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Union schemes, scams and some pushback

The #WeSue movement

Los Angeles Police Union Attacks CPPC Study

On May 17th the Los Angeles Police Protective Leagues “Board of Directors” authored a post on their LAPPL blog entitled “Inventing the headline number,” attacking the research and the motives of California Public Policy Center. Here’s how the post began:

“The playbook is familiar now—gin up a study on public pensions and government debt to be released to media outlets with a headline-grabbing number shrieking doom for public finances. The latest exhibit is a propaganda piece tossed out to the media by the anti-public employees group California Public Policy Center (CPPC) purposely inflates pension debt.”

Despite claiming the CPPC study was mere propaganda, the LAPPL failed to convincingly refute any of its findings, including the estimate that California’s state and local government debt totals between $648 billion and $1.1 trillion, depending primarily on what assumptions one uses to discount future pension obligations. The “discount rate” used to estimate a present value for future retirement payments – already earned – is equivalent to the interest rate the fund managers believe they will be able to earn each year on the assets that must be already set and invested. To the extent the market value of the invested assets at any point falls short of the estimated present value of the projected future retirement payments at that same point in time, a plan is underfunded. So the lower you set a discount rate, the lower you believe your rate of interest will be on your investments, i.e., the lower the discount rate, the greater the present value of the liability.

It is fair to hotly debate what this amount should be. A lot is at stake. For example, if the estimated interest rate on pension funds goes down by 1.0 percent, the amount of total state and local government pension underfunding goes up by at least $100 billion. Put another way, for every 1.0% the estimated interest rate on pension funds goes down, the required annual contribution by cities and counties to their pension funds goes up by at least 10% of pension eligible payroll.

As shown in the CPPC study “Calculating California’s Total State and Local Government Debt,” here’s what happens to California’s total pension liability based on various interest rate earnings assumptions for the pension funds:

At 7.5% = $128 billion (official number as of June 30, 2011 – most recent financial data available)

At 5.5% = $329 billion

At 4.5% = $450 billion

There are compelling reasons why 5.5%, or even 4.5%, are probably more realistic numbers than 7.5%, which is skewed upwards by the stock market bubble of the 1990’s combined with the real estate bubble of the 2000’s. And throughout this period, since around 1980, a debt bubble has been growing worldwide – government, commercial and consumer – that is reaching its practical limit. When debt, overall, is being paid down instead of growing, it is harder to sustain the same rates of economic growth. On top of all that, the global population is aging, meaning a larger percentage of people are selling their assets to finance their retirements, pushing down returns. For these reasons, it is unlikely that public employee pension funds can earn 7.5% per year.

This is the issue. Even reducing the earnings rate projection to 6.5% would be catastrophic to the solvency of California’s pension funds. But instead of confronting this issue in good faith, in their recent post the LAPPL made a grossly misleading statement in reference to Moody’s original intention to evaluate the credit of cities and counties based on a discount rate of 5.5%. According to the LAPPL:

“Their justification [the CPPC’s use of the a 5.5% rate for their what-if analysis]: a July 2012 Moody’s statement that considered using 5.5 percent to calculate pension debt. Of course, they simply ignored Moody’s statement of April 17, 2013, that they wouldn’t be using a fixed 5.5 percent rate.”

What the LAPPL doesn’t acknowledge here is that in Moody’s statement, they did indeed say they would not simply use a 5.5% rate. Apparently the LAPPL expects their readers to assume this means Moody’s will use a higher rate than 5.5%. But if you actually read an explanation of Moody’s final adopted method, it says this:

Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data – Excerpt:

“Actuarial accrued liability (AAL) will be discounted using a high-grade, long-term taxable bond index rate. For adjustments to pension data, Moody’s will use the Citibank Pension Liability Index (Index) posted on the date of the valuation instead of its original proposal to apply a single rate for all plans each year.”

Here are those rates, courtesy of the Society of Actuaries:  Pension Discount Curve and Liability Index. And if you take a look at these rates, you will see that they are currently lower than 5.5%. Which is consistent with our position that macroeconomic headwinds make it unlikely that 7.5% can be achieved, and that even hitting 5.5% is going to be very tough.

