Bankruptcy Won’t Help Cities Unless Courts Permit Reduced Pension Benefits

Municipal bonds have long been among the safest investments, but a coming wave of municipal bankruptcies in California – and the disturbing way one of those cities is stiffing its bondholders – could change perceptions about the wisdom of lending money to cities.

The struggling port city of Stockton has declared bankruptcy after a spending spree where officials granted city workers an absurdly generous lifetime medical care benefit, dramatically increased pensions and floated debt to finance dubious downtown redevelopment projects.

When the city couldn’t make its pension payments in 2007, it borrowed $125 million – by selling bonds – to cover the mess it created by its pension increases. Now the city government is as upside-down as many Stockton homeowners, and officials are blaming the foreclosure crisis, conveniently neglecting that the current reduction in property tax revenue followed years of dramatic revenue increases.

Now, Stockton officials want to stiff Assured Guaranty, a Bermuda-based bond insurance company, for about $103 million. The company – noting that Stockton is going under in part because it can’t make its pension payments to the California Public Employees Retirement System – argued in a statement, “If Stockton is disappointed with CalPERS’ investment performance, it should be taking that up with CalPERS rather than reneging on the city’s obligation to holders of the pension bonds.”

Stockton City Manager Bob Deis accused Assured Guaranty of “bad faith” and “whining” even as he whined that Assured Guaranty doesn’t care about anarchy in Stockton’s streets, as the city’s crime rate soars following policing cutbacks.

But it’s not the fault of lenders that city officials were so unconcerned about their residents that public safety concerns were placed behind the demands of wealthy city pensioners. Like many cities in this state, Stockton’s infrastructure is crumbling as government becomes more a benefit provider to current and retired city employees.

Deis sounds like a wastrel who spent 10 years running up debt on luxurious living, then gets mad at his bank for wanting to get paid back: “Hey, you don’t care that I can’t feed my kids!”

Of course, it’s hard to top the arrogance of CalPERS, which has responded to Assured Guaranty’s complaints by insisting that “obligations owed to the public workers of the city have priority” over creditors such as Assured Guaranty. CalPERS also insists the media is “hyping” the idea that pension promises have anything to do with cities going belly-up. CalPERS, which in 1999 advocated retroactive pension increases based on assumed rates of investment returns that essentially required the Dow Jones industrial average to reach 25,000 by 2009, is backed by taxpayers whether its projections are right or wrong.

As cities run out of money, and pension obligations grow, we can expect to see more local officials faced with the choice of protecting city workers or taxpayers. It’s not hard to understand why the politically powerful CalPERS is so confident that the demands of public employees always come first.

As the Stockton Record reported recently, CalPERS “dwarfs all other creditors with a $245 million liability in the city over the next decade. Yet National Public Finance Guarantee Corp., an insurer of several Stockton bonds, contends in court papers that CalPERS is conspicuously missing from the list of those Stockton engaged in pre-bankruptcy negotiations.”

That insurer argues persuasively that Stockton never had any intention to seek reduced payments from CalPERS. Typically in bankruptcies, the debtor can’t pay everyone what’s owed, so then the creditors fight it out. Here, it seems like city officials cherry-picked which creditors to stiff, which certainly backs the insurer’s contention that Stockton officials have showed bias, a distortion of the bankruptcy process.

While the municipal bond markets aren’t yet spooked, they do have reason for concern, given that pension debts are growing, and there are few other places to trim if public employee retirement plans are off the table.

Even the feds are sounding some warning bells. As Bloomberg reported last month, “The U.S. Securities and Exchange Commission said it plans to seek power to force better disclosures from states and cities participating in the $3.7 trillion municipal bond market.” The SEC should add this disclosure: Your retirement investments will always lose out to public employee pension demands.

Those of us who have viewed Chapter 9 bankruptcy as a useful option to help troubled cities get their books in order have miscalculated.

Public employee unions and their allies in the courts and the retirement systems are so powerful that even during dire financial circumstances, their selfish demands trump everything else. Although bankruptcy can be a valuable tool, as Orange County’s 1994 bankruptcy made clear, the process is no panacea for incorrigibly wasteful, union-controlled local governments.

The crisis is not going away, despite CalPERS’ insistence otherwise.

Former Los Angeles Mayor Richard Riordan, for instance, said this week that the state’s largest city faces “disaster” if officials there don’t fix L.A.’s underfunded pension system.

We should closely watch the unfolding proceedings in Bankruptcy court, as Stockton goes through this process. But a more significant battle is being fought in San Jose, as courts determine whether voters’ support for a June ballot measure that cuts pensions for existing city workers is legal. The key is pensions for current workers, given that simply cutting retirement benefits only for new hires will not defuse the pension-debt time bomb.

If the courts side with reformers, there may be hope for rolling back pension costs and saving city services. If not, Californians better get ready for even higher taxes and fewer municipal services, given that there are precious few options left. And without a reform path that touches pensions for existing workers, investors might want to rethink the long-term safety of their municipal bond holdings, which will become an even bigger target.

<em>Steven Greenhut is vice president of journalism at the Franklin Center for Government and Public Integrity.</em>

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Unions: It’s Just Pension Envy

Rhode Island’s Democratic state treasurer, Gina Raimondo, is fond of saying that pension reform is about math, not politics. Other blue-state politicians, ranging from New York governor Andrew Cuomo to Chicago mayor Rahm Emanuel, have moved toward fixing unsustainable pensions. But California’s top statewide political leaders have mostly shrugged at the problems caused by excessive pay and benefit packages granted to public-sector workers. The state faces an unfunded pension liability of at least $300 billion, and major cities—notably Stockton and San Bernardino—are taking the municipal-bankruptcy route; even Los Angeles is mulling the option. Until recently, even the most modest reforms to California’s public-employee compensation have gone nowhere—and though Democrats are now suddenly talking about tackling some kind of pension reform within the next four weeks, history suggests that it’s wise to be skeptical.

What is it about California’s Democratic leaders that makes them ignore fiscal reality and put politics above mathematics? Conventional wisdom holds that unions elect these politicians and that the politicians do the unions’ bidding. But in reality, the unions <em>are</em> the legislature. Most of the Democratic leadership in the state assembly and senate comes directly out of the union movement and identifies with the public sector. For these union Democrats, government is primarily a means to improve the financial condition of those who work for the government.

The best articulation of this vision can be found in a speech that state treasurer Bill Lockyer gave last October. “As a California public official, I also believe in the principle that our nation and our state have an absolute obligation, to every American and every Californian, to ensure that when the time comes for them to put down the tools and enjoy a well-deserved retirement, those workers can live the rest of their lives with dignity and good health, and not in poverty,” Lockyer said. “And in my view, nothing is more important in providing for retirement security than preserving the defined benefit pension for those who have it, and restoring and reinvigorating the defined benefit leg of the three-legged retirement stool for those across the country who have lost it in the space of a few short years.” Lockyer conceded that “pension liabilities <em>are </em>a problem,” but only because “they are driving unacceptably high contribution rates for employers and workers, too.” In other words, public pensions are a concern not because of the costs to taxpayers but because of the burden they place on government agencies and government employees. To ease that burden, union Democrats want—what else?—new taxes.

<em>Sacramento Bee </em>reporter Jon Ortiz, who covers state workers and unions, wrote that Lockyer’s speech “echoed the new argument that public employee unions are making in defense of retirement benefits.” And this year, the public got to see an incongruous legislative manifestation of Lockyer’s argument. Los Angeles Democrat Kevin de León’s Assembly Bill 1234 would have the state, in effect, create a miniature Social Security system designed to bolster <em>private</em> retirement accounts—albeit at a much lower rate of return and with much lower benefits than those enjoyed by retired public employees. De León’s bill passed the state senate and awaits a hearing before the assembly’s appropriations committee—incredible as it may seem, given the legislature’s refusal to give public-pension reform any serious thought.

The reason for the de León bill is union Democrats’ belief that the pension problem is merely, as Lockyer puts it, “a very serious and virulent strain of pension envy.” Instead of fixing the unsustainable public-pension system—which they regard as a success that has helped a portion of the public receive the kind of comfortable retirement that everyone should have—the union Democrats want to throw a few bones to private-sector workers afflicted with this “pension envy.”

Lockyer’s intransigence illustrates why San Jose mayor Chuck Reed says that getting any reform out of Sacramento is hopeless. Reed, of course, spearheaded a successful pension-reform ballot initiative that unions are now challenging in court. If pension reform succeeds in the Golden State, it will happen at the ballot box—in spite of the best efforts of union Democrats, who continue to defend the indefensible.

<em>Steven Greenhut is vice president of journalism at the Franklin Center for Government and Public Integrity.</em>

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Flood of City Bankruptcies Coming

In a welcome, common sense ruling, Court lets Stockton, Calif. cut retiree health care

A federal bankruptcy judge on Friday cleared the way for Stockton, California to cut health care benefits for retirees while it is in bankruptcy proceedings.

Stockton is seeking Chapter 9 protection from its creditors and said that it would cut retiree health benefits while it reorganizes. Retired employees sued to stop those cuts.

Judge Christopher Klein on Friday issued a temporary order denying the bid to stop the benefit cuts, and he said a formal decision was on its way.

Stockton’s attorneys had argued that bankruptcy law gave the city wide latitude on how to spend its revenue while it prepares a plan to restructure its finances.

“For the reasons explained in the forthcoming decision of this court, the Application for Temporary Restraining Order and Preliminary Injunction or in the Alternative for Relief from Stay is DENIED,” Klein wrote.

Flood of City Bankruptcies Coming

This is a good start for what needs to happen. The next step needs to be huge clawbacks on promised benefits, preferably top down, so that those with the highest pension benefits bear the brunt of the hit.

As soon as cities realize this is the way out, a flood of bankruptcies will be on the way.

About the author: Mike “Mish” Shedlock is a registered investment advisor representative for Sitka Pacific Capital Management. His top-rated global economics blog Mish’s Global Economic Trend Analysis offers insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education. Every Thursday he does a podcast on HoweStreet and on an ad hoc basis he contributes to many other websites, including UnionWatch.

Estimating CalPERS Underfunding at Various Rates of Return

Editors Note: It remains an article of faith among public sector union defenders of defined benefit pensions – as they are – that “the market’s just taken a little beating,” and “the long-term outlook does not merit a crisis mentality.” Even pension fund managers, such as City of San Jose’s Police and Fire Retirement Plan Trustee Sean Bill, quoted in our recent editorial “Moody’s Changes Pension Solvency Assumptions,” still state that these funds can be “de-risked,” and that a 7.5% return as a long-term “bogey” is achievable. It is not. But what if the rate of return that can be safely achieved isn’t even 5.5%, Moody’s new “bogey,” but is more in the range of 2.5%? This is quite likely. In the following post by Mike Shedlock, a regular UnionWatch contributor, these scenarios are explored. When reading this, bear in mind that CalPERS manages roughly one-third of California’s state and local public employee’s pensions, so triple whatever numbers he reports.

The California Public Employees’ Retirement System (CalPERS) manages pension and health benefits for more than 1.6 million California public employees, retirees, and their families. Its pension plan assumes 7.5% annual growth.

For fiscal year ending 2012 CalPERS Reports Preliminary Performance of 1 Percent.

How Underfunded is CalPERS?

Bear in mind that CalPERS was massively underfunded before this report. How underfunded?

Good question. Please consider CalPERS Lies About Equity Returns

CalPERS is both corrupt and incompetent.  If it were a private firm, the lies about return on investments would send executives to jail and billions in lawsuits filed.

“The California Public Employees’ Retirement System (CalPERS) is the biggest public pension in the country. It is also deeply underfunded. Depending on the measure used, they have just 55-75% of money needed for future expenses while 80% is considered the minimum to be safe. Their return is currently less than 99% of big pension funds.

On March 12, CalPERS voted to lower their expected return from 7.75% to 7.5%, ignoring the advice of their own chief actuary that it should be 7.25%. More than a few investment professionals consider a projected rate of 7.75% to be unrealistically high in these times and question whether 7.25% is realistic.”

Now we know that CalPERS is in the lowest 1% of all pension funds—what else would you expect from a California government agency?

“What If” Charts at Various Compounded Rates

Let’s pretend that CalPERS is 100% funded. Already that is one hell of a pretend job, but assuming so, what will CalPERS underfunding look like at various compound plan performance rates?

CalPERS currently has $233 billion in assets.
CalPERS assumes 7.5% annual growth.

What if CalPERS only returns 5%? or 2.5%?

In the following charts the left scale is in billions of dollars.
The bottom scale is in years.

Base assumption is CalPERS is currently fully funded (which it clearly is not)

CalPERS Assets Compounded at 7.5%, 5.0%, 2.5%

CalPERS Underfunding at 5.0% and 2.5%

I believe annualized returns for the next 10 years will be between 0% and 5% at most. I highly doubt they will be as good as 5%.

With that in mind, let’s take a closer look at projections for the next 10 years.

CalPERS 10-Year Asset Growth Projections

CalPERS 10-Year Projected Underfunding at 5.0% and 2.5%

Once again the above charts assume pension plans are fully funded and they ignore effects of drawdowns if exceptionally low returns happen. [Editor’s Note: “Drawdowns” means to pay pension benefits to retirees, the principle assets that need to be retained to earn interest are sold, leaving lower subsequent fund earnings because less money is left invested. This, plus the fact that CalPERS is already underfunded, compound the problem and suggest that Shedlock’s estimates, if anything, are still understating the size of the financial crisis.]

Negative Returns for 10 Years?

I have made the case that Negative Annualized Stock Market Returns for the Next 10 Years or Longer are Far More Likely Than You Think.

For follow-up posts please consider

Assume the Best

Even if you assume negative or near-zero returns are impossible (ignoring Japan for the last 20 years and the S&P 500 since the 2000 peak) clearly low cumulative annual returns over extended periods are possible.

Given boomer demographics, downsizing, student debt suppressing housing, etc., why shouldn’t growth be anemic for quite some time?

Given that pension plans are typically heavily invested in bonds, and the current 10-year treasury rate is 1.48%, it is going to be damn difficult (most likely impossible) for pension plans to come close to the annualized projection of 7.5% made by CalPERS and others.

Furthermore, the more risk pension plans take attempting to meet near-impossible goals, the more likely it is that they will blow sky high in taking that risk.

All things considered, especially with pension plan philosophy to be 100% invested in something 100% of the time, I believe pension plans will not avoid the next huge drawdown, with possibly devastating consequences.

However, let’s for the moment assume positive annual growth of 2.5% to 5%. Let’s further assume plans are not currently underfunded. Finally, let’s assume pension plans avoid the next big drawdown.

Even with those optimistic assumptions (wildly optimistic as pertains to CalPERS being currently fully funded), CalPERS still rates to be deep in the hole 10 years from today.

Lesson in Exponential Math

If that still does not shock you, hopefully the following YouTube video on Exponential Math will.

If you are not familiar with exponential functions such as 7.5% annualized growth assumed perpetually by CalPERS, please play the video above. Perhaps you should play it even if you are.

Those in CalPERS counting on 7.5% annual growth are going to instead see clawbacks, reduced rates, or outright default.

About the author: Mike “Mish” Shedlock is a registered investment advisor representative for Sitka Pacific Capital Management. His top-rated global economics blog Mish’s Global Economic Trend Analysis offers insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education. Every Thursday he does a podcast on HoweStreet and on an ad hoc basis he contributes to many other websites, including UnionWatch.

Every State Worker Deserves Social Security

On June 9th Reuters ran a story entitled “California’s Brown set for fight over pension reform” that has some interesting quotes from his Democratic counterparts in the state legislature. According to the article, Warren Furutani, an assembly member representing Long Beach. who co-heads a joint committee that will craft pension legislation, had this to say:

“There was a lot left to do [regarding pension reform], such as taking care of workers not covered by federal Social Security because of their state government jobs.” (Italics added)

This is a common refrain voiced by pension reactionaries: State and local government workers are unable to enjoy social security, and therefore we must safeguard their pensions. But has Mr. Furutani taken a recent look at the average state or local pension benefit vs. the average social security benefit?

According to the social security administration, on their FAQ page “Average monthly Social Security benefit for a retired worker,” “The average monthly Social Security benefit for a retired worker was about $1,230 at the beginning of 2012.”

On a yearly basis, this means the average social security recipient today can expect to collect $14,760 per year.

What about public sector pensions?

Here is a statistic that is easy to cook. Because most state or local government pensioners have not worked 30+ years for the government. This pulls the average pension down, as does the fact that most government pensioners are still people who retired 10+ years ago, well before rates of pay (used as the base for calculating pensions) as well as pension formulas themselves, were elevated far beyond levels that are either sustainable or equitable. But what taxpayers have to fund today are pensions based on a workforce that will retire in the future, according to formulas currently in effect. And in cases where pensions are only awarded for 10 or 15 years service, there are two or three people who will all get these partial pensions. The cost to taxpayers to fund one pension based on 30 years work is exactly the same as funding two pensions based on 15 years work. So here is the apples-to-apples typical state or local pension in California, according to the annual reports of the pension funds themselves:

If you go to the pages referenced below you will see that the AVERAGE pension for people who retired after 30 years work, and who retired in the past few years after benefits were enhanced, is nearly $70,000 per year.

