Posts

CalPERS and Unions Win Again – Taxpayers and Bondholders Lose

In bankruptcy, the federal courts have ruled that cities can reduce pension obligations. They can, but they don’t have to. In Detroit, bondholders were sacrificed to maintain police and fire pensions with minimal haircuts.

On Monday, U.S. Bankruptcy Judge Meredith Jury ruled against bondholders in favor of Calpers in the San Bernardino bankruptcy. She acknowledged that her decision is likely to be seen as unfair to the municipal bond market and might even discourage investors from buying pension obligation bonds in the future.

Please consider Calpers’ Pension Hammer Forces ‘Unfair’ Bond Ruling by Judge.

California’s public retirement fund holds so much power over local officials that pension-bond investors can’t expect equal treatment when a city goes bankrupt, a judge said in a ruling that she acknowledged seems “unfair.”

“What I see as unfair, and might seem unfair to the outside world, does not matter under law,” Jury said, referring in part to the powerful remedies Calpers can seek if the city doesn’t honor its contract.

Monday’s ruling sticks with a pattern seen in the bankruptcies of Stockton, California, and Detroit, said Marilyn Cohen, president of Envision Capital Management in El Segundo, California.

Up to Cities

Federal bankruptcy courts have many times ruled that cities can cut pension obligation, but nothing forces them to.

For example, in the Stockton California bankruptcy, a federal judge ruled that Stockton could have tried to reduce its obligation to Calpers. However, Stockton chose not to do so, arguing that fighting Calpers would take too long and could endanger employee pensions.

Conflict of Interest

I believe Stockton’s rationale is nonsense. Instead, I propose Stockton city officials had a conflict of interest.

City officials wanted to preserve their own pensions.

Chicago Connection

So what does this have to do with Chicago and the state of Illinois in general?

Lots, so let’s tie it all together.

As a result Tuesday’s Illinois Supreme Court Ruling that the 2013 Pension Reform Law Is Unconstitutional Moody’s cut Chicago’s bond rating two notches to junk. Moody’s specifically cited Chicago’s pension crisis.

I discussed this yesterday in Chicago Bond Rating Cut to Junk; City Faces $2.2 Billion in Various Termination Fees; Irresponsible to Tell the Truth.

In light of the San Bernardino ruling today, cities that have huge pension issues will see bond yields soar.

The Chicago Board of education is already paying 285 basis points more than other cities because of pensions. If bondholders keep getting hammered, those yields will rise further.

Pass a Bankruptcy Law, Give Taxpayers a Chance

A Chicago Tribune editorial by Henry J. Feinberg, says Pass a Bankruptcy Law, Give Taxpayers a Chance.

Under federal law, state governments can’t file for bankruptcy. Local governments can do so if their states give them permission. A bill now before the Illinois legislature would extend that permission to Illinois municipalities, most of which now can’t seek protection under bankruptcy law.

The right way is to amend House Bill 298 so people who hold Illinois bonds have a “secured first lien,” the fancy words needed in the law to make sure bondholders are first in line to get their money back. Passing this amended bill would do three things that the state’s local governments have not been able to accomplish for decades.

Three Reasons to Amend Bill 298

Feinberg cites three reasons to amend the pending bankruptcy bill.

  • First, it would bring opposing sides to the table to have meaningful discussions about how to save the borrower, in this case the local government, from financial ruin.
  • Second, the government could ask the bankruptcy court to modify labor contracts and order the parties to renegotiate the terms of collective bargaining agreements.
  • Finally, a law that puts bondholders first in line to get repaid would be a stroke of fairness that would help Illinois cities, school districts and other local governments avert a short-term solution like Detroit’s. There, some people who had lent money to the city by buying its bonds lost two-thirds of their investment. Meanwhile, members of the politically powerful police and firefighter unions took no cuts to their pensions (their cost-of-living adjustment was reduced). Other workers took a 4.5 percent base cut in pensions and the elimination of an annual cost-of-living increase, The Detroit News reported.

I agree with Feinberg on all three points. Bankruptcy is the only real solution for many of these plans and many cities as well.

Beware the Tax Man

Tax hikes cannot possibly address the shortfall. As discussed on May 4, in Beware, the Tax Man Has Eyes on You, the potential hike for Illinoisans is staggering.

Nuveen estimated 50% property tax hikes would be necessary. Those hikes were just for Chicago. They did not include money to bail out other Illinois pension plans. Nor did it address the $9 billion budget deficit for the state.

