Rolling Stone Magazine: Attacks Wall Street, Gives Public Sector Unions a Pass

When people think of Rolling Stone magazine most only think of music. The reality is that Rolling Stone is very influential in the politics of young people. It is the print version of the Daily Show. One of Rolling Stone’s top political writers is Matt Taibbi. He garnered national attention towards the end of the Bush Administration for railing against the bail out of Wall Street. In particular he deserves our amusement, if not admiration, for famously describing investment bank Goldman Sachs as a “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” Tabbi’s writing is a mix of populism and left leaning ideology.

In Taibbi’s recent piece, “Looting the Pension Funds: All Across America, Wall Street is Grabbing Money Meant for Public Workers,” published in September 2013, he obfuscates with half-truths the public union’s responsibility for the pension problems while excoriating their partner in crime Wall Street. The two have nearly identical goals, and that is to asset strip the private sector. Taibbi writes a credible case against Wall Street and the hedge fund industry, but then chooses to completely neglect their corrupt partner, the public unions. Corruption and fraud in public unions is probably more prolific and costly to society than Wall Street’s. Taibbi makes a lot of good points, but be sure to watch out for the obvious bias.

So let’s put on our critical thinking caps and dissect what Taibbi is saying.

“This is the third act in an improbable triple f—ing of ordinary people that Wall Street is seeking to pull off as a shocker epilogue to the crisis era. Five years ago this fall, an epidemic of fraud and thievery in the financial-services industry triggered the collapse of our economy. The resultant loss of tax revenue plunged states everywhere into spiraling fiscal crises, and local governments suffered huge losses in their retirement portfolios – remember..”

Granted there is plenty of fraud on Wall Street, and it is a travesty of justice that no one on Wall Street has paid for their crimes. But that does not mean that the citizens of this country should also turn a blind eye to the fraud and corruption that public unions have wrought. Tabbi writes:

“In state after state, politicians are following the Rhode Island playbook, using scare tactics and lavishly funded PR campaigns to cast teachers, firefighters and cops – not bankers – as the budget-devouring boogeymen responsible for the mounting fiscal problems of America’s states and cities.”

Two wrongs don’t make a right. Unions and associations representing teachers, and especially fire and police, share much of the blame. Ignorance is not a defense. Without egregious salary escalation and pension increases there would be no crisis. These unions used campaign contributions to bribe politicians into awarding clearly unsustainable pay and benefit packages.

Just because Wall Street creates an epic bubble, it does not mean that municipalities can throw all fiscal restraint to the wind and spend with reckless abandon on the public union members. In fact a hero of many left of center economists, John Maynard Keynes, would have recommend that these municipalities practice restraint during those artificial boom years and save for the inevitable rainy day. Of course they didn’t, and now they are trying to convince the public that the budget they set during the boom years cannot be adjusted down. Tell that to the millions who lost their jobs in the great recession and had to make adjustments to their families budgets. The budgets are only difficult to reduce because of overly generous union contracts that the “well-funded” politicians agreed to.

It even gets so ridiculous that these lavish union agreements can be signed by a simple majority of the city council, and once agreed to become constitutionally guaranteed in many states. It is really easy to give these benefits in the good times, and because they are constitutionally protected, it is nearly impossible to reduce them in the bad times. Private sector unions used think their benefits were rock solid too, but then they met the bankruptcy judge.

Public employees are enjoying superior rights compared to the rest of us. It is too bad the steel workers and airline employees couldn’t get added to the constitution that their pensions could in no way be harmed. Instead they were subject to ERISA, the PBGC and the bankruptcy judge. Many saw their pensions reduced to a quarter of what they had expected.

It should also be noted that private sector unions actually experienced an adversarial negotiation with their companies. In the public sector we only have the illusion of an adversarial negotiation. Not only is the person negotiating probably getting campaign contributions from the union, but they probably have a “me too clause” in their contract, meaning if the union gets more so do they. Why should they care when it isn’t their money? This is corruption.

“ERISA forces employers to provide information about where pension money is being invested, gives employees the right to sue for breaches of fiduciary duty, and imposes a conservative “prudent man” rule on the managers of retiree funds, dictating that they must make sensible investments and seek to minimize loss. But this landmark worker-protection law left open a major loophole: It didn’t cover public pensions. Some states were balking at federal oversight, and lawmakers, naively perhaps, simply never contemplated the possibility of local governments robbing their own workers.”