CalPERS Annual Financial Report FYE 6-30-2011, page 153
http://www.calpers.ca.gov/eip-docs/about/pubs/comprehensive-annual-fina-report-2011.pdf

CalSTRS Annual Financial Report FYE 6-30-2010, page 149

Apparently Assemblyman Furutani believes that we need to be careful that we don’t create undue hardship by excessively paring the pension benefits for state workers, because they don’t get social security, which pays on average $15,000 per year starting at age 68, vs. government pensions, which pay on average nearly $70,000 per year starting around age 55.

It is tempting to indulge in a bit of sarcasm here. Shall we choose? Work for the government and, on average, you can retire 10+ years earlier and receive nearly five times as much per year in retirement via your pension. But you’ll lose your social security benefit. Darn!

To be constructive, there is a lot we can learn from social security. Unlike public sector pensions, they are progressive, which means the more you make, the lower the percentage of your average earnings will come back to you in the form of a social security benefit. Applying progressive rules to the pension formulas would go a long way towards fixing them financially. For example, if the average pension benefit were reduced to merely twice the average social security benefit, or to $30,000 per year, the financial problem would disappear overnight.

Another virtue of social security is the fact that it is based on average earnings over an entire career, not the final year of pay. This eliminates the potential for spiking. Another virtue of social security is the fact that the funds are not gambled in the international markets by global bankers (i.e., pension fund managers) but are held in trust. If pension funds were required to be invested in low risk instruments such as U.S. Treasury Bills, as they once were, the great con job regarding astronomical rates of return justifying absurdly elevated benefit formulas would have never happened.

Ultimately, what Assemblyman Furutani and his ilk need to learn from social security is that it is financially sustainable, whereas government pensions are not. This is because social security only pays about one-third of average career earnings to beneficiaries, starting at age 68, while government pensions pay approximately two-thirds of average career earnings to beneficiaries, starting at age 55. And because government pensions start paying recipients earlier in life, the worker to retiree ratio in the public sector is close to 1-to-1, whereas the social security system’s worker to retiree ratio will never be lower than about 2-to-1. With no return on investment, these metrics imply social security is sustainable via 16% withholding, whereas pensions require 66% withholding to achieve sustainability. Which system do you think will crash first?

Because it provides a modest, appropriate minimum safety net of taxpayer funded retirement security to all American workers, social security is not insolvent, nor is it a Ponzi scheme, nor is it the enabler of hyper-aggressive global casino capitalist investment scams, backed up and bailed out by taxpayers. Public sector pensions are all of these things.

Assemblyman Furutani and his entire gang of pension reactionaries would be doing California and the nation a huge favor by insisting that every state worker indeed receive social security, which they have heretofore been deprived of. They can have social security and nothing else, just like every other taxpayer. Perhaps then an honest national dialog regarding the structure and solvency of social security – a far more easily managed challenge – can take place, because public and private sector employees would be united as stakeholders in the same benefit.

Why Lower Rates of Return Will Destroy Pension Funds

As reported today in Capitol Weekly, in a post entitled “CalPERS ignores Brown, delays pension payment” by Ed Mendel, the amount taxpayers will have to fork over to CalPERS next year will rise by $213 million, to a total of $3.7 billion. Governor Brown, quite rightly, believes the full amount of the necessary increase should have been assessed, another $149 million, instead of being “smoothed” over the next twenty years.

But CalPERS – the largest of over 30 major government worker pension funds in California, only manages about a third of the the state and local public sector pensions. And CalPERS is basing their increase on a lowering of their projected rate of return for their invested funds by one quarter of one percent, from 7.75% down to 7.5%.

People may debate endlessly over whether or not government worker pension funds in America, now managing over $4.0 trillion in assets, can actually earn 7.5% per year, every year, for decades on end. We have argued repeatedly that this rate of return is impossible to achieve any longer, because (1) high returns in the past depended on debt accumulation, which poured cash into the economy, which stimulated consumer spending, investing, and asset appreciation – enabling more borrowing – all of which caused investment returns to grow at levels that cannot continue now that borrowing has reached its practical limit, (2) our aging population means more people will be selling their investments to finance their retirements – including the pension funds whose participants themselves are aging and are retiring with higher benefits than previous retirees – and this puts more sellers in the market, lowering asset values and returns on invested assets, and (3) pension funds are much larger as a percent of GDP than they were in previous decades, and they are now too big to consistently beat the market.

This debate will not go away. But it is at least worth examining just how much it will cost Californians if the rates of return on state and local government worker pension funds drops by 1.0%, 2.0%, or 3.0%. The fact is, they might drop by even more than that. Go to a commercial bank and try to buy a U.S. Treasury bill or certificate of deposit that pays 4.75%. Or examine the returns on the major stock exchanges over the past 10+ years. Yields are well under 4.75%, yet CalPERS has lowered their rate of return by only one-quarter of one percent to 7.5?

What are they scared of? Why not pick a risk-free, much lower rate of return?

The table below shows how much the annual pension contribution as a percent of payroll increases when the rate of return drops. Column one shows the contributions required under the original 7.75% long-term rate of return projection, which has just been lowered to 7.5%. Columns two, three and four show the contributions required under lower rates of return, 6.75%, 5.75%, and 4.75%. The rows show just how much these contributions need to be under various pension formulas. These formulas govern most government worker pensions – the percentage noted, “1.25% per year,” for example, means that if a government worker retires after 30 years, their pension will be calculated as follows: 1.25% x 30 x final salary, or in this case, 37.5% of final salary. The amounts selected for these rows are representative of the following pension formulas:

  • 1.25% per year  –  for typical non-safety employees up until around 2000.
  • 1.6% per year  –  the average of non-safety and safety employees up until around 2000.
  • 2.0% per year  –  for typical safety employees up until around 2000; for typical non-safety employees since then.
  • 2.5% per year  –  the average of non-safety and safety employees since around 2000.
  • 3.0% per year  –  for typical safety employees since around 2000.

On the table below, row four of the pension formulas, outlined, shows how lowered rates of return will impact the contributions necessary to fund a 2.5% per year formula. Since 2.5% per year is the blended average that would represent all current state and local government employees in California, the results in this row should be of great interest to taxpayers and public employees alike. As can be seen in this case, the annual pension contribution as a percent of payroll must increase from 16.3% at the rosy rate of return of 7.75% to 21.4% (at 6.75% return), to 28% (at 5.75% return), to 36.6% (at a still impressive 4.75% rate of return).

The table above concludes by taking these pension contributions and applying them to the total payroll of California’s state and local governments, which is (using conservative estimates) 1,500,000 employees times an average annual salary of $70,000 per year (ref. U.S. Census, 2010 CA State Gov. Payroll, and 2010 CA Local Gov. Payroll). As can be seen, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $5.4 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $12.3 billion per year. And if the return projection drops to 4.75% per year, it will cost taxpayers an additional $21.3 billion per year. But wait, because the above analysis still understates the problem.

There’s one more big gotcha.

The first table is entitled “Impact of Lowered Return Projections if we could Retroactively Increase Contributions.” But we can’t do that. Contributions that are in the funds currently were made under the assumption that the 7.75% rate of return would last forever. If we lower that assumption, we still have to fund our pension obligations by investing the money we’ve already got, plus whatever additional monies we can collect from now on. This severely compounds the problem.

The next table, below, calculates how much lowered return projections will cause pension contributions to increase, if half of the contributions are already made. This assumes that in aggregate, the participants in California’s government worker pensions are at mid-career. This is an extremely conservative assumption, because there are millions of government workers who are already retired, whose pension payments are equally dependent on investment returns from the pension funds. This next table therefore understates the impact of lower investment returns on the required contributions to the fund from existing workers.

As can be seen in this more realistic, but still very much a best case scenario, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $11.3 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $24.9 billion per year. And if the return projection drops to a still quite aggressive 4.75% per year, it will cost taxpayers an additional $40.8 billion per year.


This is what the pension funds are up against. These are the scenarios the pension bankers exchange in closed meetings, where the press and even their own PR people don’t attend. Imagine if CalPERS admitted, as they should, that their funds cannot reliably expect to earn more than 4.75% per year. It would mean that – assuming all 10 million of California’s households pay taxes, which obviously is not the case – that every household in the state would have to fork over another $4,000 per year in increased taxes.

These calculations were done using a tool prepared by the California Public Policy Center that can be downloaded by clicking on “pension_analysis_model.” An explanation of how to use this model can be found in our April 2nd post “A Pension Analysis Tool for Everyone.” It is now in use by pension analysts and activists in several California cities and counties.

Critics of pensions and critics of pension reform alike are invited to verify for themselves the calculations made here, either using the model we provide, or their own tools for financial analysis. To imply, as CalPERS has, that about another $1.0 billion per year, spread among the 30 California government worker pension funds and “smoothed” over the next 20 years, is all it will take to shore up their solvency, is irresponsible. The additional amount necessary to save California’s government worker pensions is probably closer to $40 billion per year, from now until these pension formulas are reduced, across the board, and retroactively, of course.

The Sonoma County Retroactive Pension Increase: Gross Incompetence or Billion Dollar Scam?

In 2002, the Sonoma County Board of Supervisors agreed to essentially increase pension benefits by 50% back to the date people were hired. However, County records show that the deal cut between the employees and the Supervisors stated that General employees would pay for the entire cost of the increase and Safety employees would pay for half the cost of the increase. This is the story of how the employees ended up paying for 6-10% of the cost and how the current Board of Supervisors seem willing to let them get away with it.

Background

Sonoma County is one of the 20 counties governed by the County Employee Retirement Law (CERL). The county has its own plan administrators, the Sonoma County Employee Retirement Association (SCERA). Their job is to collect pension contributions from the County and the employees, perform an annual actuarial valuation each year to determine if changes in contribution rates are necessary, to manage the investment of the funds, and to distribute funds to the retirees.

When benefit levels are increased, there are specific requirements that need to be followed. They are outlined in CERL in Sections 31515.5 and 31516. Section 31515.5 requires SCERA to have an enrolled actuary prepare an estimate of the annual actuarial impact of the benefit increase on the pension fund. The actuarial data is required to be reported to the Board of Supervisors. Section 31516 requires the Board of Supervisors to secure the services of their own enrolled actuary to provide a statement of the actuarial impact upon future annual costs before authorizing increases in benefits. It also requires that the future annual costs as determined by the actuary be made public at a Board meeting at least two weeks prior to the adoption of any increase in benefits following Brown Act Requirement. An actuary is also required to attend the board meeting to answer the Public’s questions.

However, a review of County documents indicates that none of these requirements were followed. In 2002, SCERA asked their actuary Rick Roeder of Gabriel, Roeder & Smith (GRS), to provide cost estimates for the enhanced benefits for Safety and General employees.

Mr. Roeder estimated the cost impact of a 3% at 50 benefit formula for Safety employees with and without Accelerated Retirements (AR) and with AR advocated by another actuary John Bartel (JB). The analysis was also based upon only the CURRENT employees paying for the increased benefit. The estimated costs outlined in the letter were as follows:

Based on 2001 Actuary Report:  Liability Increase, Net Contribution Increase
3% at 50, no Accelerated Retirement:  $18,542,937, 6.96%
3% at 50, with Accelerated Retirement:  $22,578,745, 8.51%
3% at 50, with AR advocated by JB:  $25,182,565, 9.48%

According to the analysis, if current Safety employees paid for their retroactive benefit increase, they would have had their contribution increased by 9.48%, from 7.31% to 16.79% of payroll to cover the increased benefit cost. Later, SCERA asked Rick Roeder what the cost would be if all CURRENT and FUTURE Safety employees had their contributions increased and his estimated cost dropped to just 3.71% of payroll.

The 3.71% number appears to be what was presented by SCERA to the Board of Supervisors as the actuary’s cost estimate to cover the benefit enhancement for Safety Employees. No annual cost was provided by the actuary, as required by CERL, only the total cost of the increase which was estimated to be about $25 million.

When the benefit increase was passed for Safety employees in 2002, it included a 3% at 55 formula from 2004 to 2005, and then it became a 3% at 50 formula in 2006. According to agreements between the employee union and the County, the Safety employees would pay for half the cost of the increase with a 1% increase in employee contributions in 2003, a 1% increase in 2004 and a 1% increase in 2005.

A review of the 2002-2008 contract with the Safety unions shows that though the employees were required to contribute an additional 3% of salary to their pensions, in the same agreement, the County agreed to pick up an additional 2% of the employees previous contribution to the pension fund. So the net contribution from the Safety employees to cover a 50% retroactive benefit increase was 1% of their pay, not nearly enough to cover 50% of the cost, which was what was approved by the Board of Supervisors in 2002.

General Employee Actuarial Benefit Enhancement Study

In the actuary’s letters for the General employee cost for the benefit increase there was a lot less information provided by Rick Roeder and John Bartel, was not retained to assist with estimating the cost for accelerated retirements, as he had for the Safety employees.

The first document estimating the total cost for the increased General employee benefits is a letter dated March 20, 2002 from Rick Roeder of GRS to Robert Nissen, Plan Administrator and Gary Bei, Assistant Plan Administrator of SCERA. The letter said the cost was based upon the year 2000 Annual Actuarial Valuation. It estimated the 3% at 60 benefit enhancement cost was $60,016,104 for a 5.43% contribution increase from CURRENT employees. At the end of the letter Rick Roeder states “If you like, we can perform additional analysis to reflect the fact that increased benefits may trigger earlier retirement.”

The second and only other document estimating the cost is a letter dated June 5, 2002 that updates the benefit enhancement to 3% at 60 based upon the 2001 valuation indicating the cost is $68,614,650 for a net contribution increase of 5.78%. At the end of the letter, Rick Roeder states that “It is IMPORTANT to consider that the combination of increased benefits and earlier ages at which multipliers hit a ceiling may trigger earlier retirements, especially for the 2.7% at 55 proposal. This in turn, would have some cost increase impact. Please let us know if you wish to do additional analysis in this regard (as we did for safety 3% at 50 analyses).”

When I talked with Gary Bei of SCERA, he confirmed that SCERA never performed an actuarial study with accelerated retirements per Rick Roeder’s recommendation and the estimate did not include annual costs as required by CERL. In addition, it appears that the Board of Supervisors failed to hire their own actuary, to provide a cost estimate of the increase in benefits, also a violation of the CERL. The failure of SCERA to follow the actuary’s advice to include accelerated retirements, and to represent to the Board of Supervisors an inaccurate cost for the benefit increase is a serious issue that deserves further investigation by the current Board of Supervisors and possibly the Sonoma County Civil Grand Jury.

The County Documents and Board Resolutions

The following language was found in County documents that confirms the employees were required to pay for the increase:

  • Board Resolution No. 02-1305 Dated December 10, 2002: WHEREAS, 3% @ 60 retirement program will be effective 6/22/04 and employees are paying for prospective normal cost and past service, primarily through increased retirement contributions.
  • Agenda Item Board Date 12/10/02: Exhibit A, Summary of Salary Resolution Revisions: 3% at 60 retirement program effective 6/22/04. All unrepresented employees will be paying for costs of prospective and past service through increased retirement contributions and other offsets similar to the arrangements with represented employee groups.
  • In the resolution between the County and SEIU Local 707 (2002-2008 MOU) board date July 23, 2002: “Retirement: 3% at 60 retirement program effective in the 3rd year. Employees paying for prospective normal cost and past service, primarily through increased retirement contributions.”
  • In the Agenda Item Summary Report for the 2003 Pension Obligation Bonds on April 29, 2003: “It should be noted that the additional cost of these negotiated benefits are to be fully paid for by employees starting in July 2004.”
  • On the financial summary of SEIU MOU from Board Minutes for May 4, 2005: “The County Board of Supervisors established direction to staff that the marginal increase in costs associated with the “3% at 60” plan be borne by the employees.”

For Safety Employees

  • Agenda Item Board Date 12/17/02: Retirement: 3% at 55 retirement program effective in July 2003, and 3% at 50 retirement program effective in February, 2006 with employees paying approximately one-half of the anticipated total cost primarily through increased retirement contributions.

Retirement Pick-up: The County will pay 1% of the employees’ retirement contribution beginning in February, 2006 and another 1% in February, 2007.

The Cost of Accelerated Retirements

It became clear to SCERA a year after the new benefits took effect that accelerated retirements (that were not included in the original cost analysis) had became a problem which dramatically increased the number of retirees and the average pension.

The minutes for the Employee Retirement Association Special Meeting May 4, 2005 state, “In 2003 there were 38 General members retiring with an average annual pension of $22,468. In 2004, due to increased benefits there were 217 general members retiring with an average annual pension of $37,715. A long-term structural question needs to be explored – to what extent are people retiring earlier due to increased benefits and consequently should the actuarial assumptions be adjusted? The Retirement Board may want to look at adjusting the assumptions after the next experience study is performed.”

The True Cost of the Pension Increase

The chart below shows what each employee contributed towards the increase, 3rd column, and the value of the increase, last column, if the employee retires at 60 and lives to 80. As the chart also indicates, the employee contribution per year only covers about 1% of the additional cost to the county over their 20-years in retirement. The costs do not include cost of living adjustments (COLA) for retirees which would add as much as 50% to the County’s costs. COLA’s are optional under the current plan.

The chart below shows that since the increase and up until 2016, the employees who have or will retire contributed $55 million towards the increase and the County has ended up with an additional $805 million pension obligation. These costs will continue well beyond 2016 unless changes are made to the pension formula.