Finally, Nuveen’s estimate assumed pension plans would make their plan assumption of 7% returns or higher.

Stock Market Bubble Will Hit Pensions

I believe another serious decline in the stock market is likely. So do some of the biggest fund managers in the world.

Please check out Seven Year Negative Returns in Stocks and Bonds; Fraudulent Promises.

Pension promises were not made in good faith.

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

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

The Fragility of "Can't Fail" Thinking

CalPERS, the large California public pension plan, has filed an amicus brief in the case of Detroit’s bankruptcy.

Calpers does not like the Detroit pension plans being treated like unsecured creditors in a bankruptcy proceeding, and cites the constitutional (state constitutional, that is) protections for pensions. Thing is, there’s law, and there’s reality.

But let’s see what Calpers had to say on this matter:

“U.S. Bankruptcy Judge Steven Rhodes ruled last year that Detroit was entitled to creditor protection under Chapter 9 of the U.S. Bankruptcy Code and could try to alter the terms of workers’ pensions. The decision, which would let a bankrupt municipality fail to meet its pension obligations in spite of state prohibitions, was ‘wrong on several levels,’ Calpers said.

‘Congress did not envision that Chapter 9 would become a haven for municipalities that seek to ignore and break state laws and constitutional provisions in order to adjust their debts,’ the pension fund said.

Calpers, which has been involved in disputes with the bankrupt city of San Bernardino, California, said the judge’s decision raises issues of critical importance to its 1.7 million members. If a municipality in bankruptcy is allowed to break state laws and ignore its obligations to the pension system, it ‘may threaten the actuarial soundness of the system as a whole,’ Calpers said.”

I do not agree.

What actually threatens the actuarial soundness of public pension plans is behavior like the following:

  • Not making full contributions.
  • Investing in insane assets so that you can try to reach target yield. Or even sane assets that have high volatility to try to get high return, forgetting that there are some low volatility liabilities that need to be met.
  • Boosting benefits when the fund is flush, and always ratcheting benefits upward.

Calpers should be extremely familiar with that sort of behavior.

Here is the problem: all sorts of entities directly involved in public pensions have thought that the pensions can’t fail. Because of stuff like: constitutional protections of benefits (so paying pensions would take precedent over other spending needs, like paying for current services), “government doesn’t go out of business”, the supposedly infinite taxation power of the government, and so forth.

Because they thought that pensions could not fail in reality, that gave them incentives to do all sorts of things that actually made the pensions more likely to fail. Because, after all, the taxpayer could always be soaked to make up any losses from insane behavior.

Public employee unions have been pretty quiet over the years as states and municipalities have undercontributed to pensions. Using the state of Illinois as an example, take a look at this graph:

Changes to unfunded pension liability for Illinois from 1996 to 2013

20140512-Campbell

That’s the components of the changes to unfunded pension liability for Illinois from 1996 to 2013. Far and away, the biggest reason for the extremely low funded ratio in Illinois is that Illinois made far less than the full contributions needed to keep the plan at full funding. Note that the second highest component comes from not meeting investment targets (8% return for that period, iirc). [Editor’s note: It would be interesting to see this graph for California public sector pensions, taking into account the impact of  benefit increases]

If the employee unions in Illinois knew that it was possible that they might actually only get 40% of what was promised, they might not have been so blasé about the undercontributions. They might have asked for more realistic investment targets.

The explicit ability to renege on pensions (known by all parties) would make them less likely to fail, because employee unions would then have some incentive to make sure pension contributions are made, and they would be less likely to ask for benefits that may make their pension plan insolvent. If they knew that no, the taxpayer wouldn’t be there to bail them out of stupid investment decisions, they might not be so happy with all the opaque investments.

Detroit’s bankruptcy is making it clear that pensions are not safe, and that they can go down with the ship. They really aren’t much different than any other creditor. It may not be fair that they get whacked, but then, it’s not the bondholder’s fault either (though, really, bondholders are more faultless than those directly involved in boosting pay and benefits…and bondholders always knew they could be defaulted on.)

Calpers does not like this veil being lifted.

It was one thing when it was a puny place like Prichard, Alabama, where the pensions actually failed (and the bankruptcy itself was ultimately rejected, but the pension was gone anyway. Reality always trumps law.) Central Falls, RI, was also troubling but similarly puny. In both these cases, the pension plans were in horrid shape, and the direct cause of bankruptcies.

Detroit is much larger, and the pension plans supposedly were in good funded status. Calpers is in a similar position. And Detroit is very big. Calpers is even bigger.