Did the LAPPL do their homework before making this claim? Was it an honest oversight, or a deliberate misrepresentation to their members of financial reality? In either case, LAPPL isn’t just misrepresenting financial reality, they also completely misrepresent the CPPC:

“Driven by hatred of public employees and public employee unions, and a belief that public employees and unions are the main cause of the “downfall” of California (and perhaps, the nation and mankind as we know it), this group endeavors to influence the media through ‘research” and “studies.'”

Really?

“Hatred of public employees”? Not a chance. “Belief that public employees and unions are the main cause of the “downfall” of California”? Not a chance. Here’s a revision however that might be somewhat accurate:

“Belief that public employee unions are the main cause of the ‘downfall’ of California.”

That would be closer to the mark. A serious bipartisan debate over just how Californians can wrest control of their state, cities and counties from the grip of public employee unions is long overdue.

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UnionWatch is edited by Ed Ring, who can be reached at editor@unionwatch.org

California’s State/Local Governments Confront $1.0 Trillion in Debt

A study released earlier today by the California Public Policy Center entitled “Calculating California’s Total State and Local Government Debt” has estimated that state and local government debt is somewhere between $848 billion and $1.12 trillion. This is the first attempt we’ve ever seen by anyone to provide an estimate.

Small wonder. If Californians understood that their local city councils, school districts, redevelopment agencies, special districts, county supervisors, and state legislators had managed to put them on the hook for over $80,000 of debt per household, they might vote down the next new taxation or bond measure that appears on the ballot. Imagine how much debt this equates to per taxpaying household.

Quoting from the study’s summary, here are the categories of government debt confronting Californians:

When, along with the $27.8 billion “Wall of Debt,” long-term debt incurred by California’s state, county, and city governments, along with school districts, redevelopment agencies and special districts are totaled, the outstanding balance is $383.0 billion. The officially recognized unfunded liability for California’s public employee retirement benefits – pensions and retirement health care – adds another $265.1 billion. Applying a potentially more realistic 5.5% discount rate to calculate the unfunded pension liability adds an additional $200.3 billion. All of these outstanding debts combined total $848.4 billion. By extrapolating from available data that is either outdated or incomplete, and using a 4.5% discount rate to calculate the unfunded pension liability, the estimated total debt soars to over $1.1 trillion.

According to a Wall Street Journal editorial from April 29th, 2013 entitled “Debt and Growth,” former White House economist Larry Summers is suggesting that “the U.S. should borrow even more money today because interest rates are low.” Summers is not alone. But hasn’t America heard this song already, and quite recently? What happened to all those homeowners who borrowed money because the payments were low, then suddenly realized they owed more money than they could ever hope to pay back?

There is cruel hypocrisy at work here. Low interest rates mean people saving for retirement cannot hope to amass a nest egg big enough to earn a risk-free return sufficient to live on. Yet the government worker pension funds engage in massive risk in a desperate attempt to earn 7.5% per year, so government workers can enjoy pensions that a private sector worker would have to save millions to match. If they fail to get that 7.5%, taxpayers make up the difference.

Hypocrisy abounds. Unions representing public educators train their members to teach their students that capitalism is the problem, that “corporate greed” is why their parents struggle to make ends meet. Yet without corporate profits, the pension funds – whose 7.5% per year annual earnings guarantee them an early retirement with an income that dwarfs what private workers get from social security – would implode.

As shown in the CPPC study, for every 1.0% the projected rates of return for the pension funds drop, the debt confronting Californians increases by $100 billion. The “official” estimate for this shortfall, acknowledged by the state controller, is $128 billion. If you drop that projected rate to 5.5%, add another $200 billion to the unfunded liability. Do you think that’s still too high? If those pension funds only earn 4.5%, add another $126 billion to the unfunded liability for pensions.