Calculation of Employers Increased Pension Obligation Due to Pension Increa


Assumptions for both Charts: Average employee retires at the average salary, worked 23 years, retired at 60 and lives to 80. It uses the actual number of retirees from 2004 to 2010 with 50% of the current work force retiring from 2011 to 2016, as estimated by the County. Average actual salaries from 2004 to 2010, with an estimated 4% annual increase from 2011 to 2016.

Conclusion

As described in this document, the County and SCERA violated the CERL requirements when it increased benefits and the actuary’s estimated 3% additional employee contribution, which was suppose to cover the entire cost for General and 50% of the cost for Safety employees covered less than 10% of the cost. The bottom line is that if the proper actuarial numbers were provided to the Board of Supervisors and the they were told that the costs in excess of the estimate would be borne by the County, they probably would not have approved the increase.

Unfortunately, there is no easy fix for this problem because already 1300 people have retired with the increased benefits, and by 2016, 3000 employees will have retired with benefit levels that were improperly granted. It is a mess, but it is a mess the current Board of Supervisors cannot ignore since taking money from the General fund to pay for the pension increase is not something that was ever approved by the Board of Supervisors in 2002. As a result, they either have to find a way for the employees to pay for the increase or void the benefit increase all together.

Currently the employees are telling the Board of Supervisors that the 3% was just intended to pay for the increase and they are not required to contribute anymore towards the cost.

Ken Churchill is a retired business executive and member of a small group of financial experts in Sonoma County who are working to reform the County’s pension system. Earlier this month, he published an introduction to the Sonoma County pension challenge entitled “How Retroactive Pension Increases and Lower Investment Returns Have Blown Up Sonoma County’s Pension System.” He has written a comprehensive report on the County’s pension problem that documents how the crisis has occurred and what can be done to fix it. It is titled The Sonoma County Pension Crisis – How Retroactive Benefit Increases, Overly Generous Salaries, and Poor Financial Management Have Destroyed the County’s Finances.

Why Pension Fund Returns Will Drop Below 7.5%

One major premise underlying the criticisms leveled at pension reformers is that defenders of the current system believe 7.5% is a realistic long-term rate of return for pension funds. This is problematic for several reasons:

1 – A return of 7.5% is too high for the economic era we’ve been living in since 2008, and will be living in for at least another ten years. During the great debt binge that started in the 1980’s, accelerated in the 1990’s, and went totally out of control since around 2000, debt as a percent of GDP in the US tripled; it is now nearly 400% of GDP (that’s all debt; consumer, commercial and government, and does NOT included unfunded liabilities for future commitments such as pensions). This is a higher level of debt than during the great depression. It is difficult to overstate the impact that accumulating debt had on economic growth and therefore on investment returns – with people borrowing more than they were paying back, money was being injected into the economy and this stimulated consumer spending and corporate earnings. Stock and asset values grew accordingly. It is equally difficult to overstate the problems caused when people now have to pay back more than they can borrow. This means there is less money for purchases which stimulate economic growth, which means asset values decline and returns on investments drop.

2 – Along with the fact that we’re now in an era of debt reduction instead of debt accumulation is the reality of our aging population. As the ratio of workers to retirees shrinks, and there are fewer workers for every person retired, the number of people who are liquidating their savings and investments instead of accumulating savings and investments grows. This means there are going to be more people selling assets in the future than there used to be. In any market, this means lower prices. Equities and assets are no longer going to appreciate the way they used to because more people will be selling them to finance their retirements than before.

3 – When pension funds used to earn an average return of 8.0% or more per year, year after year, they were smaller players in the market than they are today. Now that people are beginning to retire under pension formulas that are far better than in past decades, these giant funds will have a much more difficult time outperforming the market. They will be paying out as much in pensions as they are investing with contributions from current workers. And because these pensions are now so big – with over $4.0 trillion in assets already – these pension funds will themselves also start to exert downward pressure on asset values because they are going to be selling as much as they are buying. When public sector pension funds administered smaller benefits to fewer people, and they were buying more than they sold, they could beat the market, and they could exert upwards influence on the market. Now they are the market, and at best their impact on market values is neutral.

4 – Even if public sector pension funds can deliver 7.5% returns into the future, why are taxpayers guaranteeing these returns? Why on earth should taxpayers bail out these pension funds if they don’t hit these long-term projections? When private citizens who have to save for retirement see their investments drop in value, should they really be required to pay higher taxes in order to guarantee the defined benefits for government workers?

5 – The whole idea of investing taxpayer funds in the market for one class of workers, government workers, while providing only social security to everyone else – at a level of benefits far less generous (but far more sustainable) – is fundamentally unfair. Particularly when taxpayers have to make up the difference. Taxpayer supported pension funds should be, ideally, completely out of the business of making high risk investments.

The reality is this:  Public sector unions demanded and got pension benefits for their members that are nowhere near sustainable unless these returns – 7.5% per year or more – can be delivered by pension funds for decades to come. If defenders of public sector pensions are so confident that long-term annual returns of 7.5% or more are achievable, they should have no problem releasing taxpayers from the obligation to make up for any shortfalls that may occur.

How Retroactive Pension Increases and Lower Investment Returns Have Blown Up Sonoma County’s Pension System

We should all care deeply about pension costs and the 400% increase in the costs over the past decade in Sonoma County. Why? Because every dollar going to over generous, retroactively enhanced pensions is taxpayer money that is not creating jobs, helping our fellow citizens, educating our children, or maintaining our roads and parks.

Most people know there is a pension problem, but don’t know how it was created or how big it is. Many, including our elected officials, don’t understand the options for making pensions sustainable again. The purpose of this paper is to answer those questions.

How Defined Benefit Plans Work

Our tax dollars provide our government employees with defined benefit retirement plans. These plans are designed so that the employer (government agency) and employee each contribute a specific percentage of payroll into the plan each year. This money is then invested by the plan administrator. Sonoma County’s plan is administered by the Sonoma County Employee Retirement Association (SCERA) the State and many other city plans are administered by CalPERS.

The plan contributions are calculated by actuaries each year with contribution levels adjusted so that when an employee retires, there will be enough money in their account to pay for their retirement. It is called a defined benefit plan, because the retiree gets a set amount each month during retirement from their account. Up until the last decade, the contribution was 5-7% of pay from the employer and 5-7% from the employee. If a fund lacks the money to pay the benefits that have already been earned, it is called the “unfunded liability” and becomes the responsibility of the employer.

Here’s an example: if an employee makes a $100,000 salary at retirement and they worked for 30 years under a 2% at 60 plan, which was common until 2004, when they reach 60 and retire they received 60% (2% x 30) of their salary ($60,000) each year during retirement. Some plans also provide an annual or optional cost of living adjustment.

The Cost of Changing From 60 to 90 Percent of Pay in Retirement

Let’s take the example above and change the formula retroactively back to the date the person was hired to 3% at 60 as was done for Sonoma County for employees retiring in 2005 and beyond. Now an employee making $100,000 per year would receive $90,000 per year (3% x 30), $30,000 per year more than what he received under the previous plan. If this person lives to 80, he would receive an additional $600,000 ($30,000 x 20) under the new plan, even without cost of living adjustments. A cost of living adjustment could add on an additional 50%. The problem is for all previous years the employee was paying into the 2% plan and now at retirement the plan does not have the money it needs to pay the employee’s 3% retirement benefits. And since he is retired, neither he nor the employer are contributing to his retirement account.

Another problem is that the new benefits lowered the retirement age and enabled employees to retire an average of 5 years earlier. Instead of retiring at an average age of 62, employees in Sonoma County started retiring at an average age of 57. This means there were 5 fewer years paying into the plan and 5 more years taking money out for a 10 year swing.

Options for Correcting the Unfunded Liability and Earlier Retirement Problem

So how do we correct the underfunding and earlier retirement problems? What SCERA did was ask their actuary to come up with what additional contribution going forward would be required to pay for the benefit increase. The answer the actuary came up with was an additional 3%. SCERA and the Board of Supervisors passed the increase. The understanding was that the employees would pay the additional 3% and therefore essentially pay for the entire cost of the increase and everyone would live happily ever after.

The only problem is, that 3% was way, way off and now instead of the employees paying for the benefit increase, the County is using our tax dollars to pay for it. Essentially taking tax revenues and putting them towards something they were never authorized to do while cutting services to try to balance the budget. The current supervisors understand this is a problem, but have not offered any solutions.

The only real way to pay for the increase, would have been for the employer and employee to contribute a lump sum amount to the account of the employee upon retirement to cover the unfunded liability. However, that was not something the employees or the County could afford to do and instead decided to amortize the additional cost over 30 years. So now the cost for pensions in Sonoma County have grown from $27 million in 2002 when the changes were enacted to $107 million in 2011, a 400% increase. And since the benefits are vested, the County is essentially stuck paying for pension benefit increases it cannot afford. And even though the County’s required contributions have grown, so has the unfunded liability of the plan. To date, Sonoma County sold has sold $600 million in pension obligation bonds with an outstanding balance of $515 million and the pension plan is still about $400 million underfunded.

The Double Whammy

The other critical aspect of a defined benefit pension is investment returns. They need to average a certain assumed rate to fund the plan. Up until the mid 80’s, funds were conservatively invested with 65% allocated to bonds and 35% to stocks, with an assumed rate of return of 5%. But that all changed in the mid 80’s when the voters approved a measure they were told would save money by allowing pension fund administrators to invest 65% of pension fund in the stock market. This change also seems to have allowed pension fund administrators the ability to increase the assumed rate of return from 5% to 8%. This new rate of return created an immediate surplus on paper for the funds and enabled employee unions to argue that since the pensions now had a surplus, the new higher benefit levels were affordable. It also had the effect of making the County guarantee an 8% versus 5% rate of return, and be obligated to pay for any investment shortfalls.

Investment income is supposed to provide 66% of the retirement benefits. In the past, poor returns over a single or a couple of years were offset by gains in other years. But with a decade of below average returns the County’s pension fund has racked up huge unfunded liabilities. For the pension funds to have achieved their 8% assumed returns, today the Dow would have to be at 29,000. Instead it just reached 13,000.

Over the past decade instead of an 8% return SCERA has only averaged 4.9%, 3% less than was assumed. CalPERS returns have been 4.5% over the past decade. And that 3% shortfall has a HUGE impact on the unfunded liability of the plan. For each 1% the plan misses the assumed rate of return, the employer, if they were to fully fund the plan each year, would need to contribute 10% of payroll to make up for the shortfall. This means a 3% decade long shortfall requires an additional 30% of salary each year over the past 10 years to be contributed to the plan. That did not happen, so the unfunded liability will be paid over the next 20-30 years with interest.

Even though we have seen Sonoma County’s contributions to the plans and debt service on the bonds increase from 7% in 2002 to 32% today, the County estimates that the pension costs over the next 10 years will double from $97 million in 2010 to $209 million in 2020.

The Combined Financial Impact of Low Investment Returns and Retroactive Increases

So how bad is it? In July of 2004, the new 3% per year benefit level for General employees became effective in Sonoma County. The chart below demonstrates the problem.

For all of the calculations, the following assumptions were used for a typical employee earning $100,000 at retirement at 60:

  • In 2005 his benefits went from 60 to 90% of salary
  • He received a 2% annual COLA in retirement
  • He was hired at 30 years of age and retired at 60 years of age
  • He lives until 80 years of age
  • 14% of his pay was contributed to the fund for years worked before the benefit increase
  • He received a 3% average annual salary increase and 1% annual merit increase (for promotions) over his 30 years of employment.

Additional Pre-Retirement Annual Contribution Required to Fund
Retroactively Increased Pension Benefit

The chart shows that the 3% additional contribution, the cost estimated by the County’s actuary to pay for the increase does not come close to providing the required funding. As the chart shows, everyone who retires the first 1 to 10 years after the 90% pension requires a substantial contribution of money the years prior to retirement to fund their plan. In Sonoma County about 1500 people have already retired under the new formula, and have ended up paying only a small percentage of the cost of the enhanced benefits, not the full cost as was agreed to when the increase was approved by the Board of Supervisors. That cost needs under the agreement to fall onto current and future employees. But if they pay the cost of their fellow employees, how will their pension fund grow?

As the chart shows, a person retiring 1 year after the increase in 2007 with a 5% average investment return over his 30 years worked would require an $850,000 contribution their final year of work. Remember, there are no more contributions after retirement. And if the investments returned 8%, the contribution required would be $270,000. But he only paid $3,000 towards it (3% x $100,000) so there is a $267,000 to $847,000 shortfall in this person’s pension account.

A person retiring 5 years after the increase in 2012 with a 5% return would require an $180,000 per year contribution, an amount 2 times his annual salary each year. If investments returned 8%, the contribution required would drop to $62,000.

A person retiring 10 years after the increase in 2017 with a 5% return a year would require a $96,000 contribution for each of the 10 years prior to his retirement (his entire salary) or $35,000 with an 8% rate of return.

As you can see, even a 3 percent change in investment returns, from 8% to 5%, created a 200% to 300% increase in the contribution required to fund the plan. And under the current rules, the County or public agency, not the employee is required to make this additional contribution. Where is this additional money coming from?

How to Fix the Problems

There are two big problems to fix. First, the County should have the power to change benefit levels going forward simply because it may be required to prevent the County from going bankrupt. The current interpretation of the law is that promised benefits cannot be reduced and when a benefit is increased, they are immediately vested. However there is a CalPERS document that states that vested benefits are the benefits that were in effect when the employee was hired creating the possibility that the retroactive part of the increase could be rolled back to the old level for future service.
Also, some legal experts argue, that in a financial emergency, public agencies can legally change benefit formulas for existing employees going forward. The argument is that it is ridiculous that a legislative body can’t make changes that will prevent the insolvency of the pension fund or the bankruptcy of the government agency.

The second problem that needs to be fixed is the County needs to find a way to reduce pension costs for people who have retired. These retirees are now receiving benefit levels they and their employer never properly funded i.e. the retroactive part of the increase. The California Constitution prohibits making a gift of public funds or wasting public funds. There is a very good argument for rescinding the retroactive benefit increase, which essentially pays a person again for work already performed and this is clearly a “gift”. Hopefully this issue will be decided by the courts though the California Supreme Court recently refused to take up the case.

In the meantime, until these legal issues are ultimately resolved, the County (and other government agencies) should be doing the following to reduce pension costs:

1) Lower or freeze all salaries. Salaries are one of the two multipliers in the pension formula and lowering or freezing them will save money today and reduce pension costs when people retire. Currently, Sonoma County with average salaries of $82,000 per year for General employees and $99,000 for Safety employees, pays salaries that are 27% higher than those of the 20 other Counties under the County Employee Retirement Laws.

2) Raise employee contributions to cover at least 50% of the total contribution, as was the practice before the benefit increases, or do what the City of Pacific Grove decided to do and have the employees pay all costs in excess of 10% of salary. Today, most public agencies, as well as Sonoma County, are paying 32% of salary for general employees and even more for Safety employees who can retire at 50 with 90% of their pay. The current employee contributions range from 8-12%.

3) The County should create a second tier for new employees that either just provides a 10% of salary contribution to a 401k plan and eliminates the defined benefit plan, or the formula for the defined benefit plan should be changed to a 2% per at 65 plan for general employees and 2% at 60 plan for Safety.

It is way past time to solve these problems. Every day the problem is not addressed, more people retire with pensions that are underfunded and the public agency/taxpayers are stuck with the bill.

All of us should be calling, writing letters and sending e-mails to our State and Local representatives telling them that we support comprehensive pension reform. We should also tell them we will not vote for any tax increases until salaries of public workers are reduced to comparable county or private sector levels and retirement benefits are reduced to sustainable levels.

To accomplish this we need to elect new representatives that understand the pension problem and have the financial expertise to understand and combat this problem. We need to elect people who will put the interests of the people who elected them ahead of the employee unions. We do not seem to have those people in office anywhere except for a few places right now.

Ken Churchill is a retired business executive and member of a small group of financial experts in Sonoma County who are working to reform the County’s pension system. He has written a comprehensive report on the County’s pension problem that documents how the crisis has occurred and what can be done to fix it. It is titled The Sonoma County Pension Crisis – How Retroactive Benefit Increases, Overly Generous Salaries, and Poor Financial Management Have Destroyed the County’s Finances.

A Pension Analysis Tool for Everyone

A concern often voiced by pension reform activists and politicians interested in better understanding pension finance is that they have to depend solely on the information delivered by actuaries. This information, in turn, is typically delivered in a report so voluminous and so technical that the activists and politicians have to hire their own experts to explain it all to them. The mass of data and assumptions are usually so intimidating that ultimately many people who need to understand pension finance give up. Additionally, it is difficult to eradicate bias from expert analyses of pension solvency. The result is that many people, including paid professional spokespersons and other opinion makers, offer assertions that do not necessarily reflect the reality of pension finance, while voters and policymakers alike remain uncertain regarding the the nature and severity of the problem.

This post is to provide anyone who wishes to understand some of the fundamentals of pension finance a tool that allows them to do their own “what-ifs” on pensions. Because this model has distilled the mechanics of a pension fund to a single page of data and calculations, it offers a glimpse of how pensions operate that is relatively understandable and extremely transparent. This model is not intended in any way to replace the far more complex models used by actuaries, but it can be quite useful to illustrate, for example, how very sensitive the required annual contribution to a pension is to any change in other assumptions – especially the rate of return.

