame for the unfunded liabilities of pensions, but ignoring the fact that these unfunded liabilities are caused by (1) accepting the impossible promises made by Wall Street investment firms during the stock market bubbles and using that to justify financially unsustainable (and retroactive) benefit formula enhancements, and (2) basing the entire funding analysis for pension systems on rates of return that can only be achieved by relying on stock market bubbles – i.e., doomed to crash.

You can’t blame “Wall Street” for the financial challenges facing pension funds, yet demand benefits based on financial assumptions that only those you taint as Wall Street charlatans are willing to promote.

Foster ignores the fact that the stock market bubbles (2000, 2008, and 2014) were inflated then reflated by lowering interest rates and accumulating debt to stimulate the economy. But interest rates cannot go any lower. When the market corrects, and pension funds start demanding even larger annual payments to fund pensions and OPEB that now average over $100,000 per year for California’s full-career public safety retirees, Foster and his ilk are going to have a lot of explaining to do.

There is a deeper, more ominous context to Foster’s remarks, however, which is the power that government unions, especially public safety unions, wield over politicians and over public perception. The navigation bar of the website that published his essay, PubSecAlliance, is but a mild reminder of the power police organizations now have over the political process. Items such as “Intel Report,” “Pay Wars,” “Tactics,” “Tales of Triumph,” and “The Enemy” are examples of resources on this website.

When reviewing PubSecAlliance’s reports on “enemies,” notwithstanding the frightening reality of police organizations keeping lists of political enemies, were any of the people and organizations listed selected despite the fact that they were staunch supporters of law enforcement? Because pension reformers and government union reformers are not “enemies” of law enforcement, or government employees, or government programs in general. There is no connection.

Here are a few points for Jim Foster to consider, along with his leadership colleagues at the Long Beach Police Officers Association, and police union members everywhere.

TEN POINTS FOR MEMBERS OF PUBLIC SAFETY UNIONS TO CONSIDER

(1)  Not all pension reformers want to abolish the defined benefit. Restoring the more sustainable pension benefit formulas in use prior to 1999, and adopting conservative rate-of-return assumptions would make the defined benefit financially sustainable and fair to taxpayers.

(2)  Over the long term, the real, inflation-adjusted return on investments cannot be realistically expected to exceed the rate of national and global economic growth. You are being sold a 7.0% (or more) annual rate of return because it is an excuse to keep your normal contribution artificially low, and mislead politicians into thinking pension systems are financially sound.

(3)  As noted, you can’t blame “Wall Street” for the financial challenges facing pension funds, yet demand benefits based on financial assumptions that only those you taint as Wall Street charlatans are willing to promote.

(4)  If public safety employers didn’t have to pay 50% or more of payroll into the pension funds – normal and unfunded contributions combined – there would be money to hire more public safety employees, improving their own safety and better protecting the public.

(5)  Public safety personnel are eyewitnesses every day to the destructive effects of failed social welfare programs that destroy families, ineffective public schools with unaccountable unionized teachers, and a flawed immigration policy that prioritizes the admission of millions of unskilled immigrants over those with valuable skills. They ought to stick their necks out on these political issues, instead of invariably fighting exclusively to increase their pay and benefits.

(6)  The solution to the financial challenges facing all workers, public and private, is to lower the cost of living through competitive development of land, energy, water and transportation assets. Just two examples: rolling back CEQA hindrances to build a desalination plant in Huntington Beach, or construct indirect potable water reuse assets in San Jose. Where are the police and firefighters on these critical issues? Creating inexpensive abundance through competition and development helps all workers, instead of just the anointed unionized government elite.

(7)  If pension funds were calibrated to accept 5.0% annual returns, instead of 7.0% or more, they could be invested in revenue producing infrastructure such as dams, desalination plants, sewage distillation and reuse, bridges, and port expansion, to name a few – all of which have the potential yield 5.0% per year to investors, but usually not 7.0%.

(8)  Government unions are partners with Wall Street and other crony capitalist interests. The idea that they are opposed to each other is one of the biggest frauds in American history. Government unions control local politicians, who award contracts, regulate and inspect businesses, float bond issues, and preserve financially unsustainable pension benefits. This is a gold mine to financial special interests, and to large corporate interests who know that the small businesses lack the resources to comply with excessive regulations or afford lobbyists.

(9)  Government unions elect their bosses, they wield the coercive power of the state, they favor expanded government and expanded compensation for government employees which is an intrinsic conflict of interest, and they protect incompetent (or worse) government employees. They should be abolished. Voluntary associations without collective bargaining rights would still have plenty of political influence.

(10)  Expectations of security have risen, the value of life has risen, the complexity of law enforcement challenges has risen, and the premium law enforcement officers should receive as a result has also risen. But unaffordable pensions, along with the consequent excessive payments of overtime, have priced public safety compensation well beyond what qualified people are willing to accept. Saying this does not make us your “The Enemy.”

*   *   *

Ed Ring is the executive director of the California Policy Center.