And why shouldn’t pension funds only earn 4.5% in today’s debt saturated, aging society, where 30 year treasury bills are offering a paltry 2.8%, and a 30 year fixed rate mortgage is down to 3.25%? With all this nearly free money around – courtesy of our government who spends far to much to borrow at any decent rate of interest – where on earth will CalPERS and the other pension funds invest their money with the expectation of getting 7.5% per year?

It’s important to emphasize that the CPPC study employed transparent logic, documenting all their assumptions. Just using the official numbers, California’s state and local governments still owe $648 billion, and of that amount, $265 billion or 41%, represents the officially recognized unfunded liability for government retiree health care and pensions.  Another $8.0 billion on top of that is for pension obligation bonds – and most of the data available is nearly two years old. By now, how many more of those have been issued by our financially crippled cities and counties? And how much more of the rest of this borrowing – that other $373 billion in bonds for myriad projects administered by countless government agencies – went to cover personnel costs, or pay “prevailing wages.”

California State/Local Government Debt – The Low Estimate:

As noted in the CPPC study, there is a case to be made for “good debt.” This is government investment in infrastructure such as roads, bridges, water treatment plants, aqueducts, ports, or to fund research into medicine, energy, agriculture, and other scientific endeavors. Government borrowing for infrastructure and scientific research  provides a return to taxpayers in the form of new amenities – ideally amenities that will lower the cost of living and improve the quality of life.

But you don’t have to be a raging libertarian purist to criticize the borrowing that has stuck California’s taxpayers on the hook for a cool trillion dollars. Because well more than half of the money owed has nothing to do with infrastructure, or research, or anything else that might pay dividends to society at large. Most of the money owed by California’s state and local government agencies is to pay unionized government workers rates of compensation that most private sector workers can only dream about. If you accept the CPPC study’s higher estimate, $1.12 trillion, $663 trillion is explicitly for public employee benefits, and countless additional billions in bond proceeds undoubtedly went to pay personnel costs. As noted in last week’s editorial, “What If Every Worker Made What City of Irvine Workers Make?” if every worker and retiree in California enjoyed the total compensation packages enjoyed by a typical worker employed by the City of Irvine, it would be necessary to double California’s gross domestic product in order for enough money to exist to pay them. In other words, it’s impossible. But if you can’t afford something, borrow.

California State/Local Government Debt – The High Estimate:

The primary reason California’s state and local governments are inundated with debt is because there are two classes of workers in California – government workers and workers representing government contractors and public utilities, and the rest of us. These unionized government workers can support an oppressive regulatory scheme, stifling development of land and energy, because they can afford to pay the artificially elevated prices, and higher taxes, that result from these policies.

There is a way out. As explored in our editorials “Bi-Partisan Solutions for California,” and “The Prosperity Agenda,” there is abundant land in California, and abundant energy resources. California should have the most affordable housing and the cheapest electricity in the U.S., instead of the most expensive. Public policies designed to encourage land development and energy development would decisively lower the cost to live in California, which would make public employee compensation reform a palatable option, even to those affected by it.

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UnionWatch is edited by Ed Ring, who can be reached at editor@unionwatch.org

GASB Loopholes Created Illusions of Solvency

What if most of the public employee compensation enhancements of the past decade or more in California were based on inaccurately optimistic government financial statements? Or to be blunt, what if government decision makers thought they could afford these compensation enhancements, because the information they relied on used accounting gimmicks that would land a person in private industry in jail for fraud?

Back in February the California Public Policy Center (CPPC) published a study entitled “How Lower Earnings Will Impact California’s Unfunded Pension Liability,” where, using various rates of annual investment earnings, the number ranged between $128 billion and $576 billion. This study and others highlighted the fact that starting in 2014, not only will Moody’s Investors Services begin using a much lower investment projection in their credit analysis, but GASB – the Government Accounting Standards Board – will require government entities to recognize this liability on their balance sheets.