To download this Excel model, simply click on “pension_analysis_model” and you will have a spreadsheet to save and experiment with. Start with the first tab “constant inputs,” the 2nd tab will be explained later. The graphic images below show the upper section of this spreadsheet; all of the cells that accept inputs are at the top of the spreadsheet and are highlighted in yellow. While this model is only designed to show the pension fund performance by year for one person, it is important to understand that pension funds that aggregate pension contributions and allocate pension benefits for thousands of people follow the same rules.

To use this model, simply enter the assumptions you would like to use into the yellow cells. Don’t enter anything in a cell that is not highlighted in yellow or you will overwrite a formula. The result that matters is displayed in the one cell highlighted in green. If this number is positive, it indicates a pension would be adequately funded under the assumptions input by the user. If this number is negative, it shows by how much a pension would be underfunded. The goal is to enter a combination of assumptions in the yellow cells that yields the smallest amount in the green cell possible without being a negative number. That is a financially sustainable pension.

The three examples provided here are chosen because they clearly illustrate some of the key financial issues that challenge the solvency of pensions today. In all three examples, the pensioner is assumed to work 30 years and enjoy 25 years of retirement. They are assumed to earn a 1.0% increase in their salary each of those 30 years for merit (promotions and raises), and a 3.0% increase in their salary each year for cost of living adjustments (COLAs). Once retired, they are assumed to get a 2.0% COLA increase in their pension each year. These assumptions can all be changed, since they are all driven by inputs in the yellow highlighted cells, but to show the impact of two key variables – the pension benefit formula, and the rate of return – they are held constant on all three examples to follow.

The first example, on the table immediately below this paragraph, shows what public safety pensions were historically – up until somewhere between 5 and 15 years ago, when virtually every city and county in California adopted more generous pension formulas. In the “pension formula/yr” cell, 2.0% is entered, which means that for every year worked, the pensioner will receive 2.0% of their final salary in retirement. This means a person who works 30 years, as in this example, will receive 60% of their final salary per year as a retirement pension. In the “fund return %” cell, the typical long-term rate of return for the pension funds is entered, 7.75% per year. Once you enter all these numbers, go to the “% of salary to pension” cell and enter various amounts until you arrive at one that provides the smallest positive number possible in the green cell. Doing this indicates that under these assumptions, an employee would require an amount equivalent to 13.1% of their salary to be set aside each year to fund a pension benefit equal to 60% of their final salary.

 

 

In the next example, shown below, one can view the impact of a change in the benefit formula from 2.0% to 3.0%. That is, the only change that has been made to the assumptions is the change in the “pension formula/yr” cell from 2.0% to 3.0%. This is to model the current typical pension formula for safety employees, 3.0% times years worked, times final salary. As shown, in order to still have a positive fund ending balance in the green cell, the amount to be contributed each year into the pension fund, “% of salary to pension,” now has to increase from 13.1% to 19.6%.

It is important to digress here to point out that because the change in the pension benefit formula from 2.0% to 3.0% (or from 1.25% to 2.0% for non-safety employees) was done retroactively, pension funds would have been required to increase their rate of contributions far beyond 19.6% going forward. This is because, for example, a mid-career employee, suddenly receiving this retroactive benefit enhancement, would have only been putting 13.1% into their pension fund for the entire first half of their career, a critical period since money invested that early has more time for earnings to compound. The impact of making the benefit enhancement retroactive will be explored at the end of this post.

 

 

The third and final example, below, shows the impact of a lowering of the fund’s rate of return. In this case, not only is the benefit formula enhanced from 2.0% per year to 3.0% per year, but the rate of return for the fund is lowered from 7.75% per year to 6.00% per year. At this rate of return, pension solvency would not require an annual contribution equivalent to 13.1% of payroll, or 19.6% of payroll, but 31.4% of payroll. This is a huge adjustment. In the concluding section of this post, a more in-depth analysis is presented explaining why even this may not be enough.

 

 

The model presented thus far is not designed to allow the user to input differing values in each year under analysis, but in the same Excel file “pension_analysis_model,” there is a 2nd tab, “flexible inputs,” that does provide this ability to the user. To delve into the details of how to use this model would go beyond the scope of this post. In short, any cell highlighted in yellow is an input cell, including entire columns where each row corresponds to a different year. The user will still iterate to achieve a near-zero result in the lone green cell which represents the final ending balance of the fund. The model on the 2nd tab uses exactly the same formulas and logic as the model illustrated above, except the user can assume and input differing values per year on this version. Here is a summary of the default case that is already entered on the downloadable spreadsheet, tab two, entitled “variable inputs:”

This analysis assumes that the change to the benefit formula from 2.0% per year to 3.0% per year was done in late 2000, in mid-career for the employee (year 15 of a 30 year career). This means that through the year 2000, holding all other assumptions constant, the annual pension contribution was only 13.1% of salary (because at through that point, that was all it needed to be – see example #1 above). What also happened starting around the year 2001 was the rate of return earned by pension funds fell – they have actually fallen to around 4.0% during the past decade, but in this analysis, the rate is lowered to 6.0% per year and held there through the rest of the timeline. Prior to 2001, from 1985 through 2000, the rate of return is assumed to be 7.75% per year.

Based on these assumptions, which reflect a fairly realistic assessment of history to-date, starting in 2001 it is necessary for an employee with these rate-of-return and benefit changes to make an annual contribution to their pension fund equaling 54.5% of their salary. And for every year they have not done this, that percentage must rise. Nowhere in this analysis, moreover, is the all-too-frequent practice of “spiking” accounted for, which raises necessary annual contributions still further.

By using in this final example a person for whom the pension fund adjustment was made in mid-career, it is reasonably accurate to say that whatever unfunded liability may exist in reality in this individual case, could be used as a basis for calculating the total unfunded liability of the fund in aggregate. To get a global estimate, of course, one must input a blended benefit rate that takes into account the lower formulas that apply to non-safety employees, or run them as separate studies.

Again, this model is not meant to replace actuarial models that take into account specific fund demographics and deliver results precisely aggregated for all participants in the fund. But actuarial models, for all their precision and complexity, must nonetheless rely on the same set of assumptions this model does, and how those assumptions are made delivers vastly differing outcomes. For anyone who uses it, this model may serve as a useful tool to better understand and communicate the dynamics of pensions, and to sanity check whatever does come out of the black boxes reserved for qualified actuaries.

New York Cities Borrow from Pension Funds to Make Payments into Pension Funds

In the worst possible form of kicking the can down the road, at the worst possible time as well (given the lofty overvalued condition of the stock market), To Pay New York Pension Fund, Cities Borrow From It First.

When New York State officials agreed to allow local governments to use an unusual borrowing plan to put off a portion of their pension obligations, fiscal watchdogs scoffed at the arrangement, calling it irresponsible and unwise.

And now, their fears are being realized: cities throughout the state, wealthy towns such as Southampton and East Hampton, counties like Nassau and Suffolk, and other public employers like the Westchester Medical Center and the New York Public Library are all managing their rising pension bills by borrowing from the very same $140 billion pension fund to which they owe money.

Across New York, state and local governments are borrowing $750 million this year to finance their contributions to the state pension system, and are likely to borrow at least $1 billion more over the next year. The number of municipalities and public institutions using this new borrowing mechanism to pay off their annual pension bills has tripled in a year.

Public pension funds around the country assume a certain rate of return every year and, despite the market gains over the last few years, are still straining to make up for steep investment losses incurred in the 2008 financial crisis, requiring governments to contribute more to keep pension systems afloat.

Nationwide, the cost of public retiree benefits has soared in recent years, and states including California, Connecticut and Illinois have been borrowing to pay, or even deferring, their pension bills. Many states are worse off than New York. New Jersey is still paying off bonds issued in 1997 to close a hole in its pension system.

But New York appears to be unusual in allowing public employers to borrow from the state’s pension system to finance their annual contributions to that system.

In Poughkeepsie, which is contributing $3.6 million into the state pension system this year and borrowing nearly $800,000, Mayor John C. Tkazyik, a Republican, said rising pension costs and new federal accounting requirements for retiree health coverage could have dire consequences.

“It could bankrupt the city,” Mr. Tkazyik said, adding that the city had cut its work force, to 367 from 418 employees, in four years as it struggled to compensate.

Perverted Math

Only with the most perverted actuarial math can anyone fund a pension plan by borrowing from it.

Unfortunately, it’s not just cities that are borrowing money from plans to fund them. New York state borrowed $575 million in the current fiscal year, and $782 million in the next, under Gov. Andrew M. Cuomo’s proposed budget.

The True One Percent

The following video may come across as a bit over-the-top in terms of presentation, but the examples are accurate.
Link to video: Government Employees: The True 1%

Public Pension Ponzi Scheme

As I have commented on numerous occasions, defined benefit pension plans are going to bankrupt numerous cities and states. Several smaller cities have already gone bankrupt over union salaries and pensions.

Numerous other cities are on deck. The public pension Ponzi scheme will fly apart as soon as one major city declares bankruptcy to get those pension benefits tossed out in court.

Realistically speaking, numerous cities such as Los Angeles, Houston, and San Diego are already bankrupt, as are second tier cities like Oakland, Newark, Cincinnati, and Baltimore and others too numerous to list, they just have not admitted it yet.

Simply put, pension promises have been made that cannot and will not be kept.

In the meantime, defined benefit plans need to end, city services privatized or eliminated, Davis-Bacon and prevailing wages laws scrapped, national right-to-work laws implemented, and at the top of the list, collective bargaining of public union workers need to stop immediately.

It’s time to abolish collective bargaining, a practice that makes slaves out of everyone. I make the case in …

Collective Bargaining neither a Privilege nor a Right

Paul Krugman, Stephen Colbert, Bill Maher, others, Ignore Extortion, Bribery, Coercion, and Slavery; No One Should Own You!

Clearly, huge battles loom over these issues.

About the author: Mike “Mish” Shedlock is a registered investment advisor representative for Sitka Pacific Capital Management. His top-rated global economics blog Mish’s Global Economic Trend Analysis offers insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education. Every Thursday he does a podcast on HoweStreet and on an ad hoc basis he contributes to many other websites, including UnionWatch.

Government Employees – The True “1%”

Editor’s Note: The claims made in this commentary by Wayne Allen Root are incendiary. But they are true. We are on track in the United States to pay more money to 20 million public sector retirees – at an average pension of $65,000 we will pay these retirees $1.3 trillion per year, then we will be paying in social security to 80 million private sector retirees – at an average social security benefit of $15,000 per year that will cost less, about $1.2 trillion per year. Providing a level of retirement security to government workers that only the wealthiest 1% can enjoy in the private sector is not “protecting the middle class,” it is economic enslavement by government unions over the taxpayer. This article originally appeared on FoxNews.com and is republished with permission by the author.

How did America become broke and insolvent? How did we build up an unimaginable $115 trillion in debt and unfunded liabilities? How did we allow the American Dream to become a nightmare?

All we need do is look at the primary demand the Eurozone and IMF are placing on hopelessly bankrupt Greece to get their new $170 Billion bailout — Greece has agreed to cut 150,000 government employees. Even Cuba’s leader Raul Castro recognizes too many government employees are at the root of economic destruction, as he is cutting over 2 million of them to save Cuba from bankruptcy.

The truth is that government employees are the true 1%. We have far too many of them (21 million), many of them are paid too much, and their union demands are straining taxpayers to the breaking point.

They have become a privileged class that expects to be treated superior to the taxpayers — the same folks who pay their salaries and pensions. But it is their obscene pensions that are the big problem moving forward for America.

How would you like to retire with $6 million? $8 million? $10 million? All you have to do is become a government employee to hit the jackpot.

You don’t believe me? Do the math.

I recently talked with a retired New York City toll taker. His salary averaged about $70,000 per year over 20 years. But in his last few years he worked loads of overtime and added in accumulated sick days to get his salary in those final years up to $150,000.

His pension is based on his final years’ salary. This is a common pension-padding ploy.

He bragged that he will now get a taxpayer funded pension of $120,000 a year for the rest of his life. He’s only 50 years old.

The average 50-year old male has a life expectancy of almost 80. With automatic cost of living increases, that’s a bill to taxpayers of $5 million for the next 30 years –for not working. THREE TIMES WHAT HE EARNED WHILE WORKING.

And, of course, we’re also paying his medical bills.

No country, no budget, and no taxpayers anywhere in the world can afford this. Ask Greece.

But here’s a frightening question- what if he lives to 90? Or 100? His pension could rise to $8 million or higher.

Multiply this times 21 million government employees (on the federal, state and local level) and you now get a sense of what is bankrupting America.

Are these stories the exception, rather than the rule? Over 77,000 federal government employees earned more than the governor of their state.

On the federal level, it was just reported by USA Today that the average federal civil servant compensation is $123,049 per year.

That’s more than double what private sector workers earn (average of $61,051). Since 2000, federal government employee compensation has grown by 36.9% versus 8.8% for private sector employees.

In Las Vegas (Clark County) the average firefighter earns $199,678 per year.

When he retires at age 45 or 50, we owe his pension based on that obscene salary. But here’s the clincher –when he finally dies, the taxpayer has to continue paying the pension to his spouse. Add up the damage to the economy. It is catastrophic. Talk about a 1 per center — a single firefighter could retire with $8 to $10 million for not working for the rest of his life.

This is madness.

Now it’s true that policemen and firefighters are heroes. But they make up a small portion of government employees.

Recent studies prove the average janitor that works for government makes over $600,000 more in his career than a private sector janitor. Are janitors heroes too?

Again, this is madness.

Three stories on the same day in this past Sunday’s Las Vegas newspapers sum up this national outrage.

Let’s start with the Las Vegas teachers union. It was reported that more than a third of the union’s entire $4.1 million annual budget went to pay just nine union leaders.

The Teachers Union Executive Director received $632,546, while the CEO of the union-created Teachers Health Trust was paid $546,133.

So next time you hear educators scream that we must spend more money on education, because “it’s for the kids,” you’ll know the truth. It’s for the unions.

It’s always been for the unions.

Bernie Madoff has nothing on the government employee union scam.

Article number two in Sunday’s Las Vegas Review Journal was about those highly paid Las Vegas firefighters.

It turns out they weren’t satisfied with making almost $200,000 per year. They also abused sick leave, rigged work schedules to pump up their pensions, and appear to have engaged in widespread disability fraud.

About half of all Clark County firefighters retired with work-related injuries in recent years- garnering bonus payments averaging $320,000 apiece. That’s in addition to their obscene pensions for life.

Is this also “for the kids?”

Article number three in Sunday’s paper was about a now retired Las Vegas homicide detective and possible police brutality. It had nothing to do with pensions. But interestingly, the retired homicide detective they quote in the story is 47 years old.

He’s 47 and already retired?

Want to bet that you and I are on the hook for $5 to $10 million in pension and health benefits from now until the day he dies- for not working. Is this also “for the kids?”

I’ll say it one more time… this is madness.

These aren’t CEO types. These are average government employees retiring with the equivalent of $5 to $10 million. These are the true 1% privileged class that are bankrupting our country and destroying the once great U.S. economy.

Something is very wrong here.

No one has a right to complain about the high incomes of business owners in the private sector (the 1%). We rarely have pensions and our compensation doesn’t cost taxpayers a dime. We risk our own money to start our businesses and often work 16 hour days, weekends and holidays.

Yet for all that risk and hard work, do you know any small business owners who retire with $5 to $10 million? They are few and far between. But that’s exactly what a private sector employee would need in the bank on the day of his or her retirement to match the $100,000 per year pensions (plus health care benefits and cost of living increases) of government employees paid out over 30 to 50 years.

Keep in mind that government employees never risk a dollar of their own money. They have lifetime job security. And they rarely work beyond 9 to 5, let alone weekends or holidays.

Yet government employees are paid millions by taxpayers to retire early, often on pensions fattened by gaming the corrupt system.

They are the true 1%.

This is a national disgrace that is bankrupting America. The gall of this scam would make Bernie Madoff blush.

But hey…”It’s for the kids!”

Wayne Allyn Root is a former Libertarian Vice Presidential nominee. He now serves as Chairman of the Libertarian National Congressional Committee. He is the best-selling author of “The Conscience of a Libertarian: Empowering the Citizen Revolution with God, Guns, Gold & Tax Cuts.” His web site: www.ROOTforAmerica.com. This article originally appeared on FoxNews.com and is republished with permission from the author.

California Senator Proposes State Mandated Pensions for Private Workers

The challenge of providing retirement security to all citizens is the broader issue behind the debate over what level of public sector pension benefits are both equitable and financially sustainable. California Senator Kevin De Leon’s proposed legislation, SB 1234, will hopefully further this debate.

As reported in the Sacramento Bee by Jon Ortiz on February 24th “California Democrats push pension plan for nongovernment workers,” and in the Los Angeles Times by Mark Lifsher on February 23rd, “Private-sector retirement savings plan proposed for California,” DeLeon’s bill will require every employer in the state with five or more employees to participate in the plan. If employers already offer a pension plan or 401K plan, they would be exempt.

Plenty of commentators have already weighed in with sobering missives on the many problems with DeLeon’s bill. You can read them in the San Bernardino Press Enterprise, the Pleasanton Weekly, CalWatchdog, CalWhine, and elsewhere. But when DeLeon says his bill “is designed to supplement Social Security retirement benefits,” he is on to something bigger than he may realize.