Taibbi cannot see what is staring him right in the face. The unions and politicians did not want to be a part of ERISA, because it would make it much harder for them to trade in favors. With ERISA public plans would have had to use a much more conservative discount rate. This would have led to higher contributions to the funds and smaller pensions to the union members. Obviously this was not appealing to either.

The lesson from ERISA is that defined benefit plans that rely on optimistic earnings assumptions to justify overly-generous benefits and minimal annual contributions will all eventually fail. ERISA tried to help, but all it did was forestall the failures for a few years. We shouldn’t be surprised that these funds are in bad shape. Most of are run like Ponzi schemes. That may sound hyperbolic, but the mechanics of a Ponzi Scheme and a deeply underfunded public pension plan are the same.

“Then they get elected, and instead of paying for the cops, garbage men, teachers and firefighters they only just 10 minutes ago promised voters, they intercept taxpayer money allocated for those workers and blow it on other stuff.”

In large part, that “other stuff” was payoffs to the unions. Instead of hiring more cops and fire fighters like they promised (In many cases unnecessary as well due to ridiculous union work rules), they just paid the existing ones more money and offer better pensions. Anyone who has driven around in California can tell you that the “intercepted” money is certainly not being used to fix roads.

So the reality is that these “other budget items” are mainly made up of police and fire budgets. Police and fire take up nearly 80% of most municipalities’ budgets in California. So what really happened is, the city promised too much to current and retired employees, and tried to pay for it with accounting gimmicks. The same group of people who are being hurt with underfunded pensions are the ones who created the problem.

“What the study didn’t say was that this supposedly massive gap could all be chalked up to the financial crisis, which, of course, had been caused almost entirely by the greed and wide-scale fraud of the financial-services industry – particularly with regard to state pension funds.”

“Instead, it was then that the legend of pension unsustainability was born, with the help of a pair of unlikely allies.”

The above statement is ludicrous, but neatly summarizes the misconception that Taibbi, along with literally thousands of union and pension fund spokespersons, have been spreading. Public sector defined benefit pension funds can go on for quite some time, but anything that is predicated on a growth rate above the true growth rate of an economy will eventually runaway. It is the math of exponents. This is an immutable reality. It is the reason private sector pension funds all blew up once reform regulations forced them to recognize lower, more sustainable projected rates of return.

Public pension plans admit that they are underfunded, but what they don’t tell you is that the reality is much worse. Some claim they are 75% funded, but to get to 75% they have to use an unrealistic discount rate. There have been numerous studies published using realistic discount rates showing these funds to be extremely underfunded. Also, let’s not forget that the stock market is again at all-time highs. Therefore blaming it on the financial crisis is really a stretch. It is simply too many big political promises coming due.

As for unlikely allies perhaps Mr Taibbi should put a little more critical thought into the link between public unions and Wall Street.

“So even if Pew’s numbers were right, the “unfunded liability” crisis had nothing to do with the systemic unsustainability of public pensions. Thanks to a deadly combination of unscrupulous states illegally borrowing from their pensioners, and unscrupulous banks whose mass sales of fraudulent toxic sub prime products crashed the market, these funds were out some $930 billion. Yet the public was being told that the problem was state workers’ benefits were simply too expensive.”

In California currently there are 12,000 CALPERs retirees receiving $100,000+ pensions. Some 6,000 retired educators receive $100,000+ pensions. Then there are thousands more from places like Los Angeles who do not participate in CALPERs. If you drop the threshold from 100K to 70K, still a nice retirement, the numbers get very large. Nearly all retiring public safety union members are receiving pensions of at least 80K. How expensive is this!

A recent egregious example of these lavish pensions comes from Oceanside, California, a small town in north of San Diego. At the age of 51 with 29 years of service, Chief Frank McCoy retired from his $287,000 a year job and will receive a pension benefit of $172,000 a year. To put this in perspective, making prudent earnings assumptions, a private employee who wishes to retire at this age with this income would need to have saved at least 3.5 million; probably much more in order to also cover medical costs.

“The supposed impending collapse of Social Security, which actually should be running a surplus of trillions of dollars, is now repeated as a simple truth. But Social Security wouldn’t be “collapsing” at all had not three decades of presidents continually burgled the cash in the Social Security trust fund to pay for tax cuts, wars and God knows what else. Same with the alleged insolvencies of state pension programs. The money may not be there, but that’s not because the program is unsustainable: It’s because bankers and politicians stole the money.”