RELATED ARTICLES AND POSTS

Pension Reform is BAD for Wall Street, and GOOD for California, April 14, 2015

Desalination Plants vs. Bullet Trains and Pensions, April 7, 2015

The Glass Jaw of Pension Funds is Asset Bubbles, February 24, 2015

Police Unions in America, December 9, 2014

How Police Unions and Arbitrators Keep Abusive Cops on the StreetAtlantic Monthly, December 2014

More Taxes and Tuition Buy Time for the Pension Bubble, November 25, 2014

The Amazing, Obscure, Complicated and Gigantic Pension Loophole, November 18, 2014

Estimating America’s Total Unfunded State and Local Government Pension Liability, September 9, 2014

Two Tales of a City – How Detroit Transcended Ideology to Reform Pensions, July 22, 2014

Government Employee Unions – The Root Cause of California’s Challenges, June 3, 2014

California’s Green Bantustans, May 21, 2014

Conservative Politicians and Public Safety Unions, May 13, 2014

The Unholy Trinity of Public Sector Unions, Environmentalists, and Wall Street, May 6, 2014

Public Pension Solvency Requires Asset Bubbles, April 29, 2014

Add ALL Public Workers to Social Security, March 25, 2014

How Much Does Professionalism Cost?, March 11, 2014  (The Kelly Thomas Story)

Pension Funds and the “Asset” Economy, February 18, 2014

Middle Class Private Sector Workers Are NOT “Ripping Off the Next Generation”, December 17, 2013

Unions and Bankers Work Together to Protect Unsustainable Defined Benefits, November 26, 2013

A Member of the Unionized Government Elite Attacks the CPC, November 19, 2013

How Public Sector Unions Skew America’s Public Safety and National Security Agenda, June 18, 2013

To Save Defined Benefit, Unions Need to Accept Investment Realities

Editor’s Note: The president of the California Professional Firefighters union, Lou Paulson, has criticized Mayor Chuck Reed’s pension reform, stating “His idea of pension reform is, you sign up for one pension system, we’re going to change it now in mid career, and now you’re going to get something different.” But Paulson, and anyone who thinks defined benefit pensions can remain financially sustainable with only incremental adjustments, is ignoring a potential “mid-career” imposition of “something different” that could hit these funds like a seismic wave – a severe and prolonged market correction. That has already happened twice in the last 20 years, and each time, the rebound was triggered by lowering interest rates. But how much lower can interest rates go? In the following article by UnionWatch contributor Mike Shedlock, he highlights a just released forecast by GMO, a global investment management firm, that projects real rates of return for stocks and bonds stagnating at near zero levels for the next several years. What if they’re right? Shedlock’s article goes on to describe the situation with Illinois state pensions. The situation in California is scarcely better – after a bull market lasting nearly eight years, California’s state and local pension funds are still a bit shy of 80% funded, which is considered the minimum level for a healthy pension system. Saving defined benefits will require adopting much lower rate of return projections, and returning benefit formulas to pre-1999 levels. The sooner the leaders of government unions accept and support this, the more likely they will be able to save the defined benefit for all their members.

It is extremely refreshing to see a large, prominent, and historically accurate fund manager lay it on the line.

GMO does that quarter after quarter, with no-nonsense projections.

As of March 31, their 7-Year Asset Class Real Return Forecast is as follows.

GMO 7-Year Real Return Forecasts by Asset Class
2015 through 2021
20150423-UW_Shedlock-1

Serious Question for Pension Plans

Given pension plan assumptions of 7-8% annualized returns how many of them can survive negative returns for seven years? It’s important to note that GMO is talking about “real” inflation-adjusted returns with an assumption of mean-reversion inflation to 2.2% over 15 years.

Still, that leaves US equities at zero to -1% returns and US bonds at negative 2.4% returns.

Even if GMO is wrong by say 3%, many pension plans will be in deep serious trouble at those returns.

Illinois Pension Plans

I keep harping about this issue, but it’s an important one. In the state of Illinois, and in spite of an enormous rally in the stock market since 2009, Illinois pension plans are only 39% funded.

A “Special Pension Briefing” last November, shows the Illinois State Retirement Systems are in dismal shape.

Unfunded Liabilities

  • Teachers’ Retirement System (TRS): $61.6 Billion
  • State Retirement Systems (SERS): $61.6 Billion
  • State Universities Retirement System (SURS): $21.6 Billion
  • Judicial Retirement System (JRS): $1.5 Billion
  • General Assembly Retirement System (GARS): $0.3 Billion

The above numbers show actuarial (smoothed) asset valuations.

Liability Trends – Not Smoothed

Illinois State Pension Systems Combined
Unfunded Liability History 2000 – 2014 ($=B)20150423-UW_Shedlock-2

In spite of the massive stock market rally, Illinois liabilities increased every year since 2011.

For still more details, please see Illinois Pension Plans 39% Funded; Taxpayers On the Hook for $105 Billion in Liabilities; It Will Get Worse!.

Any notion that pension shortfalls can be balanced on the backs of Illinois taxpayers needs to vanish now.

How did Illinois plans became so underfunded?

In general, by promising far more than can possibly be delivered.