Calpers may very well win the legal argument. In the short-run.

But they’re not going to win the argument with reality. It always wins.

If they only knew that ahead of time.

About the Author:  Mary Pat Campbell is an actuary who takes an interest in Mozart, public pensions, math, education, and math education, amongst other things. She publishes on her blog STUMP, where this post – used with permission – originally appeared in April 2014. Campbell is a resident of Illinois.

Pension Battle Shifts to San Jose, San Bernardino, Stockton

Now that a federal judge in Michigan has properly ruled pension obligations are not sacrosanct (see Lesson for Union Dinosaurs) the spotlight is once again on union dinosaurs in California.

Bankrupt San Bernardino foolishly did not attempt to shed pension obligations in bankruptcy, but perhaps it can now reconsider.

What about Stockton and Vallejo?

On April 1, 2013 Judge Rules Stockton CA Bankruptcy is Valid, City Acted in Good Faith. Hopefully Stockton will follow inevitable pension cuts in Detroit.

Second Chance for Vallejo

Vallejo had a golden opportunity to shed pension obligations in its first bankruptcy. When the city failed to do so, I made an easy prediction: Within years, Vallejo would be back in bankruptcy court.

That prediction appears well-founded. On October 20, 2013 I penned Vallejo, Mired in Pension Debt Again; Lesson for Stockton and Detroit – Shed Those Pension Obligations Now!

My comment from above: “Stockton and Detroit have a choice. They can cut pensions now, or cut them later in a second bankruptcy, just like Vallejo will.

Will Stockton get it right? Hopefully, but some things will depend on Detroit. We have not yet seen the final ruling, but steep haircuts on pension promises and unsecured general bonds should be forthcoming.

Battle in San Jose

The battle in San Jose, population 983,000 and California’s third-largest city, is of a similar nature.

San Jose spends 33% of its general fund revenue on pensions, the highest among the 25 most populous U.S. cities.

Mayor Chuck Reed wants to make changes to the pension plan. Specifically, Reed, a 65-year-old Democrat, is leading a statewide voter initiative to allow changes in future benefits for existing employees.

Union Dinosaurs Part II

Of course union dinosaurs are fighting the initiative, which means unions would rather see San Jose go bankrupt than negotiate.

Bloomberg reports San Jose Pension Crush Spurs Bid to Ease California Pacts.

San Jose, a city of 983,000 that is California’s third-largest, has been forced to make deep cuts in basic services as its retirement costs soared to $245 million in 2012 from $73 million in 2002. The city’s pension and retiree health-care liability is almost $3 billion, according to Reed, who was first elected in 2006.

San Jose voters last year approved retirement changes requiring new employees to pay 50 percent of the plan’s total cost, or about twice as much as current employees. Workers already on the city’s payroll could keep their existing plans by increasing their contributions or keep their costs steady by choosing a plan with more modest benefits.

Unions including the San Jose Police Officers’ Association and the San Jose Retired Employees Association sued to block the change. The case is pending.

Reed’s ballot initiative would amend the California constitution to give local governments the power to negotiate changes to existing employees’ future pension or retiree health care, while protecting benefits they’ve already earned.

“What they’re trying to do is overturn decades of case law, Supreme Court decisions and change the California constitution to allow public employers to either change, cut or eliminate public employees’ pensions in the middle of their career,” said Dave Low, executive director of the California School Employees Association and chairman of Californians for Retirement Security, a coalition of public employees and retirees.

“It’s a vested right,” Low said.

“In talking with other mayors around the state, everybody would benefit from having clear authority to be able to negotiate changes for future benefits for work yet to be performed for current employees,” Reed said of his ballot measure.

Mayors Pat Morris of bankrupt San Bernardino, Tom Tait of Anaheim and Bill Kampe of Pacific Grove are backing the plan. Santa Ana Mayor Miguel Pulido dropped out as a formal supporter and was replaced by Vallejo Vice Mayor Stephanie Gomes. Opponents include Oakland Mayor Jean Quan and San Francisco Board of Supervisors President David Chiu.

Also assailing the plan are the California Public Employees’ Retirement System, the largest U.S. public pension, and the California State Teachers’ Retirement System, the second-biggest U.S. public pension contending with a $70 billion unfunded liability.

The proposal “threatens the retirement security of existing and future educators, who have provided many years of service to California’s students,” Jack Ehnes, the teacher pension’s chief executive officer, said in a statement.