The goal of taxpayer funded retirement security, whether it is for a retired government worker or a retired private sector worker living on social security, is not to support an affluent lifestyle. A taxpayer funded retirement pension should be a modest amount, better than social security – but not some huge amount that enables an affluent lifestyle. To have an affluent lifestyle in retirement, people should expect to save money and eliminate debt, not just show up at a government job for 20 or 30 years then collect far more than a social security recipient could ever hope to collect. Why not eliminate public sector pensions, and provide everyone social security, supplemented by the plan DeLeon is proposing?

When estimating just how much DeLeon’s pension plan for private sector workers is going to actually be able to pay out, it will highlight a fundamental principle that still seems to be lost on the public sector apologists: Not all of us are libertarians, nor are all of us against improved retirement security for all citizens. But whatever it is that taxpayers are asked to support has to be equally accessible to ALL workers according to the same merit-based and need-based formulas. We can disagree on the formulas. We can disagree on what we believe is financially sustainable. But however our government may enable better retirement security – it should be the SAME DEAL for all taxpayers. The disgrace is that public sector unions have used their political muscle to offer deals to their members in the government workforce that could never, ever be financially feasible to all workers.

As DeLeon’s bill is debated, hopefully it will not only highlight the truly grotesque disparity between government worker pensions and social security for the rest of us, but it will shed light on the biggest single variable affecting the affordability of public sector pensions: The long-term annual rate of return for the pension fund.

As quoted in the Los Angeles Times, DeLeon said “The board would be required to invest only in conservative instruments, such as U.S. government Treasury bonds.”

Does Senator DeLeon understand what sort of can of worms he is opening here? A ten-year U.S. treasury bond pays around 3.0% per year. Yet CalPERS still claims they can earn 7.75% per year. How much money will this “supplemental pension,” expressed as a percent of final salary, deliver to someone who contributes 3% of their salary for 40 years, invested at 3% per year?

As the chart following this post proves, taking 3.0% from a paycheck – assuming normal inflation and minimal merit increases (which increases ultimate fund earnings by concentrating more investment in the early career years) – will buy a person who retires after 40 years of full time work at a final annual salary of $50,000 with a whopping $2,010 pension per year; that’s an extra $168 per month. Anyone who dismisses this decidedly math-centric, wonkish claim as “right-wing spin” is invited to verify these calculations for themselves.

What Senator DeLeon is going to learn, along with many other worthy liberals in the State Legislature who are grappling with the pension crisis, is the extreme sensitivity of pension fund solvency to the achievable rates of return for these funds. And if Senator DeLeon wants to impose a “risk free” rate of return on a pension fund for private workers, he may wish to impose the same restrictions on public sector pension funds. Or stop having taxpayers make up the difference when those more aggressive investments fail to meet expectations.

There is nothing wrong with our legislators trying to address the issue of retirement security. But while doing so, they might question why we are now on track to pay more money each year, in absolute dollars, to our retired public sector workers in the form of pensions, than we will pay in social security to the other 80% of our workforce when they retire. They might also question why they have gone into partnership with the very Wall Street wizards they rhetorically condemn, by allowing them to promise absurdly high rates of pension fund returns to public sector employee negotiators, then together turn on taxpayers to cover the inevitable shortfall.

*  *  *

California Politician Submits “Personal Pension” Legislation

The gall, arrogance, and stupidity of public union pandering has reached new heights. A senate bill sponsored by written by Sen. Kevin de León, D-Los Angeles seeks to force businesses with five or more employees to create personal defined benefit plans, managed by CalPERS.

The Sacramento Bee reports California Democrats push pension plan for nongovernment workers

Senate Bill 1234, written by Sen. Kevin de León, D-Los Angeles, would require businesses with five or more employees to enroll them in a new “Personal Pension” defined benefit program or to offer an alternative employer-sponsored plan.

The new system’s investments would be professionally managed by CalPERS or another contracted organization. Employees would contribute about 3 percent of their wages through a payroll deduction, although they could opt out of the plan.

The fund would assume much lower investment returns than the 7.75 percent that the California Public Employees’ Retirement System says its investments will generate, de León said.

Steinberg rejected suggestions that Democrats are pushing de León’s bill to fend off pressure to enact substantial public pension changes.

“Absolutely not. We’re not running away from it,” Steinberg said, calling de León’s bill the private sector “bookend” to public pension reform measures he expects lawmakers will send to Brown before the current session ends.

Pure Insanity

There is no polite way to put this so I won’t. Sen. Kevin de León is clearly a certifiable nutcase.

Stockton and Vallejo California are both bankrupt over insane promises made to public union employees. So is Detroit Michigan, Central Falls Rhode Island, Providence Rhode Island, and Harrisburg Pennsylvania.

Numerous other cities will eventually be forced to seek bankruptcy. Los Angeles and Oakland are at the top of the list.

Numerous airlines and GM went bankrupt over defined benefit pension plans.

De León’s bill would bankrupt countless small businesses trapped in its wake.

Things That Would Happen If Passed

  1. Immediate large-scale firings by small businesses. No small business owner in his right mind would have over four employees.
  2. Any business that could, would leave the state.
  3. Many businesses that do stay would be destined to go bankrupt.
  4. California would end up like Detroit or Greece

States on the Right Path

The road to reform is 180 degrees opposite. Governor Scott Walker in Wisconsin, Governor John Kasich in Ohio, and Governor Mitch Daniels are on the right path.

Five Point Road to Reform

  1. End collective bargaining of public unions
  2. Scrap Davis-Bacon and all prevailing wage laws
  3. Scale back existing pension benefit promises via bankruptcy if necessary
  4. Eliminate defined benefit pension plans
  5. Institute national right-to-work laws

Corruption of America

The gall, arrogance, and stupidity of Senate bill 1234 sponsored by Sen. Kevin de León, D-Los Angeles, is absolutely stunning.

Here are a few particularly relevant paragraphs from my post Fatally Flawed Approaches to the Budget Deficit and Taxes; Debt Will Swell Under 3 of 4 Republican Hopefuls’ Tax Plans 

Porter Stansberry wrote a tremendous article on The Corruption of America and how public unions are at the center of it.

Golden State on road to Greece, by way of Detroit

Stansberry touched on Detroit in his article and so did the Orange County Register in an editorial Golden State on road to Greece, by way of Detroit

The Chicago Tribune reported Chicago teachers asking for 30% raises over next 2 years.

Is that insane or is that insane? The only way to stop such insanity is by ending collective bargaining of public unions, scrapping Davis Bacon and all prevailing wage laws, and instituting national right to work laws.

Legal Bribery

As long as public unions, corporations, and lobbyists can bribe legislators with campaign contributions, then bills are going to be written by public unions, corporations, and lobbyists.

Tax reform alone cannot and will not work. In addition to a balance budget amendment, something must be done to rein in the power of public unions and corporate lobbyists at the center of this mess.

Ending collective bargaining rights of public unions and passing right-to-work legislation would be a wonderful first step.

Addendum:

I missed the words “Employers could make voluntary contributions into the fund.” Sorry, but I still don’t buy it. This would be the first step towards mandated involuntary contributions. Moreover, maintenance of the plan would cause headaches, and giving money over to CalPERS to manage is inane.

If people want to enter such programs on their own, let them. Mandating businesses offer such plans is another ridiculous burden on all businesses, especially small businesses. Nothing at all stops private companies from offering such plans.

Who is going to guarantee these benefits anyway, and who will be at risk when the plans fail to meet the goals? The answer today may be one thing, the answer down the road is sure to be taxpayers and businesses.

About the author: Mike “Mish” Shedlock is a registered investment advisor representative for Sitka Pacific Capital Management. His top-rated global economics blog Mish’s Global Economic Trend Analysis offers insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education. Every Thursday he does a podcast on HoweStreet and on an ad hoc basis he contributes to many other websites, including UnionWatch.

San Diego Public Employee Unions Go to Court to Fight Pension Initiative

In my last column, I documented how California’s pro-union Attorney General Kamala Harris provided an unfair and dishonest title and summary to a pair of pension reform initiatives submitted to her office, thus effectively killing the measures. Last week the unions tried—and almost succeeded—with an even nastier stunt designed to undermine democracy.

In San Diego, unions are fearful of a new pension reform measure referred to by supporters as Comprehensive Pension Reform, or CPR, that has qualified for the June 2012 ballot. Instead of simply gearing up to fight this political battle, the unions petitioned one of those ridiculous commissions that most Californians have never even heard of, the Public Employment Relations Board, which is unfriendly turf for taxpayers. The union said placing the initiative on the ballot amounted to an unfair labor practice, and PERB called for an injunction to stop the election until it could complete its sham proceedings.

In essence, the unions and this unelected board insist that the people of San Diego have no right to vote on pension reform. This is just the latest reminder of the totalitarian ethics of a public-sector union movement that doesn’t care about anything other than protecting its benefits.

“Never in the history of this state … has there ever been a requirement to meet and confer over a citizens’ initiative placed on the ballot by voter signatures,” wrote city attorney Jan Goldsmith in a toughly worded letter to PERB. Pension reform advocate Carl DeMaio, a councilman and mayoral candidate, criticized PERB’s assault on Californians’ constitutional rights. Fortunately, a judge agreed with the city, but expect the unions to head back to court if their campaign against CPR fails.

The unions that dominate Sacramento are not about to let any serious reform take place given that real reform—especially in light of frightening new unfunded pension liability numbers—means that the days of millionaires’ pensions (one would need millions in the bank to receive the amounts commonly received by recent California government retirees) eventually have to end. Unions don’t mind undermining the public’s right to vote. They don’t care if our taxes go through the roof and businesses flee the state. They don’t care if services are slashed. They want their money.

Even Gov. Jerry Brown’s modest pension reform proposals are going nowhere in a Democratic-controlled Legislature that continues to promote expanded benefits for public employees, including a recently introduced Public Employees Bill of Rights. That leaves few other choices than a continuing gallop toward the brink.

While other liberal states such as Rhode Island are addressing their pension problems, and some Midwestern states such as Wisconsin, Ohio, and Indiana are fighting battles over union power, California does basically nothing. I appreciate the governor’s pension proposals, but he continues to view hefty tax increases as the only real solution to the state’s budget problems. The deficit has shrunk a bit, and Standard & Poor’s pushed up the state’s credit rating a tad, but the fundamentals have not improved here very much.

Where does that leave us?

Economist Allan Meltzer once quipped that “Capitalism without failure is like religion without sin. It doesn’t work.” Americans have been witnessing this axiom on a broad scale, as government efforts to prop up industries, bail out the financial sector, and protect select private businesses from failure have only caused a prolonged financial crisis. Without failure, there is no day of reckoning and no effort by the failed party to make the fundamental changes needed to avert future crisis.

The problem in the public sector is that government never is allowed to fail. There never is a day of reckoning no matter how poorly a government agency may provide its so-called services. Often, the worst agencies are rewarded for their failure by being granted additional public dollars. California governments have continually ramped up pension promises, but governments can’t go out of business, so they just keep piling up the debt.

When there’s no money left, officials play games with the numbers or—as Gov. Brown continues to do—make it their main objective to raise taxes.

Since reform can’t take place because of union control, some have proposed wider use of the bankruptcy option so municipalities can reorganize their debt. The main critics of the bankruptcy option are the unions. They know that bankruptcy would enable governments to abrogate these unaffordable contracts. The public-employee unions championed a bill, signed into law by Brown in October that makes municipal bankruptcy more cumbersome by forcing localities to get approval for such actions by additional committees.

Some even see the bankruptcy option as something that should be allowed for states. In January 2011 GOP pols Jeb Bush and Newt Gingrich ignited this debate with a Los Angeles Times op-ed titled, “Better Off Bankrupt” that argued that an organized bankruptcy process might help states overcome staggering budget deficits. But other conservatives, concerned about the impact of bankruptcy on bond markets, have been campaigning against this idea. They note that the highly publicized Vallejo bankruptcy ultimately did little to reform that city’s super-sized pensions for public employees.

I’m not advocating for bankruptcy per se, but what happens when all other reform options are taken off the table? What happens when the politics of a state won’t allow the reforms necessary to save that state? In other words, what happens when failure is not an option? If the likes of Harris and PERB and the unions continue to get their way, we very well may get to see the answer here in California.

Steven Greenhut is vice president of the Franklin Center for Government and Public Integrity. He is based in Sacramento.

Self-Employed Workers vs. Government Workers – A Financial Comparison

When discussing what level of compensation is appropriate and affordable for government workers, it is helpful to make apples-to-apples comparisons between public and private sector workers. In this analysis, the ultimate private sector taxpayer, the self-employed worker, is compared to the typical state or local government employee in California. In both cases, the annual compensation used for comparison is $70,000, which is the average base salary paid to state and local government employees in California (ref. U.S. Census data for California: State, and Local). But the impact of benefits paid by the government employer, combined with the impact of mandatory employee contributions (taxes, retirement set-asides, and healthcare costs), yield dramatically different end results in terms of total net compensation. Both the self-employed worker and the government worker make $70,000 per year. But to say they make the same amount of money is grossly misleading.

The table below, “Total Compensation – Gov’t vs. Self-Employed Worker,” begins to illustrate this disparity. The difference between total compensation and gross earnings in the case of the self-employed worker is zero. There is nobody paying for benefits beyond what the self-employed person earns. Whatever amenities they need to purchase, they have to pay for out of their gross earnings.

In the case of the government worker, there are a host of employer funded benefits; only the basic ones are covered here, using conservative assumptions. If it is assumed the average household health insurance coverage is $500 per month, and the employer pays 50% of that, this adds $3,000 per year to the total compensation of a government worker. In reality, factoring in employer coverages of medical, dental and vision plans, it is very unlikely the average government worker doesn’t get well in excess of $3,000 per year in employer health care benefits.

Current expenses for health care, however, are not the only health expenses that governments pay for their workers. Typically there are provisions for retirement health care coverage that are taken on as obligations by the government for their workers. For example, there are “medigap” plans, with all or part of the premiums paid for by the government. In some cases, such as with most safety employees and management employees, the government pays 100% of the premiums for lifetime premium health insurance plans. These future obligations must be funded during current employment. To estimate another $2,000 per year for this cost, or, more generally, to estimate $5,000 per year per employee for the average government contribution to current and retirement health care, is definitely conservative.

In addition to healthcare costs, state and local government employers cover pension benefits for which much of the costs – and in many cases 100% of the costs – are paid by the government, not the employee. If one assumes a contribution by the government employer of only 12% of gross salary per year – clearly lower than reality – this adds another $8,400 to the total compensation of a government worker.

A simmering question regarding pensions for government workers – how much can these pension funds really earn each year in interest – generates the next estimate. In our analysis “How Much Could California’s Government Pensions Cost Taxpayers,” along with “What Payroll Contribution Will Keep Pensions Solvent,” we have explored the underlying calculations in depth. The reader is invited to review those calculations and assumptions. But the bottom line is this: If pension funds have to lower their long-term expected rate of return by 2.0%, and they will, this will add at least $11,200 per year to the cost of funding the average pension. These obligations may be scaled back, but until they are, this amount must be included when adding up the total compensation of the average government employee in California.

Taking all of this into account, a self-employed person making $70,000 per year makes $70,000 per year. A government worker making $70,000 per year in base pay is actually making $94,600 per year in total compensation, 35% more. But it doesn’t end there.

The next table, below, examines the impact of what might best be described as “mandatory employee contributions,” taking the form of the employee share of health insurance coverage, retirement pensions and social security, along with state and local taxes. Once these mandatory contributions are deducted from the income (before tax in the case of health care and retirement contributions) of both the self-employed and the government worker, and the employer provided benefits – which are tax-free – are added back to the income of the government worker, the disparity between their actual net total compensation becomes even more dramatic.

If one assumes that the self-employed person is going to purchase health insurance for their household, they will pay 100% of the premium. Using the same assumptions, this means they will spend $6,000 per year for these benefits, whereas the government worker, paying 50% of the premium, will only spend $3,000 per year.

By participating in social security and medicare as a self-employed person, they are obligated to pay both the employee and the employer share of those assessments, which at a gross annual income of $70,000 will cost them $10,500 per year. By contrast, even if the government worker pays 10% of their salary into their pension – a level that is still fairly unusual to see among government workers – this will only cost them $7,000 per year.

In the above table, “Net Total Compensation – Gov’t vs. Self-Employed Worker,” these before tax deductions are subtracted from their base annual salary to arrive at their taxable annual salary. This taxable amount then has deducted from it what a California household in 2011 would have to pay in state and federal taxes. Finally, the non-taxable employer contributions are added back to the actual take-home pay to yield the net total compensation after mandatory contributions.

This is the apples-to-apples result: A self-employed person making $70,000 per year, once they’ve paid their taxes. social security and insurance premiums, will enjoy compensation of $45,021 per year. A government worker making $70,000 per year, once they’ve paid their taxes, pension contribution and insurance premiums, with the value of the employer paid current and deferred benefits added back, will enjoy compensation of $74,781 per year, 66% more.

It doesn’t end there. As shown on the next table, “Retirement Security – Gov’t vs. Self-Employed Worker,” the self-employed worker, who must pay $10,500 per year for social security and medicare, can expect to retire at the age of 66 with a social security benefit of $20,144 per year. The government worker, who must pay $7,000 per year for their pension, can expect to retire at the age of 60 with a pension of $46,666 per year. The total value of these respective retirement benefits, based on a life-span of 80, is $282,016 for the self-employed worker, and $933,324 for the government worker.