Illinois State Pensions – Summary of Liabilities and Unfunded Ratios

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Congratulations go to the Illinois General Assembly Retirement System (GARS) for having one of the worst, (if not the worst) pension plan in the entire nation. It is 16% funded.

No doubt, that increases the pressure of the General Assembly to put the burden of bailing out the system on the backs of Illinois taxpayers.

Fraudulent Promises

Pension promises were not made in good faith.

Rather, pension promises were the direct result of coercion by public unions on legislators, mayors, and other officials willing to accept bribes because they shared in the ill-gotten gains of backroom deals at taxpayer expense.

Illinois taxpayers cannot be held accountable for coercion of public officials by public unions. Fraudulent promises will be held “null and void” in any “non-stacked” court of law in the nation.

Given the 31% funding of the Illinois Judicial Pension Plan (JRS), the sorry state of Illinois pensions is likely headed to federal courts.

*   *   *

About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

Michigan Court: Reduce Pensions or Reduce Retirement Health Benefits

Editor’s Note: Notwithstanding recent court challenges that could go either way, one way to negotiate meaningful steps towards financially sustainable defined benefit pensions, i.e., reductions or suspensions of COLAs, prospective reductions in the multiplier, increased employee contributions towards the unfunded liability and not just towards the normal contribution, etc., is to offer to reduce OPEB (other post employment benefits) instead. From Detroit to Stockton, this option has been part of the discussion. The scale of OPEB liabilities are comparable to unfunded pension liabilities, in some cases, they actually exceed unfunded pension liabilities. But in general, cities, counties and states can exercise more discretion with OPEB commitments when their agencies face severe financial stress than they can with pensions. Leverage is scarce in the world of pension reform, and OPEB is being used. In this article, author Mike Shedlock reports on how this is playing out in Michigan and Illinois – something to be watched closely in California.

Illinois state pension and retirement plans are in dire straits. The only way to fix the problems is with plan changes.

Michigan did that in 2012. And in a 6-0 decision yesterday, the Detroit Free Press reported the Michigan Supreme Court, rejected arguments from unions, and upheld the 2012 state law requiring teachers to put more of their pay toward their pension plans or face cuts to benefits.

The Michigan Supreme Court, rejecting arguments from unions, has upheld a 2012 state law requiring teachers and other school employees to put more of their pay toward their pension plans or face cuts to benefits such as post-retirement health care.

The law, backed by Gov. Rick Snyder and the Republican-controlled Legislature, was intended to cut an estimated $45-billion unfunded liability in the Michigan Public School Employees Retirement System by more than $15 billion.

The American Federation of Teachers and the Michigan Education Association unions argued the law impaired contracts and amounted to uncompensated takings of pension benefits.

But both the Michigan Supreme Court and the appeals court said the law doesn’t violate a Michigan constitutional provision protecting earned pension benefits, because only future benefits are affected. Also, unlike an earlier law that mandated 3% contributions toward health care, the 2012 law provides an opt-out provision, the court said.

Good News For Illinois

What passes constitutional muster in Michigan may not do so in Illinois, but the unanimous ruling provides a model for what may work elsewhere. This is good news for all cash-strapped states.

In Illinois, Gov. Bruce Rauner Wants Changes to Insurance Programs for State Workers, Retirees.

Health insurance for active state workers and retirees is being targeted for big savings in Gov. Bruce Rauner’s budget plan.

“By bringing health care benefits more in line with those received by the taxpayers who pay for them, we save an additional $700 million,” Rauner said Wednesday in his budget speech.

His budget also calls for an end to state subsidies to the health insurance programs for retired downstate teachers and community college workers.

Right Path

Governor Rauner is on the right path. Benefits must be cut. For starters, Illinois needs to move all employees going forward into 401K type plans. Next, Illinois needs to address spiraling costs for those in defined benefit plans.

Michigan passed one law the Michigan Supreme Court rejected, and a second one in 2012 law that was upheld unanimously. Illinois would be wise to pursue changes that are likely to be upheld in court. We now have at least one model that works.

For more on problems in Illinois and what to do about them, please see …

Illinois desperately needs to address the root of its fiscal problems: untenable pension benefits and promises.

Massive proposed tax hikes are not the answer. Tax hikes will do nothing but make already uncompetitive Illinois even more uncompetitive.

About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

Eureka Faces Pension Headwinds – Just Like Every Other California City

The city of Eureka on the far north coast of our state is part of a fabled land, far removed from the rest of drought stricken California. The winds that the ridiculously resilient ridge of high pressure push north find welcoming mountains and canyons in and around Eureka, drenching them with rain, nourishing endless groves of the tallest trees on earth, the magnificent coast redwoods. Gushing rivers run through thick green forests scented with maritime air. Downtown, the mansions of the 19th century lumber barons defy time, marvelous, intricate, stunning. And on postcard perfect shorelines, the rugged Pacific surf surges against the rocks. It’s hard to imagine a more beautiful place.

But when it comes to government unions making sure their compensation crowds out any hope of fiscal sanity, Eureka is as ordinary, and as challenged, as every other city in California.