Reed said cities can continue to cut services and raise taxes, make employees pay more, cut benefit payments to retirees or cut benefits for current employees.

“None of those is fair, so it is better to talk about changing expectations of future accruals for future work,” Reed said.

CalPERS, Oakland Mayor Against Reed’s Plan

It’s not yet official, but Oakland is as bankrupt as bankrupt can be. Why its mayor would not want to back Reed’s initiative has three possibilities: reelection motives, sheer stupidity, or to preserve her own ill-gotten pension.

Rights of Dinosaurs vs. “Right Thing” 

Dave Low, executive director of the California School Employees Association and chairman of Californians for Retirement Security, a coalition of public employees and retirees, whines “It’s a vested right“.

Low can whine all he wants, but bankruptcy is a “right” as well. And rights in bankruptcy overrule alleged rights of unions.

Speaking of which, those alleged rights were primarily obtained via a process of coercion, threats, bribery, and back-room deals with crooked politicians willing to give unions what unions want so the politicians can get elected.

What’s “right” about that?

From a taxpayer perspective, the “right thing” to do is end collective bargaining of all public unions, after-which public unions, like dinosaurs, will become rightfully extinct.

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

California’s Public Employment Relations Board Thwarts Pension Reform

When it comes to state government, most people think of the governor and the members of the Legislature, those who are elected by the voters and do their business under the Capitol dome.

However, there is an entire class of faceless, unelected appointees to the state’s hundreds of boards and commission who determine whether or not state residents receive good services and a decent return for billions of dollars of taxpayer money.

These boards and commissions are generally tasked with oversight of various aspects of state management. However, some of these obscure agencies have proven to be nothing more than fronts for special interests.

One of the most egregious of these is the powerful Public Employment Relations Board (PERB) which is comprised of officials who behave as if they were a separate branch of California government. The members of PERB are currently taking aggressive action that could have a major negative impact on taxpayers in San Diego, San Jose, and potentially other communities.

PERB describes itself as quasi-judicial administrative agency charged with administering the collective bargaining statutes covering employees of California’s public schools, colleges, and universities, employees of the State of California, employees of California local public agencies (cities, counties and special districts), trial court employees and supervisory employees of the Los Angeles County Metropolitan Transportation Authority.

PERB is now using its tremendous clout in an effort to overturn landmark pension reform initiatives overwhelmingly approved by voters in the cities of San Diego (67%) and San Jose (70%). Board lawyers have filed complaints against the two cities claiming that public officials failed to bargain in good faith on pension issues with unions representing city employees, prior to the passage of the initiatives.

Voters in San Diego and San Jose acted proactively to avoid the fate of Vallejo, Stockton and San Bernardino, cities that have gone financially toes up because past city council members, elected with the support of government employee unions, agreed to lavish pension benefits that were unsustainable. With the future of their own cities on the line, citizens used the initiative process to approve reforms that would put pensions on an actuarially sound footing.

While the reforms approved by each community are slightly different, neither takes anything away from what employees have already earned. For public employees, having to contribute a little more to their own pensions, or to work several extra years for pension eligibility, is not a bad trade off if it means both cities will avoid bankruptcy and will be in a position to meet their future obligations to these workers.

However, Jerry Brown, who talks a good game of pension reform, is nonetheless beholden to the government employee unions for his repeat trip to the Governor’s office. Therefore, it should come as no surprise that he has used his discretion to stack the PERB with union hacks.

So now the dirty work to overturn pension reform at the local level is being done by PERB, and the governor will raise his hands, palms outward, and say, “Who me?”

With the huge public support for reasonable reform, isn’t it time for the governor and PERB to get out of the way and allow these pension changes that are fair to both employees and taxpayers to proceed?

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

The Bankruptcy Tsunami

First Vallejo, then Stockton, then Mammoth Lakes and now San Bernardino.  As Orange County Supervisor John Moorlach told Bloomberg News, the bankruptcy dominoes are starting to fall. One California city after another — following a decade-long spree of ramping up public-employee pay and pension benefits, as well as redevelopment debt — are becoming insolvent.

Not that the state’s legislators have anything constructive to offer. California’s Democratic leaders are not only unwilling to rein in the costs of benefits for their patrons, the public-sector unions, but they have been erecting roadblocks to those localities that want to fix the problem on their own. Yet all the political blockades in the world cannot fix the basic problem of insolvency.