It is important to emphasize how conservative these numbers are. While the average pay of a government worker in California is only about $70,000 per year, the average pension for state and local government workers in California is not $46K per year, but nearly $70K per year. For state and local government workers who retire at age 66 and spend their careers in government service, the average pension-eligible final salary is nearly $100K per year (ref. CalPERS Annual Report FYE 6-30-11, page 153, and CalSTRS Annual Report FYE 6-30-11, page 149). This means the assumptions used to calculate pension contributions at various rates of return, which assumed pensions equivalent to 66% of average salary, are obviously inadequate. This is because pensions aren’t calculated on average salary, they’re calculated on final salary. The assumptions underlying our pension contribution estimates also don’t take into account the current state of underfunding for pensions.

For a self-employed person to enjoy a net total compensation equivalent to the average government employee who makes “only” $70,000 per year, they would have to earn well in excess of $100,000 per year, particularly since as they climb in gross income, they encounter higher and higher tax brackets. A self employed person who makes less than $108,000 per year and more than $74,000 per year, because their income is still under the social security withholding ceiling, actually pays taxes at the margin of over 50%. But that is a topic for another post.

Government Workers Just Keep Feeding Pension Thieves

Every year state politicians loot the pensions of more than 17 million public workers and retirees to “balance” budgets, yet those workers keep putting the looters back into office while fighting the few who try to head off this $4-trillion national economic catastrophe.

A look at the latest U.S. Census data shows that over four years the geniuses running state pensions lost almost 20 percent — $552 billion in total investment value — and blew more than $600 billion of income needed to pay benefits. They lost $4.33 for every dollar public workers “contributed.”

However, the geniuses did manage to pocket $36.6 billion in “Other Expenses” for themselves and their pals in the process.

That puts funds almost $1.3 trillion behind where they promised to be and increased the real long-term funding shortfall to well over $4 trillion despite taxpayers pumping $378 billion into the void through employee and government “contributions.”

Why do rank-and-file public workers continue to feed this devouring beast? Maybe it’s because they think oblivious taxpayers will endure decades of service cuts and tax increases to pay for it. They should think again.

One question not asked or answered by panels on Collective Bargaining, Public Pensions and Voters: The Policy and Politics of Public-Sector Employees in the 2012 Elections at the American Enterprise Institute last week is:
Why do state and municipal workers cling to those who betray them?
Here’s an answer: The few getting rich off this scam use accounting tricks to lie about how deep the public pension crisis really is.
This crisis goes beyond Republican or Democrat, liberal or conservative. Delusion and denial are so entrenched many propagating the lies actually believe them. Others cynically coordinate a propaganda disinformation campaign in an attempt to hold off the day of reckoning as long as possible. That lets them take as much off the top as they can and flee before their house of lies crashes.
Crash it must, eventually. Census data for the top 100 state and local pension plans through the third quarter show 2011 will be another year of public pension catastrophe.
The latest full fiscal year survey from Census shows another disaster trend: Fewer “active” members paying for more “inactive” members and average benefits increasing more than 13 percent even as money to pay them dwindles.
Despite politicians’ claims of drastic personnel cuts, total membership increased 3.9 percent from 2007 to 2010. But that’s only 1.2 percent more “active” members paying in, with “inactive” rising 12.5 percent.
Fewer paying in more, and more taking out more is a formula for certain disaster. It means young public workers are doomed to lifetimes of harder work, lower pay, higher contributions, later retirements and slashed benefits.
Yet they continue to cling to their oppressors. Take Wisconsin, please.
A Pew Center on the States “Widening Gap” study last year cited Wisconsin as fully funded with full contributions to sustain the pension fund forever.
That pension plan was fully funded if you believed investment gurus would get 55 percent in 2011, the gain needed just to stay even. The investment gurus in fact failed. Now Wisconsin taxpayers have even more to make up.
From July 1, 2007, through June 30, 2010, total holdings actually crashed 12.5 percent, down more than $10 billion instead of up the $43 billion gain politicians promised. Earnings actually were a loss of $1.8 billion, for an average over the period of minus 0.61 percent. Some performance.
But get this: Public workers “contributed” almost $2.9 billion of taxpayer money during those years while the politicians shorted them by putting in only $2.5 billion. That shortage is money taken from pensions to “balance” budgets.
Worse, for every worker dollar invested, fund managers lost $4.27 in value and earnings while “Other Payments” to those who lost it totaled $1.8 billion. Such a deal.
This robbery of workers and taxpayers happened long before Scott Walker won the governor’s hot seat in the 2010 election. Now he faces recall for his fumbling attempts to pull Wisconsin out of a fiscal death spiral even he does not fully comprehend.
Who is leading the recall campaign? The very public workers who got screwed while their guy, Gov. Jim Doyle, held office and Democrats controlled the Legislature.
What a racket. These slaves actually pay their masters and fight to put them back in power.
The trend is ugly and inexorable. Despite any claims of austerity in Wisconsin, “Covered Payroll” over this time increased 14.5 percent, while “Active Membership” went up only 1.7 percent. In fact, “Total Beneficiaries” went up almost six times the increase in those carrying the load.
While the state lost more than $12 billion in value and earnings, it paid out $16.4 billion in benefits and expenses. That means the Wisconsin pension system never can recover from the past four years.
Yet taxpayers keep dumping good money after bad in “contributions” extorted through chump state workers and lying politicians.
And remember, Wisconsin claims to have one of the best fully funded pension plans in the country. That claim is patently false.
It does, however, prove the magnitude of our national municipal and state pension crisis. We are at the point of no return, a fiscal event horizon of perpetual debt.
Government workers should be fighting those who take money out of their pockets and blow it instead of going after the taxpayers who put money into their pockets.
If our state leaders do not act this year to honestly admit hidden debt and begin reducing it, they indenture generations of taxpayers and public workers.
Frank Keegan is editor of Statebudgetsolutions.org, a project of sunshinereview.org. The State Budget Solutions Project is nonpartisan, positive, pro-reform, proactive and anchored in fundamental-systemic solutions. The goal is to successfully engage political journalists/bloggers, state officials and opinion leaders in a new way of thinking about state government and budgets, fundamental reforms, transparency and accountability.

How Much Could California’s Government Pensions Cost Taxpayers?

This week both of California’s largest government employee pension funds, CalPERS and CalSTRS, released their portfolio earnings numbers for the most recent twelve months. In a statement released on January 24th, “CalSTRS Calendar Year-End Investment Returns Show Slight Gains,” CalSTRS disclosed “Investment returns for the California State Teachers’ Retirement System (CalSTRS) ended the 2011 calendar year posting a 2.3 percent gain.” CalPER’s statement released on January 23rd, was titled “[CalPERS} Pension Fund earns 1.1 percent return for 2011 calendar year.”

These funds, and the rest of California’s many local government employee pension funds, are still clinging to long-term rate of return assumptions of between 7.5% and 7.75% per year. So how much would taxpayers be on the hook for if rates of return stay this low?

The first step towards determining this would be to estimate the average pension paid out to a state or local worker in California, based on recent retirees who have worked a full 30 year career. Despite the claim that “The average CalPERS pension is $2,220 per month” (made yet again in the final paragraph of their above-referenced press release), for a more accurate figure, one must look at the average pension awarded recent retirees, based on a full 30+ year career. The problem with the low figure used by CalPERS and others is that it includes people who retired decades ago when salaries and pension benefit formulas were much lower, and it includes people who may have only worked a few years for the government. Since we will be multiplying this average pension by the number of full time state and local government workers in California, we have to assume a full career when calculating the average pension, since for every worker who only worked 10 years, for example, two additional retirees will also be in the system who have themselves also only worked 10 years. To calculate the cost of a full-career pension, you have to add all three of these part-career retirees together. Here is what these pensions really average, based on CalPERS Annual Report FYE 6-30-11 (page 153), and CalSTRS Annual Report FYE 6-30-11, (page 149):

CalPERS average final salary for 30 years work, retiring 2010: $82,884
CalPERS average pension for 30 years work, retiring 2010: $60,894  –
Pension equals 73% of final salary (average of 25-30 year and 30+ year stats)

CalSTRS average final salary for 30 years work, retiring 2010: $88,164
CalSTRS average pension for 30 years work, retiring 2010: $59,580  –
Pension equals 68% of final salary (average of 25-30 year and 30-35 year stats)

If one extrapolates the CalPERS and CalSTRS data to the many independent pension funds serving local agencies – many of these are quite large, such as the one for Los Angeles County employees – it is probably conservative to peg the average pension going forward for full-career government workers in California at at least $60,000 per year, and at least 70% of final salary.

The next step in figuring out how much state and local government worker pensions could cost California’s taxpayers in the future is to establish the sensitivity of pension contribution rates to changes in the rate of return of pension funds. UnionWatch has explored this question repeatedly, with a good summary in the July 2011 post entitled “What Payroll Contribution Will Keep Pensions Solvent?” Using the same financial assumptions as were used in that analysis, here is how the required pension contribution rates – expressed as a percent of payroll – change in response to lower earning rates for the pension funds. This is based on pensions averaging 70% of final salary, and assumes 30 years working, 25 years retired, and salary (in real dollars) eventually doubling between hire date and retirement date:

If the pension fund’s return is 7.75%, the contribution rate is 22% of payroll.
If the pension fund’s return is 6.75%, the contribution rate is 28% of payroll.
If the pension fund’s return is 5.75%, the contribution rate is 37% of payroll.
If the pension fund’s return is 4.75%, the contribution rate is 48% of payroll.
If the pension fund’s return is 3.75%, the contribution rate is 63% of payroll.

What the above figures quickly indicate is not only that the required payroll contributions go up sharply when projected rates of investment return come down, but that the lower the rate of return goes, the more sharply the required contribution rises.

To complete this analysis, one only needs to multiply the number of full time state and local government employees in California by the average payroll for these employees, and multiply that result by the various required contribution rates. Using 2010 U.S. Census data for California’s State Employees and for California’s Local Government Employees, one can quickly determine that there are 339,430 state workers earning on average $68,880 in base annual salary, and there are 1,185,935 local government workers earning on average $69,399 in base annual salary.

To sum this up, there are currently 1,525,365 full time (not “full-time equivalent,” which would be an even higher number, but those part-time employees may or may not have pension benefits) state and local government employees in California. They earn, on average, $69,284 per year in base pay. Here is how much pensions will cost for these workers each year based on various rates of return:

If the pension fund’s return is 7.75%, the state pays $23 billion to pension funds each year.
If the pension fund’s return is 6.75%, the state pays $29 billion to pension funds each year.
If the pension fund’s return is 5.75%, the state pays $39 billion to pension funds each year.
If the pension fund’s return is 4.75%, the state pays $51 billion to pension funds each year.
If the pension fund’s return is 3.75%, the state pays $66 billion to pension funds each year.

It is interesting to note that both CalPERS and CalSTRS failed to even achieve a 3.75% return in calendar year 2011, the lowest amount used in these examples and the lowest amount that can even keep pace with inflation.

When one takes into account the fact that only about five million households in California pay net taxes, the impact of the pension con job Wall Street brokerages have enlisted the support of public sector unions to foist onto taxpayers is even more dramatic. Because if, during the great deleveraging that likely will consume this economy for at least another decade, California’s pension funds only deliver 3.75% per year, instead of 7.75% per year, that will translate into $8,600 per year in new taxes for each and every taxpaying California household.

CalPERS Earned 1.1% on Investments in 2011, Plan Assumptions are 7.75%

Pension plans rebounded sharply in 2009 and 2010 from the devastating losses in 2008. However they never got back to even. 2011 was another poor year, and in spite of the start to 2012 I expect this year and/or next year to suffer more losses, or alternatively the market to limp along with no gains for a number of years.

In other words, pension plans are already in trouble and things are about to get worse. For example, the LA Times reports CalPERS earns 1.1% on investments in 2011

The nation’s largest public pension fund, the California Public Employees’ Retirement System, posted a 1.1% return on its investment portfolio in 2011, Chief Investment Officer Joseph Dear told his board.

The 2011 performance was well below the estimated average annual return of 7.75% that the fund’s actuaries say is needed to meet current and future obligations to its members.

The $229.5-billion CalPERS provides retirement and other benefits for 1.6 million state and local government employees and their families.

CalPERS’ annual investment results, whose volatility has echoed that of the overall markets, have become the focal point in an ongoing debate about looming pension fund liabilities and the ability of future generations of taxpayers to continue financing them. Gov. Jerry Brown has said he wants to overhaul state and local government pension programs, but whether he and the Legislature have the political wherewithal to do so in an election year remains unclear.

During the 2011 calendar year, CalPERS lost 7.95% on its public equity investments, lost 2.29% on its hedge fund investments, earned 12.38% on bonds and earned 9.92% on real estate.

CalPERS had a return of 11.6% for fiscal 2010 and a massive recession-related loss of 23.4% for fiscal 2009.

Note those first set of numbers are for the calendar year, the latter set for the fiscal year. Fiscal year returns post on June 30.

I have been saying for years that it is going to be next to impossible for pension plans to make their plan assumptions. Even 5% annualized for the next decade will be very hard to get in a stocks and bonds portfolio with bond yields so low.

A move to equities risks another 2008-style plunge.

Pension benefits and plan assumptions are simply too high. A taxpayer revolt in California over those promises is inevitable.

About the author: Mike “Mish” Shedlock is a registered investment advisor representative for Sitka Pacific Capital Management. His top-rated global economics blog Mish’s Global Economic Trend Analysis offers insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education. Every Thursday he does a podcast on HoweStreet and on an ad hoc basis he contributes to many other websites, including UnionWatch.

More Pension Truths and Why You Should be Very Angry

How much is that sweet retired teacher who lives down the street draining from your bank account? As the public employee pension mess worsens in California, little Rhode Island shows a way out.

In last week’s post, I focused on “air time,” a little known scheme in California and 20 other states that allows teachers and other public employees to pad their pensions at taxpayers’ expense. Also, not very well known is just how many of Joe and Jill Taxpayer’s tax dollars are going into the pockets of retired teachers.

In California, teachers contribute 8 percent of their pay to their retirement system. Where do the rest of the contributions come from? The current rates include 8.25 percent from the teacher’s employer and 2 percent from the state. But wait a minute. Who is the teacher’s employer? It’s the school district. In Los Angeles, for example, most school district money comes from the state, some from the federal government and the rest is local revenue. Hence, the employer’s contribution is all really the taxpayer’s burden, as the state, city and feds generate no money on their own. So it would be much more honest to say that 10.25 percent comes from the taxpayer.

Let’s look at the taxpayer’s responsibility another way. Sandy, a teacher I know, worked for 24 years in CA and retired at age 61. The amount of money she contributed into the system at retirement (including interest accrued along the way) was about $150,000. Sandy started collecting a pension of about $40,000 year (plus a yearly 2 percent COLA increase) for life. Whatever interest this money accrues over the next few years, Sandy’s contribution will have evaporated in about four years. So, at age 65 she will start living off other people’s money – whatever the “employer” (i.e. taxpayers) kicked in, whatever the “government” (i.e. taxpayers) kicked in and whatever is left, the taxpayers will have to fork over.

Should Sandy live to be 80, 15 years of her pension will be coming from the taxpayer – about $600,000 worth. (Note: there are about 755,000 current and retired teachers in the state as well as another 1.6 million in the California Public Employee Retirement System who can and are taking advantage of this system.)

Can anyone justify this? Hardly. The question then becomes what to do without impoverishing retired teachers and other public employees, while at the same time stopping the rip-off of taxpayers.

First, those who are retired need to show good will and agree to take a cut in their pensions. Additionally, those districts offering virtually free health care for life – many teachers are required to contribute only miniscule co-pays — need to curtail their generosity.

An example of what can be done just took place in Central Falls, Rhode Island. About to go under due to its suffocating union contracts, the city convinced firemen and cops to agree to accept a cutback in their pensions. Accomplished in a Democrat controlled state, maybe there is some hope for the rest of the country. Rhode Island State Treasurer Gina Raimondo recently gave a talk at the Manhattan Institute where she explained that they pulled off such a feat with “political nerve and good judgment.

“The plan enacted in November cuts $3 billion of the state’s $7 billion unfunded liability by raising the retirement age, suspending cost-of-living increases until the pension system is 80% funded, and even moving workers into a hybrid plan that has a smaller guaranteed annuity along with a 401(k)-style defined-contribution plan.

“‘We decided we owe each other a bright future,’ said Ms. Raimondo, who said she and fellow Democrats (as well as Independent Governor Lincoln Chafee) came to the conclusion they could no longer afford the lavish promises made to state workers without destroying economic opportunity for everyone.

“‘More government revenue wasn’t an option because Rhode Island already suffers from the nation’s 5th highest state and local tax burden—a full 10.7% of per capita income, according to the Tax Foundation. Everyone in the pension system had to give something, from new employees to retirees.’ But a key to reform, Ms. Raimondo said, was to avoid blaming these beneficiaries for the mistakes of the past. ‘No finger pointing’ was her mantra, along with a corollary: ‘Math, not politics.’

“The first step was an education campaign to explain why a tiny state could not afford an unfunded liability that was more than $7 billion and headed north. This also helped to blunt union opposition. Once there was a consensus that the problem was real, citizens were ready to consider solutions.

“Ms. Raimondo said those solutions had to be discussed openly. Rhode Island’s reform process was so transparent that even when a draft bill to implement the changes leaked to the press before its formal introduction, it was essentially a nonstory because the reforms had already been discussed publicly.”