A few weeks ago the California Policy Center released a study “California City Pension Burdens” that compiled key financial indicators for every city in California. When it came to pension contributions as a percent of general fund revenue, the city of Eureka made the top ten. That is, in 2015, Eureka will send 11.3% of its entire incoming revenue from taxes and fees to the giant pension fund, CalPERS.

These findings, covered in the Eureka Times-Standard, earned this rebuke in a guest editorial submitted by Eureka City Councilmember Linda Atkins on March 17th:

“… the California Policy Center, a renowned conservative pressure group disguised as a “think tank” that’s out to push the California public into believing that they deserve government services for free and that a secure retirement is only for those with enough income to provide it for themselves. Their hope is to dismantle all reliable retirement systems, including Social Security, so that you and I will live a frightening old age in poverty, while the execs and corporations rake in the billions.”

One may attack the messenger, or face facts. The city of Eureka has an officially recognized unfunded pension liability of $53 million, which equates to $4,529 per household. That number, of course, does not include the additional liability facing local taxpayers for Humboldt County’s pension liabilities, or local school districts, or state agencies. And if there is another market downturn, these unfunded liabilities and the city’s required annual contribution will go way up.

No reasonable person expects government services to be free. But in Eureka during 2013 the average full time police officer collected pay and benefits – including the city’s contribution to CalPERS – of $110,280; the average full-time firefighter, $120,243 (download spreadsheet). The average pension collected in 2013 by retired city employees with 30+ years of service, public safety and miscellaneous combined, was $58,397. All of this in a town with a median household income of $36,393 and an unemployment rate of 9.7%. It should be possible to question these rates of pay and pensions for Eureka’s city employees while still respecting and appreciating the work they do.

To set Ms. Atkins’ mind at rest, on the topic of retirement security, here are just two of the California Policy Center’s well-documented recommendations for rescuing the finances of cities and counties in California, including Eureka:

(1) Preserve Social Security by enrolling every government employee in the program, subject to the same rules and benefit formulas that apply to current participants. In terms of return on investment, Social Security pays high income individuals far less in retirement compared to low income individuals. Therefore, because government workers make so much more than private sector workers, enrolling America’s millions of highly compensated government workers in Social Security would significantly reduce any eventual financial challenges the system will face.

(2) Preserve defined benefit pensions for government employees by changing the benefit formulas, retroactively, to the precise annual multipliers and retirement ages that were in effect prior to 1999, when pension bankers and unions began pressuring politicians into enhancing these benefits, retroactively, to levels far beyond what is fair to taxpayers or financially sustainable. Alternatively, simply suspend pension cost-of-living increases, change benefit formulas prospectively, and raise employee contribution rates, until the systems are 100% funded.

We invite Ms. Atkins to identify any “right wing pressure group,” anywhere, that supports either of these recommendations.

Atkins is at her most thoughtful when she describes the crash of 2008. She writes:

“Then came the criminal actions from Wall Street that caused the Great Recession, where risky mortgages were “bundled” into investment instruments that were sold to many retirement funds as “safe” investments. Investing in Americans’ mortgages used to be very safe; people were vetted very well before they were given the opportunity to buy a home. Then came Wall Street with “sub-prime” mortgages, giving loans to people who never had a chance of being able to pay them back. The banks then bundled these loans and offered them as stable investments. Then came the crash of 2008. Who got hurt? All the pension fund investors who purchased the bogus “bundles” and of course the rest of America who lost jobs, homes and futures because of the greed and avarice of those Wall Street bankers.”

All true. But what Atkins doesn’t care to admit is that public sector pensions are the last, best con job of the most corrupt among these “Wall Street bankers.” Just as people bought overpriced homes who could never afford to pay them back, pension funds – who are the biggest players on Wall Street – are pretending they can earn high-returns forever. And just like the big bankers, the pension funds expect taxpayers to bail them out.

There is a hypocrisy involved in lumping advocates for pension and contribution reform in with “execs and corporations” who “rake in billions.” Because the high returns pension funds currently earn depend on a rising stock market, jacked up by debt fueled, unsustainable consumer spending. Without corporate profits, corporate stocks don’t appreciate, and pension funds go broke. No profits, no pensions.

The hypocrisy doesn’t end there. When pension funds struggle financially – which they will more than ever when we return to sustainable rates of asset appreciation – the government unions and their supporters call on us to “tax the rich.” But those taxes aren’t for us. Those taxes are to pay government employees twice as much, or more, as ordinary private citizens.

But all of this is far too big to constitute a “sound bite,” so none of it can possibly be true, right Councilmember Atkins? It’s easier to suggest that any criticism of pension excess must emanate from a “right wing pressure group.”

*   *   *

Ed Ring is the executive director of the California Policy Center.

REFERENCES

Transparent California listing of CalPERS participating employers
(includes average pension for 30+ year participants)

Transparent California listing of city of Eureka individual retiree pension recipients

Transparent California listing of Eureka active employees

Pension Funds and the Ultimate Hedge, Taxpayers

“We’re trying to make these guys’ money toxic because, as we’ve seen, their money is toxic,” Jonathan Westin, the director of New York Communities for Change, told Business Insider on Thursday. “I think it’s connecting the dots that many people don’t always connect.”
–  “Activists think they found a way to convince Democrats to stay away from ‘toxic’ hedge fund money,” March 13, 2015

There’s nothing new about this talking point, courtesy of the labor funded ACORN successor “New York Communities for Change.” If you don’t like an idea, don’t attack by arguing its merits. Just attack the “dark money,” or the “toxic money,” that funded whomever had the inspiration and did the work to develop the idea.