Stockton negotiated the new process created by a state law requiring a 60-day period of negotiations before filing for Chapter 9 bankruptcy. That period is over and the city – a hard-pressed port on the edge of the California Delta – has become the largest city in the country to pursue municipal bankruptcy. The cause was a pension system eating up 30 percent of the budget, an absurdly generous retiree medical program that provided lifetime benefits after working for the city for a short period, and excess bond debt for pension obligations and redevelopment projects.

Soon after, Mammoth Lakes decided to pursue bankruptcy. That city’s problem came after it lost a judgment in a development case. Although not tied to public-employee compensation, the situation was caused by city officials who prefer to play developer than tend to the nuts-and-bolts of city government – a long-term problem in that eastern Sierra vacation town. In 1996, Mammoth Lakes lost a court case after it declared its downtown area blighted because of excess urbanization, in a ruling the judge said exemplified the misuse of redevelopment power.

The latest city to declare bankruptcy is San Bernardino, which has declared an emergency situation that will allow it to evade the negotiation period mandated by state law. The city simply doesn’t have the cash to keep operating. As Bloomberg reported, “San Bernardino and its agencies have more than $220 million of debt, including $48.6 million of taxable pension-obligation bonds, according to financial statements.” Pension-obligation bonds are used by cities to pay ongoing pension expenses, yet San Bernardino’s problems show that a city cannot borrow its way out of debt.

Other big cities, including Los Angeles, are talking more openly about the bankruptcy option. Not long ago critics who mentioned the B-word were considered Chicken Littles.

The latest talking point is that these cities couldn’t control what happened to them – that they were victims of the foreclosure crisis that rocked the inland areas where housing construction boomed during the housing bubble.

Foreclosures

The Riverside Press-Enterprise reported: “The city of San Bernardino’s financial woes are a directly correlation to a torrent of foreclosures in the Inland area of Southern California, the national foreclosure tracking firm RealtyTrac said Thursday. ‘Property taxes plunged in San Bernardino because of an avalanche of foreclosure activity during the recent housing bust,’ said RealtyTrac vice president Daren Blomquist.”

There’s no doubt San Bernardino and Stockton — Ground Zero for the housing crisis — suffered from the problem described above. But what did those cities do with the rapid increase in property tax revenues during the price run-up? We know – they squandered it on increased compensation for government employees, on redevelopment projects and other questionable spending deals. They squandered the money when it came flowing in, now depict themselves as victims of circumstance when the funds dried up.

The real culprit, as I argue here in City Journal, is foolish decision making. Stockton, for instance, refused to take advantage of an exemption in prevailing wage laws – something that could have saved it money but would have angered the powerful unions.

The housing bubble hit the hardest in cities inland from the growth-controlled major metropolitan areas. When the prices went up in Los Angeles and San Francisco, developers moved inland, where it was easier to get the permits necessary to respond to the demands of the marketplace.

Coastal cities

But even coastal cities are struggling. Los Angeles is not a victim of the foreclosure crisis. Pension costs in San Jose — where the housing market has rebounded thanks to a healthy tech-based economy — rose 350 percent in 10 years and now consume 20 percent of the general-fund budget. That city passed pension reform on the November ballot to stop the fiscal bleeding.

Here Joe Mathews debunks San Bernardino’s allegations that the state is to blame for its fiscal problems: “Local elected officials who complain about a lack of state money have things backwards. The state of California is relatively spare in its spending, compared to national averages. California’s local officials are, by contrast, big spenders, at or near the national lead in compensation for local workers, especially law enforcement.”

There’s no doubt the problem is fiscally profligate local governments, who busted the bank on public-safety pay and benefit packages and now are looking to cast blame anywhere they can.

Bankruptcy is not a great option but at least it gives cities a chance to get their house in order and start fresh. Unfortunately, Vallejo and Stockton refused to tackled existing pension debt in their bankruptcy plans. Orange County emerged from bankruptcy in the 1990s in better shape than ever, but as Chris Reed explained for CalWatchdog, subsequent boards of supervisors then began spending like crazy on public-sector compensation.

Bankruptcy cannot stop future officials from wasting the taxpayer dollar. But when there’s no money, there’s nothing left to do. In Scranton, Pa., a judge issued an injunction to stop the mayor’s plan to begin paying all city employees minimum wage. But there’s no money left to pay any more than that, he said. The city will gladly pay more as soon as it has the cash to pay it.

Only when the money runs out will cities find the necessary solutions. That’s perhaps the saddest commentary on the situation in California cities these days.

Steve Greenhut is vice president of Journalism for the Franklin Center for Government and Public Integrity.