This one is a whopper. While Social Security is currently unsustainable it is also easily fixed. Congress just needs to pass a law to change how it is setup. Tweaking it around the edges will fix it. Small changes in the FICA tax percentage, an increase in the income cap, an increase in the eligibility age, means testing, and a small reduction in benefits and Social Security is fixed.

Under Social Security the maximum amount you get is about $24,000 a year depending on your age at retirement. That works out to be worth approx $289,000. Most people don’t get the maximum and those that do, especially higher wage earners, put in far more than $289,000. Annual Social Security payments in this country total 1.2 Trillion dollars, whereas payments from public pensions are estimated to total 1.5 trillion dollars. The number of people who collect Social Security (not including the many public servants who have qualified for both Social Security AND a public pension) is about four times more than the number of those on public pensions. Public sector pensioners, while only one quarter the number of Social Security recipients, receive more money. What does that say about the relative sustainability of these programs?

Comparing public sector pensions to Social Security is red herring argument.

As for stolen money, politicians have been taking money from private sector taxpayers and handing it over to the public unions for years.

“The Arnold Foundation released a curious study on pensions. On the one hand, it admitted that many states had been under contributing to their pension funds for years. But instead of proposing that states correct the practice, the report concluded that “the way to create a sound, sustainable and fair retirement-savings program is to stop promising a benefit.”

How then, does Mr. Tabbi propose they correct the underfunding problem? The money doesn’t exist. Politicians have been bribed for years to give these unsustainable benefits to public employees. The typical liberal response would be to raise taxes. Well that has been going on for years. The primary reason taxes have gone up, especially at the state and local level, is to pay for more public union benefits. Instead of confronting the financial issues that challenge pensions, Mr. Taibbi uses a typical ideologue defense, creating a “boogeyman.”

The northern California city of Vallejo went into bankruptcy in 2008 because of its union obligations. At the time its bankruptcy pension costs consumed 11% of the city’s budget. The city failing to address these obligations exited bankruptcy in 2011 with pensions consuming 14% of the budget. Today the pensions eat up 18% of the city’s budget and the city will most likely find its way back to the bankruptcy court.

Taibbi goes on to make a lot of good points about hedge funds and their fees. It is hard to disagree with much of what he writes. So the question is, why are we not arguing for imposing strict standards for investing public pension funds? Why doesn’t ERISA apply to public pension funds? Why should public pension funds be allowed to take so much risk when the taxpayers are ultimately the ones who are asked to make up the difference? Taibbi conveniently fails to address any of these issues.

Of course the answer is that the unions and Wall Street are both guilty of pillaging Main Street. One could go as far as saying they are in bed together. If you don’t believe that then take a look some big name Democratic donors. The top donors are always Wall Street and the public unions. The unions need Wall Street. They need Wall Street to take on risky investments as a cover for their extravagant benefits. If changes were made to reduce the risk in public pension’s investment portfolios, then all benefits would need to be slashed due to the massive underfunding.

In finance risk is equal to reward. Simply put the more risk you take the greater your chances of making a high return are, but you also equally increase your chances of a big loss. When the taxpayer is the insurer of public pension funds, it is inappropriate for the money to be invested in risky investments. One can agree with Mr. Taibbi that they should not be investing in hedge funds. Public pension funds are acting like a person with a gambling addiction. They are doubling down in hopes of making big returns so they can avoid the inevitable insolvency for a few more years. In this case, however, the gambler knows that when they screw up the taxpayer will be there to bail them out.

Public employees should be entitled to the assets that are currently in their pension funds, but the taxpayer backstop needs to be lifted. They should be subject to the same economic laws that private union members were when their pension plans became insolvent.

Wall Street and the public unions have created tremendous distortions in our economy. If the issue of public pension unsustainability is not addressed soon, the distortions and damage to our social fabric may be too great. It used to be that people went to work for the government to serve the public. They generally were paid less, but enjoyed job security and a modest pension. In the past several decades the public unions have turned that old axiom on its head. We are quickly turning into a three tiered society of the elites, government workers, and the rest of us. Matt Taibbi is invited to apply his passion and prose to this complexity. Instead, he is entertaining and influencing the youth of America with comforting partisan indignation that has the ironic effect of reinforcing a great injustice.

Bill White is a financial analyst with over a decade of experience. He holds a MBA in Finance and has consulted for various industries. He became interested in municipal finance when he realized what a threat it was to the social fabric of our country and has since dedicated much of his time to informing the citizenry about the powder keg that municipal finance has become. He believes strongly that a democratic republic can only prosper with a informed electorate.