The long list of causes whose advocates may or may not have accepted “toxic money” just got longer, since the New York Communities for Change – and their inevitable spawn in other states – are now accusing Charter Schools of being financed by “hedge fund billionaires.”

Here in California, charter school advocacy, and, more significantly, charter schools themselves, are indeed supported by many wealthy individuals, but the vast majority of them are self-made entrepreneurs who earned their riches by actually creating something of value to society, from high-tech innovations to office parks and housing developments. Others earned their money in the entertainment business, or through providing legitimate financial services including managing investments on behalf of clients. The idea that “hedge fund billionaires” are the primary force behind the charter school movement is a convenient myth.

With that out of the way, let’s “connect the dots that many people don’t always connect.”

When union activists accuse the financial industry of being overbuilt and riddled with corruption, they’re right. But they are unable to distinguish between honest advisers who manage investments for their clients with integrity and prudence, and rapacious predators whose unchecked greed and insatiable appetite for risk literally threatens to crash the global economy. And the most salient method to distinguish between good and bad investment managers? The good ones are personally accountable for their losses, and the bad ones depend on government bailouts.

There’s no defense for investment managers who use supposedly risk free, low yield consumer deposits as collateral to make high risk investments, and then collect taxpayer bailouts to restore solvency to their client accounts when their schemes fail. Financial bailouts are bad. Financial firms that take risks because they know they will get bailed out are bad. We agree. So why are the pension funds for government workers not included? Why aren’t they at the top of the list? Why aren’t the unions who pay for reinvented former ACORN activists to identify “toxic money” not including pension funds among their targets?

Why aren’t those dots being connected?

Back in 1999, California’s pension funds lobbied California’s politicians to increase pension benefits. California’s all-powerful government unions were quick to hop on that bandwagon. Pension benefits weren’t just enhanced, they were enhanced retroactively. And since the market was roaring, nobody thought it would cost a penny more to fund all of this.

Fast forward to 2015, after years of market volatility, pension funds in California, collectively, are only about 75% funded. With the debt fueled bull market of the past few years beginning to sputter, pension funds are midway through imposing a roughly 100% increase in required contributions by cities and counties. That is, by taxpayers.

Pension funds, which control over $4.0 trillion in assets on behalf of state and local government employees in the United States, are the biggest players in American finance. They invest in anything that will get them a rate of return, after inflation, that averages 4.5% per year – that’s currently 7.5% before taking inflation into account. They invest in hedge funds, they invest in private equity, along with real estate and public equities. And when they don’t hit their numbers, taxpayers bail them out.

Why aren’t those dots being connected? Pension funds rely on taxpayers to hedge their bets. They can make whatever promises they want, take whatever risks they wish, indulge in optimistic projections and lobby for excessive benefit formulas, because taxpayers will bail them out. How deep is the hole? We’re talking trillions, not billions.

Connect the dots. Government pension funds and “hedge fund billionaires” are cut of the same toxic cloth. Perhaps taking money from taxpayers to fund government unions and their activist “volunteers,” and taking money from taxpayers to bail out government pensions are the bigger “toxic” threats to our democracy and our economy.

*   *   *

Ed Ring is the executive director of the California Policy Center.

New Hampshire Police Union Members Resent Pension Reforms

Editor’s Note:  This article quotes a New Hampshire police officer, disgruntled about his pension benefit reductions. He claims – and his Facebook quote appears below – that if he’d put 12% of his pay into a 401K he would “be better off.” Here’s what he expected: To work till age 47, with 22 years of service, and collect 50% of his final pay in retirement. The reality? If he’d put 12% into a retirement account at 7.0% annual return and collected withdrew each year in retirement a pension equivalent to 50% of his final salary, he’d run out of money in nine years. The officer in question is encouraged to download the spreadsheet and see for himself, as are all public servants, in New Hampshire and in California, and everywhere else, who may think they’re getting a raw deal. 

Many cities in New Hampshire use highly paid (overpaid) police officers for routine work like holding stop signs when utilities have to trim trees along roads.

A debate is now brewing in the legislature as to whether to use flaggers instead of police officers for such work.

Courtesy of the New Hampshire Union Leader, here is an image. Click on the link for an article and other details.

20150317-UW_Shedlock-1

Police vs. Flaggers

For the third time in five years, a bill was introduced into the N.H. legislature requiring the use of flaggers instead of police where appropriate. The article noted that in many cities, police chiefs make the call.

The result is just what one might expect. Police cherry-pick the easy jobs, letting flaggers have the rest.

Police work pays in the range of $40 to $50 with an additional $25 or more per hour tacked on by the town for benefits and “administrative charges.”

The utilities have to pay this expense. Of course, utilities pass that expense on to local taxpayers.