Those of us in California need look at what has happened in Rhode Island – recognition of a big problem, honest dialogue about it, transparency, shared sacrifice and a move to privatization – and start the ball rolling in that direction. Teachers and other public employee pensioners need to come forth and be a part of the process. They need to recognize that pension fund managers are clueless Pollyannas and that their unions have conned them by insisting that the current system is sustainable. This cannot happen too soon. If we don’t do something in the near future, the state could conceivably go into default and we could see the current exodus of business owners and taxpayers become a full-fledged stampede if California’s fiscal malaise gets any worse. I wonder how many Californians can fit into sensible little Rhode Island?

About the author: Larry Sand, a former classroom teacher, is the president of the non-profit California Teachers Empowerment Network – a non-partisan, non-political group dedicated to providing teachers with reliable and balanced information about professional affiliations and positions on educational issues.

California Court Backs Government Union’s “Contract on California”

As the public employee pension and health care benefit crisis sweeps across the nation, some states are dealing seriously with these multibillion-dollar threats to public services and treasuries. And other states remain in deep denial. California, to no one’s surprise, is moving stridently in the wrong direction.

The tiny state of Rhode Island, for instance, faced enormous pension liabilities. Its state system was about 40 percent funded and on the brink of collapse. The Legislature and governor last month reformed the pension system by shifting to a hybrid pension plan (rather than a pure defined-benefit plan), suspended cost-of-living raises for retirees and boosted the retirement age. The reforms reduced benefits for current employees.

These sweeping reforms were passed in a union-dominated state, where Democrats control even bigger legislative majorities than in California. Time magazine called Rhode Island “The Little State That Could.”

By contrast, California is “The Big State That Can’t.” Or maybe the right word is “won’t,” given that there is no real reason that California leaders can’t adopt similar reforms if they had the desire to do so. California politicians’ childish refusal to deal seriously with this massive problem has long been evident in the union-controlled Legislature, where even no-brainer proposals to, say, strip government pensions from convicted felons, go nowhere. Gov. Jerry Brown at least pretends to offer pension reform even though he refuses to use any political capital to push it ahead.

And now the judicial branch has gone one better and actually expanded benefit costs for California agencies.

Just as Rhode Island is reducing benefits for current public employees and retirees, the California Supreme Court is inventing new rights for state retirees, which the court found deep within the penumbras of the state constitution. In a unanimous decision last month, the state high court has made it virtually impossible for municipal governments to reduce “nonvested” health care benefits for government retirees.

There are “vested” benefits and “nonvested” ones. Vested benefits are guaranteed by contract. Under California law, they must be paid, no matter what. They cannot be reduced unless the employees and their unions agree to the cut. That has put California in a bind with regard to pensions. Governments can’t afford them. The economic assumptions upon which they were based had more to do with politics than economic reality, but the courts treat these pension contracts as if they were etched in stone and brought down from the mountain by Moses.

Limits in Rhode Island

Law is different in other states, and Rhode Island is an example where legislators believe that they will be able to limit vested benefits and pass court muster, although their unions will almost certainly challenge the latest reform.

But even in California, it has long been accepted that nonvested benefits, which are noncontractual and not guaranteed, can be changed. There’s no long-term promise inherent in such benefits.

Typically, government retiree medical benefits fit into this category.

Virtually no retiree in the private sector gets these deluxe health care freebies because they are so expensive they would eventually destroy any company stupid enough to grant them.

These health care promises may impose an even bigger potential financial problem on governments than their overly generous pension promises. As reporter Ed Mendel of the CalPensions Web site reported, “Unlike pensions, which are usually a fixed cost with some adjustment for inflation, retiree health care can be an open-ended promise to pay for services, whatever the cost. Again, unlike pensions, retiree health care is usually ‘pay as you go.’ Most government employers are not setting aside money to invest, presumably paying for much, if not all, of the retiree health care promised current workers in the future.”

Orange County Reform

Faced with this retiree medical issue, Orange County supervisors came up with a reform in 2007 that reduced the county’s liabilities. It received the support of the Orange County Employees Association, which championed the reform as proof of its willingness to be cooperative in cost-reduction efforts.

Essentially, the retirees and current county workers were placed in the same risk pool for medical benefits. Because retirees are older, the health care costs are higher. So the county was subsidizing them. This was never an obligation, but was something the county as an employer provided as a benefit. After the reform was passed, retirees had to pay an extra $200 or $300 a month, but they still receive a Cadillac health care plan at an extremely modest cost.

The retiree association sued. The case made it to the state Supreme Court, which went beyond the wildest dreams of even the most devoted union official: it found that even nonvested benefits might have the weight of vested benefits. “We conclude that a county may be bound by an implied contract,” the court ruled.

This is the equivalent of finding a right that no one ever saw before. Another court will have to decide whether such an implied contract exists in the Orange County case, but the precedent is set – unions will have a powerful new weapon to stop any possible reduction of benefits anywhere in California.

Orange County Supervisor John Moorlach told me he was shocked to find the court display “such a bias in favor of public employees” and so unwilling to help resolve the state’s “financial conundrum.” The ruling leaves only more drastic options, such as ending retiree medical plans in their entirety, or slashing the size of the government workforce or reducing salaries for public employees. As the money runs out, the options only become more grim.

Wouldn’t it be nice if California’s legislators, governor and courts rolled up their sleeves and behaved like their counterparts in Rhode Island? Then again that would take a level of political maturity not seen in this state for a long time.

About the author: Steven Greenhut is the editor-in-chief of Cal Watchdog, an independent, Sacramento-based journalism venture providing original investigative reports and news stories covering California state government. Greenhut was deputy editor and columnist for The Orange County Register for 11 years. He is author of the new book, “Plunder! How Public Employee Unions are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation.”

Calculating Public Employee Total Compensation

A study released late last year, sponsored by U.C. Berkeley’s “Institute for Research on Labor and Employment” entitled “The Truth about Public Employees in California: They are Neither Overpaid nor Overcompensated,” contains its conclusion in its title, but whether or not this study is presenting the “truth” or not is worthy of further discussion.

According to this study, “the wages received by California public employees are about 7% lower, on average, than wages received by comparable private sector workers; however, public employees do receive more generous benefits. An apples to apples comparison, or one that controls for education, experience, and other factors that may influence pay, reveals no significant difference in the level of employee compensation costs…”

While the study goes on to explain the variables they evaluate in order to arrive at an “apples to apples” comparison, it never actually estimates the actual amount of wage disparity between the average compensation packages for California’s public employees compared to California’s private sector employees, so here goes:

Using California’s Employment Development Department’s 2010 report “Labor Market Trends,” (ref. figure 1) it is evident there are 2.4 million Federal, State and Local employees in California, 12.2 million full-time private sector employees who work for an employer, and another 1.4 million “self-employed” private sector workers. Worker compensation as reported by the Bureau of Labor Statistics don’t include estimates for California’s 1.4 million self-employed workers, nor does the U.C. Berkeley study. If these estimates were included, they would almost certainly skew average private sector compensation downwards, since according to California’s Employment Development Dept., self-employment does not include anyone working for a Corporation or LLC, even their own, meaning that more highly-compensated professionals fall within the BLS statistics for California’s 12.2 million private sector employees, whereas the remaining self-employed include part-time workers, independent contractors; in aggregate, a marginally compensated multitude who have to cover 100% of their benefits  – a 2x payment for social security, and zero paid time off, or free insurance of any kind, or automatic pay for sick time and retirement.

Returning to the 14.6 million people in California who either work for the government or are employed by private sector firms, according to the Bureau of Labor Statistics report “May 2009 State Occupational Employment and Wage Estimates California,” their average annual compensation (not including employer funded benefits) in 2009 was $49,550. In order to extract from that average the compensation for the 2.4 million government workers in California, one may refer to Census Bureau data for 2009 as follows – for 394,000 state workers ref. State Government Employment Data, and for 1,451,619 local government workers ref. Local Government Employment Data. If you combine and average the compensation data for these two groups, you will arrive at an annual average pay – before any employer funded benefits – of $65,000 per year.

Making just one assumption, that California’s 500,000 federal workers not included in these statistics are earning the same average salary as the state and local workers, it is possible to subtract the figures for government workers from the pool of 14.6 million workers, who, according to the BLS earn an average of $49,500 per year, in order to calculate an average private sector (not including self-employed) compensation of $46,528 per year. This means that the Berkeley study has “normalized” for education, experience, and “other factors” to turn a 40% disparity between public and private sector compensation into a 7% disparity.

Before accepting the conclusion of this study, there are several assumptions it makes, both factual and subjective, that should be questioned; starting with this: “The average age of a typical worker in state and local government is 44 compared to 40 in the private sector.” The benefit of coming up with a “fact” like this, of course, is because by combining this fact with the assumption that compensation increases with seniority, the researchers are able to normalize downwards the average compensation of public employees significantly. For example, if one assumes an average career of 30 years, and that a worker’s inflation-adjusted salary will double between when their career begins and when they retire, than one might reasonably conclude a “normalized” compensation average for the public sector worker must be adjusted downwards by 13.3% in order to represent an “apples-to-apples” comparison with the younger private sector workers. Here again, it is serendipitous for the Berkeley study to exclude self-employed individuals, since according to California’s EDD, for workers over forty years of age, fully 50% of the civilian workforce is self-employed (ref. EDD’s California’s Self-Employed Workforce,” figure 6).

Another normalizing factor used by the researchers is gender, wherein they claim 55% of the state and local government workers are women, compared with 40% of the private sector. This is partially skewed, again, by the fact that 60% of self-employed people are men, but even adjusting for that, this fact, if accurate, represents another huge opportunity for the researchers to “normalize” compensation statistics in favor of reducing the disparity between private and public sector pay. Without having access to the work-papers used by the researchers, one can only speculate, but here’s the logic that could have been used: If women make 30% less than what men make for comparable work requiring comparable credentials, and if women represent 55% of the government workforce compared to 40% of the private sector workforce, this means an “apples-to-apples” comparison would require adjusting the public sector compensation upwards by  17% (55% x 30%) vs. an upwards adjustment of only 12% (40% x 30%) for the private sector workforce. Voila, another 5% of pay disparity is vaporized. The problem here is whether or not the “30%” pay differential rests on valid assumptions. When one normalizes for technical degrees vs. non-technical degrees, and the actual supply and demand parameters for jobs that might be deemed “comparable,” as well as for the significant percentage of women who opt out of full-time work in favor of being moms, much of this gender disparity may disappear. Whether or not there remains a gender bias in employee compensation is certainly open to debate, but the researchers should be transparent regarding how significant this factor was in their calculations.

The other major normalizing factor employed by the researchers is education, because the researchers have determined that 35% of the private sector workforce have earned at least a bachelors degree, compared with 55% of the public sector workforce. The researchers also claim the “return to education,” wherein people who have higher educational attainment should earn more, is skewed; that is, they claim private industry rewards education more than the public sector. What the study ignores here, however, is the fact that educational attainment yields qualitative dividends – what degrees are being compared? Is a sociology degree from Sonoma State the equivalent of a computer science degree from Stanford? Is it appropriate to pay more to employees with advanced degrees even if the job they do doesn’t require that level of education? The study doesn’t address this.

In any event, by excluding 1.4 million self-employed and part-time workers, and “normalizing” for seniority, gender and education, the Berkeley study has concluded that an average public sector salary in California is not 40% more than an average private sector salary – and without any normalizing adjustments, 40% higher wages for public sector vs. private sector workers appears to be a conservative estimate – but instead, that public sector wages are 7% less than private sector wages.

When turning to comparing benefits for public employees vs. private sector workers, it is important to understand that salary is the base on which the most significant benefits are calculated. In particular, the largest benefit category in the public sector is retirement pensions, which are calculated based on final salary earned. This means that even if public employee pension benefits were calculated in the same parsimonious manner as social security, they would apply to an average compensation base that is 40% larger for public employees. Moreover, public sector pensions are linear, meaning the benefit increases exactly proportionally to the amount of base salary without limit, whereas social security benefits increase at progressively lower rates, meaning that the more one makes, the lower percentage of their final salary will actually be realized in a social security benefit. These sound like nuances, but have enormous financial consequences.

Before independently estimating the disparity between public employee and private sector employee benefits, here is the Berkeley study’s specific conclusion: “public employers contribute on average 35.7% of employee compensation expenses to benefits, whereas private employers devote 30% of compensation to benefits.

By far the biggest single cost for employee benefits in both the public and private sector is the cost of retirement security. The calculation in the private sector is relatively straightforward – the employer withholds 6.2% for social security and 1.45% for medicare from employee paychecks, and contributes an equivalent amount themselves as a benefit – 7.65%. Some private sector employers will match a 401K contribution up to 6.0%, but the percentage of private sector employers who do this, combined with the number of private sector employees who take full advantage of this, is probably under 25%, which means the average overall retirement benefit paid by private sector employers is probably 10% (or less) of total wages.

For the public sector in California, the cost of retirement security borne by the employer is something else entirely. The typical formula for non-safety employees (about 85% of the public sector workforce) is to multiply the number of years they work by 2.0%, and apply the resulting percentage to their earnings in their final year of active employment. For example, if a non-safety employee works for 30 years, then 60% of their final salary will be the amount of their retirement pension. For safety employees, the typical formula is the same, but based on a 3.0% per year accrual. In the public sector, unlike with social security, the money contributed each year to fund the future retirement benefit is invested by a pension fund, which means the value of this benefit – and the funding required each year to ensure the pension fund remains solvent – must be calculated based on the expected investment returns of the pension fund. This is a matter of great controversy.

In the CPPC’s UnionWatch post “What Payroll Contribution Will Keep Pensions Solvent?,” a best-case and realistic-case set of scenarios are offered:

(1) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 20% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.

(2) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 30% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.

(3) At a real rate of return of 2.75% per year, a worker would need to set aside an additional 36% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.

(4) At a real rate of return of 2.75% per year, a worker would need to set aside an additional 54% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.

For this independent estimate of the value of public sector employee pension benefits, using an assumption that 15% of public employees receive the enhanced “safety” pension, and assuming that the real rate of pension fund returns going forward will be 3.0% per year (still quite optimistic), it is necessary to contribute an amount equivalent to 38% of the average public employee’s pay in order to keep their pension solvent. Since, on average, public employees contribute about 5% of this amount in the form of withholding, an additional 33% has to be contributed by the employer. Many public employees receive supplemental retirement health insurance, for which few of them contribute anything at all in the form of withholding. It is certainly accurate to value this additional benefit as at least twice the amount of medicare, which adds another 3.0% per year.

Adding this all up, using conservative assumptions, the employer contribution to retirement security in the private sector is at most 10% of average salary, whereas in the public sector the employer contribution is at least 36% of average salary.

When assessing the value of current benefits granted public employees, most reviews of public sector benefit schedules suggest the standard package is a comprehensive set of benefits – for example, if one refers to the State of California’s Dept. of Personnel Administration, some of the current benefits include health insurance, dental benefits, a vision program, long-term care insurance, and long-term disability insurance. While these benefits are partially funded through employee withholding, the amounts withheld almost never exceed 50% of the premium, even for dependent coverage. To suggest that current benefits for public employees are, on average, less generous than the average current benefit for private sector employees strains credulity. What about the millions of part-time workers and self-employed people, who have to pay 100% of whatever health insurance they can afford – at premium rates that aren’t discounted and guaranteed by the insurance companies the way they are for the huge state employee bargaining units? What about all the small companies out there, employing at least 50% of full-time private sector workers, who can barely afford to offer basic health insurance, much less dental, vision, long-term care and long-term disability? It would be conservative indeed to simply assume the cost of current health insurance and other current benefits paid for by the employer is the same for both public and private sector workers, at approximately 5.0% of payroll.

The other significant factor to assess when estimating the value of public sector benefits is the amount of paid time off enjoyed by public sector employees vs. private sector employees. On this matter the Berkeley study makes a claim that they simply must substantiate; they state: “public employees receive considerably less supplemental pay and vacation time.

Perhaps to rebut this preposterous claim one must revert to anecdotes, but here at least are some quantitative considerations: there are 723,000 teachers in California who work for the government either in primary and secondary school or in higher education. Every one of these instructors and administrators works about 180 days per year, which when one considers there are 260 weekdays in a year (52 weeks x five days per week), indicates that teachers in California get 16 weeks of paid days off each year. What about college professors who only teach one class per week, yet enjoy total compensation packages worth $138K per year (ref. The Real Reason for College Tuition Increases). If you review compensation studies for safety employees in the city of Costa Mesa (ref. The Price of Public Safety), or firefighters in Sacramento (ref. California Firefighter Compensation), you can see, for example, that before overtime, full-time service for a veteran firefighter in Sacramento requires them to work, on average, two 24 hour shifts per week. Does the Berkeley study normalize for any of this? Compare vacation time in any public entity in California against private sector norms – the average vacation days awarded in the public sector allocate employees after about 10-15 years of service 20 days of vacation per year, and by the end of their careers, up to 30 days of vacation per year (ref. CA Dept. of Personnel Administration, Leave Benefits). This amount of paid vacation is rarely offered to employees in the private sector – with many small companies offering virtually no vacation to their employees, a generous assumption might be 10 days, half as much as public sector vacation benefits. With respect to paid holidays, the typical public sector benefit is at least 12 days, while small private companies often only award six (Christmas, New Year, Memorial Day, July 4th, Labor Day and Thanksgiving), if that. In addition to vacation and holidays, many local governments and various state units also offer paid “personal days,” something nearly unheard of in the private sector. It is also common for sick time to be accrued without limit in the public sector, also something nearly unheard of in the private sector. And self-employed workers, of course, get nothing.