Earlier this week, the CPPC published a new study entitled “Unmasking Staggering Pension Debt and Hidden Expense,” that took a look at seven California counties, Alameda, Contra Costa, Marin, Mendocino, Orange, San Mateo, and Sonoma, and restated their balance sheets based on the new GASB financial reporting standards and the new Moody’s credit evaluation criteria. In his analysis of these seven California counties, researcher John Dickerson calculated that the new GASB rules will lower their combined net worth by a factor of ten, from a current reported $10.2 billion to less than $1.0 billion. And all of these losses, in any private enterprise, would have already been recognized.

Starting in 2014, GASB (Government Accounting Standards Board) will require state and local governments to report their unfunded pension obligation as a liability on their balance sheets, eliminating a loophole in their current regulations. It’s about time. The loopholes being plugged by GASB 68 have permitted California’s cities and counties to declare balanced budgets when in fact they were failing to report billions in pension expense.

The study not only calculates the impact of GASB 68, but goes on to estimate the impact of GASB’s new ruling combined with Moody’s new credit evaluation criteria on government financial statements. As Dickerson writes: “These seven counties all together would drop from $10.2 billion of Net Assets down to a negative $8.3 billion hole – $19 billion less. On average, they would have more unfunded pension debt than assets.”

One may argue heatedly as to whether or not Moody’s 5.5% discount rate is too low, but for the moment, let’s forget about the discount rate. Let’s go ahead and accept the long-term earnings projection of 7.5% per year as realistic. This still means that the seven counties analyzed had failed to report over $10.2 billion in liabilities. This still means that across all of California, the state and local governments had failed to report over $128 billion in liabilities. Because $128 billion is the State Controller’s officially acknowledged amount of unfunded pension liabilities.

When financial analysts warn us that the steps GASB and Moody’s are taking will make it harder for cities and counties to acquire credit by erasing most (or all) of their net worth, and will hasten awareness of the need for compensation reform, they’re right. But that’s only half the story: For the last decade or more, as cities and counties were negotiating enhancements to public employee pension plans, and other compensation enhancements – sometimes in council meetings packed with indignant public workers, other times in binding arbitration – they were basing their decisions on financial statements that were inaccurate. Would pension formulas have been enhanced from 2.5% at 55 to 3.0% at 50, for example, if everyone at the negotiating table had been examining city or county financial statements that were correctly recording these billions in losses?

No business can survive for long with bad financial information. Any auditor whose picked apart a few balance sheets, or any general ledger accountant whose closed a few fiscal years, understands how easy it is to commit fraud. If bankers and investors are wary of a company’s financial performance and need to see more profit, an unscrupulous entrepreneur might revalue their inventory to “market value,” and voila, a loss turns into a profit. What GASB 68 is going to prevent might only excite an accountant, but since its consequences affect us all, it’s still a story worth trying to tell.

When many of California’s cities and counties fell behind in their payments to the pension funds, they didn’t record a payable on their balance sheet – because GASB didn’t have a standard in place to force them to. Then when the time came to make the payment, they needed to borrow the money, but they didn’t want to ask voters to approve a pension obligation bond. So they essentially sued themselves, securing a court ruling that documented the fact that they owed the money. This allowed them to characterize the pension obligation bond’s issuance as a refinancing of existing debt, avoiding the need to submit the bond to voters for approval. Then (accounting wonks, pay attention here), when they put the pension obligation bond debt onto their balance sheet as a liability, because they had not recorded a preexisting payable to the pension fund, instead they put the debit onto the top of the balance sheet as an offsetting asset, which they are slowly amortizing. GASB 68 will wipe all of this out, creating billions in extraordinary losses that will mostly be declared in prior period adjustments of past financial statements.

This sort of behavior violates fundamental accounting concepts, most particularly, matching expenses to the time they are incurred. But during the 1990’s and since, it allowed cities and counties to avoid placing billions in losses on their income statements. And that allowed public employee unions, politicians, and arbitrators, to all make decisions based on flawed, overly optimistic financial information. And it enabled what is now a legacy of contracted compensation enhancements that are considered by their supporters to be beyond even the power of a bankruptcy court to amend.

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UnionWatch.org is edited by Ed Ring, who can be reached at editor@unionwatch.org