The police unions object to the new bill. They use storms, utility work, etc., to pad hours of police officers, typically giving the work to officers in their last five years because pensions are based on salary made in the last five years.

These guys get to retire at age of 45-50 with half their maximum salary.

Eye-Opening Arrogance

Check out the arrogance of union worker, Stephen Soares, from a Facebook comment regarding the New Hampshire Union Leader article.

20150317-UW_Shedlock-2
At first I thought the above snip sent by reader Matt might be sarcasm. A perusal through more of Soares’ Facebook comments shows that is the real deal.

This public union “servant” actually complains about having to work to age 47 where he can then retire collecting half his salary for perhaps another 30 or more years, making more in retirement than he ever did in public service.

Eye-Opening Arrogance

The absolute arrogance of people who are supposed to be “public servants” is staggering. The only reason pension benefits are as absurd as they are is because corrupt politicians got in bed with corrupt union bosses and screwed the people they were supposed to be serving.

Now they have the gall to complain about the slightest cutbacks in benefits gained by graft and coercion.

I wish I could say his attitude is atypical, but I don’t believe it is.

Solve the Pension Crisis Overnight!

If Soares thinks a 12% IRA contribution (actually paid by taxpayers in the form of higher salaries) would have made him better off, then I say give it to him.

Let’s take 12% of Soares’ earnings for every year back to when he started working, and put those contributions in a back-dated S&P 500 account that also factors in reinvested dividends.

Better yet, let’s do that for every police, fireman, and other public union worker in the country. It would solve the pension crisis overnight.

*   *   *

About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

LAUSD Offer Worth $122,938 Per Year – Will They Strike Anyway?

“Our demands, they’re not radical. When did it become radical to have class sizes that you could actually teach in? When did it become radical to have staffing and to pay people back after eight years of nothing?”
 – Alex Caputo Pearl, President, UTLA, February 26, 2015, Los Angeles Times

If the 35,000 members of the United Teachers Los Angeles, the union that represents employees of Los Angeles Unified School District, actually go on strike, in large part it will be because they want an 8.5% salary increase and the district is only offering them 5%. They also want smaller class sizes – tough to do when you’re passing out salary increases. But how much do these teachers actually make?

If you review the most authoritative source of public information on LAUSD salaries, the California state controller’s public pay website you will get the impression they aren’t making much. The summary page for LAUSD shows “average wages” of $40,506 per year and employer paid “average retirement and health” benefits at $10,867 per year.

This is extremely misleading. These “averages” include part-time workers such as student teachers and substitute teachers. But the “Raw Export” tab of the state controller’s website yields more comprehensive information.

20150303-UW_Ring-LAUSD-SCO

If you eliminate part-time workers and eliminate workers who were hired or left employment mid-year – based on screening out of the data any individual record where the recorded “base pay” is 10% or more less than the stated “minimum pay for position” for that record – a very different compensation profile emerges. In reality, teachers who worked full-time during 2013 for the LA Unified School District made direct pay that averaged $72,781, and they collected employer paid benefits averaging $17,012, meaning their total pay and benefits package was $89,793. And they collected this in return for working between 163 and 180 days per year (ref. UTLA/LAUSD Labor Agreement, page 30).

20150303-UW_Ring-LAUSD-Actual

Properly estimating how much LAUSD teachers make, however, requires at least two important additional calculations, (1), normalizing their pay to take into account their extraordinary quantity of vacation time, and (2) taking into account the state of California’s direct payments into CalSTRS as well as the necessity to increase CalSTRS contributions in order to pay down their unfunded liability.

Normalizing for vacation time is easy. Using the larger number referenced in their labor agreement, 180 days per year of work, based on 260 weekdays per year, means LAUSD teachers work 36 weeks a year and get 16 weeks off. The typical private sector worker rarely gets more than four weeks off, two weeks of vacation and two weeks of paid holidays. While many professionals earn more than two weeks of vacation, they are also required to be perpetually on call and often work far more than 40 hour weeks. Many entry level or low income workers don’t get paid for any holidays or vacation. It is reasonable to assume the typical teacher works 12 weeks less per year than the average private sector worker. This translates into a $24,260 value on top of the average LAUSD teacher’s direct pay of $72,781 per year.

“Eight years of nothing.” Really, Mr. Caputo Pearl?

Normalizing for the value of pensions is not easy, but using similarly conservative assumptions we can develop reasonable estimates. For starters, from the CalSTRS website, here’s what the state contributes:

“The state contributes a percentage of the annual earnings of all members to the Defined Benefit Program. Under the new funding plan, the state’s contribution is increasing over the next three years from 3.041 percent in 2013–14 to 6.328 percent beginning July 1, 2016. The state also contributes an amount equal to about 2.5 percent of annual member earnings into the CalSTRS Supplemental Benefit Maintenance Account. The SBMA account is used to maintain the purchasing power of benefits.”

Sticking with current contributions – 3.041% plus 2.5%, based on “member earnings” referring to “direct pay,” that adds another $4,033 to the average earnings of an LAUSD teacher.