In order to continue to make conservative assumptions, however, one may estimate the average number of paid days off in the private sector to be 20 per year (probably high) and the average number of paid days off in the public sector to be 30 per year (probably low). How does this all add up?

The average public sector worker makes $65,000 per year, with the employer contributing an additional 21,450 for their retirement pension, $1,950 for their retirement health insurance, $3,250 for their current health insurance and other benefits, and they earn vacation worth an additional $10,575 – making their average total compensation $102,225 per year. It is interesting to note that the benefits as a percent of total compensation in this analysis agree with the Berkeley study – 36.4% vs. 35.7%, because the Berkeley study has almost certainly understated the value of the required pension fund contribution, which is another reason why the assumptions made here to estimate the value of all the other public employee non-pension benefits are probably conservative.

The average private sector worker makes $46,500 per year, with the employer contributing an additional $4,650 for their social security, medicare, and 401K, $2,325 for their current health insurance and other benefits, and they earn vacation worth an additional $4,113 – making their average total compensation $57,558 per year. The average private sector worker’s benefits as a percent of total compensation in this analysis is 19%, not 30% as claimed in the Berkeley study. And again, the Berkeley study failed to consider any of California’s 1.4 million self-employed and part-time workers in the pool they evaluated .

It is left to the reader to decide which numbers are more accurate, the numbers put forward here, or the numbers put forward by the Berkeley research team. Similarly, it is left to the reader – and the voter – to decide whether or not the services provided by California’s state and local governments, and the skills required to render them, entitle California’s public servants to earn, on average, $102K per year, compared to average annual earnings of $57K by those of us whose taxes sustain them.

Government Worker Pensions ARE Wall Street

In an editorial posted in January 2011 entitled “Wall Street & Public Sector Unions,” we identified an irony still lost on the occupy movement’s rank and file – Wall Street is financed by the pension funds of unionized government workers. Every year, taxpayer funded government agencies pour hundreds of billions of dollars into Wall Street investment funds.

Occupy Wall Street? Why not “occupy” Wall Street’s union paymasters, the government employee pension funds?

Here’s a summary of the dynamics between Wall Street, unionized government workers, and the taxpayer:

(1) The government workers provide services vital to the taxpayer, and charge the taxpayer, on average, about 40% of their income (middle class worker, all taxes – state, federal, social security, medicare, property, sales) to receive these services.

(2) The government workers receive, in addition to their normal pay, funded by these taxes, pensions that are, on average, five times better than what taxpayers get from social security (the average government pension is $60K per year with an average retirement age of 55, the average social security benefit is $15K per year with an average retirement age of 65).

(3) The government workers tell the taxpayers – don’t worry – you don’t have to pay additional taxes for us to get these generous pensions, because we’ll invest the money on Wall Street, and Wall Street will earn 7.75% per year on these investments.

(4) Wall Street invests the taxpayer’s money, funneled through the government worker pension funds, demanding a return of 7.75%. To achieve this return, they invest in hedge funds and other manipulative, highly speculative investments. This increases the volatility of the markets, crowds out small investors, and drives down returns for small investors.

To fund government worker pensions, what has happened is the government workers have taken the taxpayer’s money, and essentially lent it back to the taxpayers at a rate of 7.75% – at a time when 30 year mortgages are below 4.0%, the 10 year treasury hovers at around 2.0%, and the rate of GDP growth is at or below 3.0%, which is roughly the rate of inflation.

Taxpayers provide the seed money for pension fund investments, these investments are aggressively managed which undermines the individual retirement investments the taxpayers make for themselves, then when the pension funds ultimately fail to meet their 7.75% targets, the taxpayers are assessed to cover the losses. Triple jeopardy.

Every time another public sector union or government pension fund spokesperson claims that taxpayers do not bear the brunt of funding public sector pensions, read between the lines, and this is the rest of the story.

The truth is contagious.

On November 18th a prominent Southern California blogger of indeterminate political leanings (certainly no rock-ribbed conservative), Will Swaim, published an expose of his own entitled “How the revolutionary California labor movement became Wall Street’s biggest gambler.” Here are some excerpts from Swaim’s inimitable prose:

“CalPERS is to Wall Street what a whale is to a Vegas Casino. A high roller. A player. The biggest swinging male appendage in the room. With $235.8 billion in assets, it is the nation’s largest pension fund, and among the biggest investors in the world. And it’s largely on the expected gains in its Wall Street investments that CalPERS has been able to persuade officials in many California cities and counties that they could pay rising pension benefits to their public employees…”

“It wasn’t always this way. For decades after its 1931 founding as a pension program for state workers, CalPERS—then called the State Employees Retirement System (SERS)—made stodgy, sure-thing bond investments. That changed in 1953 when the legislature allowed SERS to invest in real estate. Thirteen years later, there was another loosening of the restraints on the agency’s investments when state voters passed a union-backed proposition allowing CalPERS to invest a quarter of its portfolio in stocks. In 1984, high on the fumes of the Reagan Revolution, labor pushed Prop. 21, allowing CalPERS to invest anything/everything in Wall Street. CalPERS had become a whale…”

“You can begin to see the confluence of forces that would generate a pension problem when you also consider that, with life-expectancy rising and retirement-age falling, California offered public workers more generous pension benefits. In 1932, that benefit was 1.4 percent per year of service; the percentage increased to 1.6 percent under Gov. Warren, and to 2 percent when Gov. Ronald Reagan took over the Governor’s Mansion in Sacramento. It’s between 2 percent and 3 percent today…”

“CalPERS has a reputation as an activist investor. The organization has insisted on quid pro quos: in exchange for investment cash, it has pushed for caps on executive pay and transparency; has led the way for human rights, environmental and labor standards in emerging markets; and participated in class-action lawsuits against major health insurance companies, including UnitedHealth Group…”

“Leveraging that tradition, the city’s workers could reform their union and its bloated pensions. They could start by demanding that CalPERS invest their pensions in solid/stolid/boring U.S. bonds rather than in the speculative junk that fueled Wall Street’s rapid, unprecedented rise through the 1990s and its post-scriptural crash in 2008. That might—might—mean more modest retirements, of course, but it would certainly end union members’ hypocritical reliance on Wall Street—their affection for gambling when Wall Street inflates their pensions, their hatred of the market when it shapes the contours of their daily work…”

Brown’s Pension Reforms Face Union-Controlled Legislature

Despite some encouraging details in Gov. Jerry Brown’s recently announced pension-reform proposal, there’s virtually no chance the state will seriously reform — or even seriously attempt to reform — a system creaking under the weight of up to an estimated $500 billion in unfunded liabilities.

The proposal isn’t bad. It doesn’t go far enough to fix the problem even if implemented in its entirety, but it goes further than most pension reform advocates had expected from a Democratic governor who, to date, has governed as an extension of the public-employee unions that elected him to office.

But the plan probably is dead on arrival in the union-dominated Legislature. One might even argue that Brown is being cynical here — offering reasonably tough reform proposals that he knows will go nowhere. Then he can claim that he has tried to fix the problem but could not surmount the insurmountable.

On the budget, Brown has ended up like Arnold Schwarzenegger — kicking the can down the road. But he did pull out the stops for his tax-hike ideas.

They are bad ideas, but he tried to get them approved. What are the chances he will try equally as hard on pension reforms given that they seem to go against his nature? As a friend of mine says, the ballpark chances are somewhere around zero.

On taxes, Brown needed only to overcome Republican opposition and win over a few legislators, but he failed. On pensions, he needs to shift the thinking of his entire party, including the two top Democratic leaders, who have spent years working in the government employee union movement. As the Sacramento Bee reported, “California’s powerful labor interests objected to major parts of the plan, and the leaders of the Democratic-controlled Legislature — neither of whom attended Brown’s announcement — reacted warily.”

Lavish Packages

You can’t argue with these defenders of the current system. The unions are trying to protect lavish compensation packages for themselves and their members, and their legislative allies are supporting their benefactors. “It is difficult to get a man to understand something when his salary depends on his not understanding it,” Upton Sinclair once wrote. How is Brown going to promote renewed understanding of the pension debt in the light of this reality?

Regarding specifics, Brown would require public employees, current and future, to begin sharing in the cost of their own retirements. Frequently, and especially in the case of public-safety workers, the taxpayer pays the employer’s and the employee’s share of the cost.

Per Brown, “Given the different levels of employee contributions, the move to a contribution level of at least 50 percent will be phased in at a pace that takes into account current contribution levels, current contracts and the collective bargaining process.”

Higher contributions often are offset with salary increases, so it’s imperative –for taxpayers, anyway — that one hand doesn’t give back what the other hand takes away. I doubt unions will give an inch during the collective-bargaining process, where they tend to exert the most power.

Another key component of the Brown plan is a hybrid system that combines a defined-benefit plan public employees currently enjoy (where a set payment is guaranteed) with the 401(k)-style defined-contribution plan combined with Social Security, a combination common in the private sector. Unfortunately, Brown would require a study to come up with the specifics, and the devil always is in the details.

Brown, still working at 73, also would increase retirement ages, which is a great idea.

Currently, public safety officials can retire at age 50, and they often do so, then begin double-dipping — drawing retirement and a new salary as they continue working. Other government employees can retire as early as age 55. As Brown explained, “We have to align retirement ages with actual working years and life expectancy.” For most employees, retirement will be pushed out to age 67, which is in line with the retirement ages for those of us in the private sector.

Reasonable Limits

Furthermore, Brown wants reasonable limits on pension-spiking abuses.

He would require that pensions are based on the final three years’ salary rather than on the absurd California-only policy of basing retirement pay on an employee’s final year. He would strip pensions from felons — something that his colleagues in the Legislature refused to even consider this year — and require that pensions be based on regular pay rather than on pay and the padded benefits often included in the formula. He would stop the scam called “airtime,” in which public employees can buy additional retirement benefits, often for pennies on the dollar. He would start to reform the scandal-plagued California Public Employees Retirement System.

He would also ban the practice of granting pension increases retroactively. Courts have allowed county boards of supervisors and city councils to grant retirement increases back to the first day of an employee’s service, granting them the equivalent of an unearned gift of public funds. But courts will not allow state legislatures to reform pensions by going backward to revise agreements. As always, the rules are rigged to favor the unions.

The Brown plan would at least start to fix that.

These are all good reforms. But most of these items apply only to new hires, which does virtually nothing for the current pension debt because it doesn’t do much about current employees. As the watchdog Little Hoover Commission reported, public employees should receive all the pension benefits they’ve been granted through today and start earning pension benefits at a lower level tomorrow. But the specifics of the plan aren’t as important as the politics of California government.

Will the governor use his political capital on behalf of this proposal? Will Democrats in the Legislature face the pension mess and agree to these reforms? Probably not, and definitely no. That leaves, as always, the initiative process. It’s time for pension reformers to agree on a serious overhaul and start collecting signatures. Only a naïve person would put much faith in Brown’s plan becoming reality.

About the author: Steven Greenhut is the editor-in-chief of Cal Watchdog, an independent, Sacramento-based journalism venture providing original investigative reports and news stories covering California state government. Greenhut was deputy editor and columnist for The Orange County Register for 11 years. He is author of the new book, “Plunder! How Public Employee Unions are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation.”

Public Sector Pensions Investing in Hedge Funds

In less than five years California will have over 10 million residents who are over the age of 55 (ref. U.S. Census, California Demographics). If every one of these people were to receive a pension equivalent to what the average public employee in California can now expect after working full-time for no more than 30 years, it would cost taxpayers nearly $700 billion per year. To put this in perspective, $700 billion is 40% of California’s entire gross domestic product.

When spokespersons for California’s public sector unions claim that pension reformers are “trying to destroy the middle class,” they should be asked this question: How on earth can any system of retirement security – not even including health insurance benefits – possibly expect to consume 40% of the entire economic output of the state or nation in which such benefits are being provided, and yet remain financially sustainable? Universal and equitable retirement security in America will never be realized by offering everyone the deal that public sector employees currently receive. Their benefits must be reduced. But instead, government worker pension funds are making riskier investments.

Public sector pension funds rely on investment returns to make up for the shortfalls in taxpayer revenues. But can investment returns really hope to sustain public sector pensions when there are as many people drawing pensions out of the fund as there are people (and taxpayers) contributing money into the fund? That tipping point, where there is as much money going out as there is going in, has not yet been reached, since most pensioners in the system currently are drawing benefits that were calculated when pensions formulas were far less generous. For example, a teacher who retired in 1985 and is still alive will receive today a pension of barely $30,000 per year. A teacher of the same seniority retiring in 2010 after a 30 year career will receive a pension on average of $70,000 per year. This same sort of disparity applies across all public sector disciplines, and is the reason there is still more money going into public sector pensions than is being paid out. Once these pension funds start selling as many securities as they are buying, even more downward pressure will apply to stock prices than already applies.

As we documented in “What Payroll Contribution Will Keep Pensions Solvent?,” for every 1.0% that the rate of return for a pension fund falls, the required contribution into the pension fund must increase by about 10% of payroll. This means, for example, that if CalPERS lowers their projected rate of return from 7.75% per year down to 6.75%, the contributions their members (or taxpayers) will have to invest in CalPERS every year will rise from (for example) 20% of payroll to 30% of payroll. It is difficult to overstate just how dire the pressure is on public sector pension funds to claim they can continue to earn 7.75% per year.

One way that public sector pension funds are trying to maintain their rate of return is by investing in hedge funds. These virtually unregulated funds utilize manipulative tactics to extract larger than market returns – often at great risk. But to beat the market, someone else has to lose. Public sector pension funds investing in hedge funds are encouraging a phenomenon – market manipulation – that is driving value investors and small private investors out of the market altogether. As reported in the Wall Street Journal on October 18th in an article entitled “Traders Warn of Market Cracks,” the dominance of program trading and other manipulative tactics is taking taking liquidity out of a market that is already in trouble:

“One surprising element of the fall-off in liquidity is that one key set of players actually appears to be more active in recent months: so-called high-frequency traders. These hedge funds use computer models to trade at a rapid pace. In recent years they have replaced brokerage firms as the go-betweens when investors trade stocks. But with so many other players stepping back from the market, the liquidity that high frequency traders are providing isn’t creating much of a cushion, traders say. In fact, some say they may be making matters worse.”

Yet public sector pension funds have to invest in hedge funds. They have to be high-risk players, exploiting the tactics that value investors would never consider and small investors could never afford – and THIS is the reason they claim they can outperform the small investors – because without these high-risk, manipulative, barely-legal, market-killing, short-term acts of desperation, they would already have to admit they cannot possibly earn 7.75% per year. And their actions only postpone that admission.

Here are some examples of how much money is now being poured into hedge funds by public sector pension funds, as documented in Pensions & Investments (online):

“The New Jersey Division of Investment, which manages the state’s $71.6 billion in public pension assets, could put as much as $10.7 billion in hedge funds if it moves to a full 15% allocation. That would make the New Jersey fund the second largest hedge fund investor among P&I’s top 200 pension funds.

Another large pension fund looking to increase its hedge fund limit is the $108 billion Texas Teacher Retirement System, Austin.

Another Lone Star State fund, the $18 billion Texas County & District Retirement System, Austin, in March increased its target allocation to hedge fund as part of a new asset mix, confirmed Paul J. Williams, investment officer.

After two years of study, Connecticut Retirement Plans & Trust Funds, Hartford, finally moved its first $200 million into hedge funds, investing $100 million each in funds of funds with Prisma Capital Partners and Rock Creek Group.

The State of Wisconsin Investment Board, Madison, which oversees $83.3 billion, last year began to search for single and multistrategy hedge fund managers to run a total of $1.4 billion, as part of the rollout of its new hedge fund allocation;

The $154.7 billion Florida State Board of Investment, Tallahassee, early last year invested $250 million each directly in three activist hedge funds, but did not create a dedicated hedge fund allocation with a 6% target until June. Investment staff is at work getting the first 2% or $2.2 billion invested directly in single and multistrategy funds.

Colorado Fire & Police Pension Association, Greenwood Village, took its absolute-return investments down to zero in 2009 from 5%. The fund set a new 11% absolute-target and restructured the allocation to invest about 70% in hedge funds and 30% in commodities.

After nearly six years of study, three of the five pension fund systems within the $113.4 billion New York City Retirement Systems finally made large first-time hedge fund investments last month.”

Distilling all this arcana yields chilling realities. The public sector unions who claim Wall Street is to blame for our economic challenges are actually collection agents for Wall Street, at the same time as they are a corrupting influence on Wall Street. Year after year, they pour hundreds of billions of dollars of taxpayer’s money into some of the seamiest investment vehicles ever invented, bankrupting our cities and states to collect their tithe. At a time when assets are deflating everywhere, when the federal government is issuing 10 year notes at under 3%, the public employee pension funds are claiming they will continue to earn 7.75% on their money. They are essentially lending money at 7.75%, a grossly over-market rate, and forcing the smaller, private investors in the market to cover the difference.

If the market crashes again, and it might, look no further than your local public employee pension fund campus, that beachhead of Wall Street at its worst, to find an avid culprit. Public sector pensions are not sustainable, and the notion that they are is Wall Street’s last, biggest con.