In summary, LAUSD teachers are threatening to strike because they only make – using real world equivalents – $97,041 in direct pay, plus $21,045 in employer paid benefits. The average full-time LAUSD teacher earns total compensation worth $118,086 per year. Throw onto direct pay the 5% offer from the district, worth another $4,852 per year, and you have a total average teacher compensation proposed to go up to $122,938 per year.

Any critic of this analysis who happens to be an LAUSD teacher is invited to work 48 weeks a year instead of 36 weeks a year, or, of course, give up their pension benefit. Otherwise, these are the numbers. To verify them, download this spreadsheet analysis which uses payroll and benefit data provided by LAUSD to the California State Controller’s office:  LAUSD_2013_Compensation-Analysis.xlsx (10.0 MB).

No reasonable person should fail to sympathize with the challenges facing teachers in Los Angeles public schools. But the solution is not higher pay. The solution is to purge the system of bad teachers, reward excellent teachers, give principals more autonomy, stop promoting and retaining teachers based on seniority, measure teacher effectiveness based on the academic success of their pupils, and, gasp, improve the ratio of teachers to support staff. As it is, during 2013 LAUSD spent $2.6 billion on full-time and part-time teachers, and $2.1 billion on full-time and part-time other staff. Do they really need to spend 45% of their payroll outside the classroom? The solution is also to lower the cost of living for everyone, through supporting government policies that encourage competitive development of land and resources.

Finally, this estimate of the value of average total compensation for LAUSD full time teachers is still dramatically understated, because CalSTRS remains wallowed in an underfunded position that is officially recognized at $73.7 billion.

To the extent the leadership of the UTLA and their membership subscribe to “left wing” political sentiments, remember this:

There are currently $4.0 trillion of state/local U.S. government worker pension fund assets overseen by managers who rampage about the entire planet demanding annual yields north of 7.0% per year. This is a financial maelstrom of cataclysmic proportions that is corrupting the entire global economy. It is an act of wanton aggression against honest capitalists and private households attempting to save for retirement. Ongoing annual returns of this size require asset bubbles which require risky investments and cheap credit – antithetical to sustainable economic growth.

Remember this as you fight to enhance your compensation and defend your pensions as they are – you have exempted yourself from economic reality and are recklessly gambling with the future of the people you supposedly serve. Through your pension funds, you are benefiting from capitalism in its most aggressive and parasitic form.

Remember all this when you go on strike because you’ve had “eight years of nothing.”

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Ed Ring is the executive director of the California Policy Center.

Illinois Pension Plans 39% Funded – Taxpayers On the Hook

Editor’s Note:  When it happened in Detroit, they said it couldn’t happen in Chicago. Most Californians will agree that our economy is bigger, and more diverse and resilient than that of Illinois or Michigan. But pension fund solvency relies on perpetual bull market rates of return – and the moment the market hiccoughs again, California’s state/local pension system’s collective unfunded liability will balloon from somewhere south of $200 billion to somewhere north of $400 billion. And it could happen almost overnight. California can learn from Detroit’s solution, which preserved defined benefits but adjusted the the ongoing formulas downwards to preserve solvency. An adjustment like that now, instead of later, might leave far more for California’s retired public servants, because it would allow more time for the funds to reduce their unfunded liability before the next market downturn.

A “Special Pension Briefing” last November, shows the Illinois State Retirement Systems are in dismal shape.

Unfunded Liabilities

  • Teachers’ Retirement System (TRS): $61.6 Billion
  • State Retirement Systems (SERS): $61.6 Billion
  • State Universities Retirement System (SURS): $21.6 Billion
  • Judicial Retirement System (JRS): $1.5 Billion
  • General Assembly Retirement System (GARS): $0.3 Billion

The above numbers show actuarial (smoothed) asset valuations, as does the following chart.

Summary of Liabilities and Unfunded Ratios

20150302-UW_Shedlock-1
Congratulations go to the Illinois General Assembly Retirement System (GARS) for having one of the worst, (if not the worst) pension plan in the entire nation. It is 16% funded.

No doubt, that increases the pressure of the General Assembly to put the burden of bailing out the system on the backs of Illinois taxpayers.

Smoothed Returns

The above chart shows “smoothed returns” that even out the 2007-2009 dip as well as the 2010-2014 blast higher. Illinois resorted to using “smoothed returns” minimize the effect of the 2007-2009 dip. But now, with the rally, Illinois wants to use actual market returns.

On a non-smoothed (market) basis the numbers are slightly better. Non-smoothed, the total deficit is $105 billion instead of $111 billion.

Liabilities Per Household

Let’s be generous and assume the lower $105 billion number. The US Census Bureau shows there are 4,772,723 Illinois households.

The potential taxpayer burden to make up the deficit is $22,000 per household. That’s not even the worst of it as the following chart shows.

Liability Trends – Not Smoothed

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In spite of the massive stock market rally, Illinois liabilities increased every year since 2011.

Expectations

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Zero Percent Chance of Success

Its bad enough that Illinois is $105 Billion to $111 billion in the hole and liabilities have increased in spite of a massive rally in both stocks and bonds.

Illinois plan expectations are icing on the “Zero Percent Chance of Success” Cake.

I discussed this at length in my post Beggar Thy Taxpayer: Currency Wars, QE Strain Life Insurers and Pension Plans; Negative Returns With 4-7% Promises.

Europe vs. US

In Europe, pension plans and retirement funds have promised 4% returns. Future promises in Germany are now down to 1.25%. However, yields on 10-year German bonds are 0.35%.

In Illinois, the plan assumption for TRS, the biggest system with the biggest unfunded liability, is 7.5%. There has been no meaningful reduction in plan promises over the years.

7.0% to 7.5% Assumptions Will Not Happen for Two Reasons

  1. US Treasury Yield Curve
  2. Stock Market Valuations

US Yield Curve

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US Promises

In the US, pension funds have not made 1.25% promises or even 4% promises, but rather 7.0%+ promises with the 10-year bond yielding about 2%. Annuities promise 6% or so.

Illinois promises range from 7.0% to 7.5%. How you get 7.5% in a 2% world?

The correct answer is: you don’t. But insurers and pension plans try, by taking risks. And the more risk they take, the higher and higher into bubble territory go stock market and junk bond valuations.

This is well understood and established behavior. And it’s precisely what the Fed has sponsored. At the end of 2012, even mainstream media recognized what was happening, as shown by the following quote from the CNBC article How the Fed Is Pushing Investors to Buy Junk Bonds

The market is thirsting for yield and the Fed is pushing people to do things like this [buy junk],” said Lawrence G. McDonald, who as head of LGM Group specializes in junk-bond trading. “So big asset managers are reaching, reaching, reaching and companies know this and are issuing, issuing, issuing all this crap.

We have seen that effect in Illinois pension plans as well. In our own report, 401(k)s are better than politician-run pensions, we noted pension funds often invest in riskier assets to try and boost their returns.

A look at the Illinois Teachers’ Retirement System, or TRS, portfolio, for example, reveals a portfolio of investments in junk bonds, real estate, derivatives and private equity. TRS has more than $1 billion invested in bonds that Moody’s Investors Service or S&P Ratings Services rate as junk.

Seven Year Negative Returns

As of January 31, 2015, Stock and bond prices are so stretched that GMO’s 7-Year Asset Class Real Return Forecast shows negative real returns for seven years in US equities and bonds.

20150302-UW_Shedlock-5
The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forward‐looking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.

As of December 31, 2014 GMO managed $116 billion in assets.

Broken Model

In the US, pension plans have aggressively shifted from investing in AAA rated bonds to equities and junk bonds because yields in US treasuries and AAA rated corporates are not high enough.

Denial that this has happened is nearly everywhere one looks. Of course the Fed, and most others, cannot and will not see a bubble until it bursts wide open.

Even if the air is let out slowly (something that has never happened in practice), negative real returns, and perhaps zero nominal returns for seven years are the only other plausible outcomes unless one expects an even bigger bubble coupled with even longer negative returns in the future.

Simply put, numerous US pension plans are in deep, deep trouble. Illinois is at the top of the list. Plan assumptions cannot and will not be met. It’s far too late for token improvements.

Honest Discussion Needed

Not even massive tax hikes can save the system at this point. Businesses and taxpayers would flee. And Illinois is already struggling with corporate and individual flight.

The Illinois pension system is totally broken. It’s time to have a truly honest discussion of what to do about it.

Postscript- Illinois Taxes – Loser Spoils

For a look at the Chicago downgrade, please see my post Chicago’s Fiscal Freefall: Moody’s Cuts Chicago Credit Rating to Two Steps Above Junk; Snake Oil and Swaps; It’s All Junk Now.

This is my second column for the Illinois Policy Institute, where I am now a senior fellow.

The article was written well ahead of the Moody’s downgrade of Chicago pensions last Friday, with a final edit made on Friday, and posted then on the IPI website.

My first article for IPI was Right-to-Work Sweeps Midwest, Heads for Passage in Wisconsin.

Both articles are up on the Illinois Policy Institute  website where you can also learn (assuming you did not know),Illinoisans pay high taxes compared to other Midwest families.


Loser Spoils

Inquiring minds may also be interested to learn via the IPI website, that former governor Quinn Will Receive Millions in Pension Payments

When he ceded his office to Gov. Bruce Rauner on Jan. 13, former Gov. Pat Quinn gave up a $180,000 salary as well.

But that same day marked the beginning of a lucrative consolation prize: monthly pension checks that will add up to $137,000 in Quinn’s first year of retirement, according to WUIS 91.9. The former governor will receive $3 million in pension payments over his lifetime should the Illinois Supreme Court strike down Senate Bill 1, a pension-reform law passed in 2013. Should it be upheld, Quinn would still receive over $2 million.

Over his public tenure, which included stints as the state treasurer and lieutenant governor, Quinn contributed a mere $190,000 toward his pension as of November 2014, according to the Chicago Sun-Times. This contribution is not sufficient to cover even the first 18 months of benefits he will collect.

In case you were wondering how Illinois plans became so underfunded, you now have a clear picture: in general, promising far more than can possibly be delivered.

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About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.