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The Pension Scandals in Sonoma and Marin Counties

Two Case Studies on How Two Counties Purchased Outside Legal Opinions That Delivered Aggressively Self-Serving Interpretations of the Law in Response to Grand Jury Reports That Found That Substantial Pension Benefits had Been Granted Illegally.

Introduction

In California, public pensions are guided by different divisions of the government code. The largest administrator is CalPERS which administers pensions for most cities, some counties and most political districts pursuant to statutes known as The Public Employee’s Retirement Law (PERL).

The County Employee’s Retirement Law (CERL) governs counties, cities and districts that elected to be governed by CERL. These CERL agencies have an administrative agency for their plan that is local and not governed by CalPERS.

This article deals with pension abuses by two separate CERL agencies, the counties of Sonoma and Marin. Each has its own retirement board. In each county, the civil grand jury found serious procedural violations that were preconditions to the adoption of retirement increases:

Grand Jury Report – Marin County

Grand Jury Report – Sonoma County

Each grand jury report documented the grant of pension increases from 2002 through 2008 without providing the board of supervisors (BOS) and citizens mandated actuarial reports estimating the “annual” cost of each enhancement.

Each county obtained outside legal opinions, which committed direct violations of fiduciary duties owed the client (the County) and failed to provide “material matters” to the client as required by the “Rules of Professional Conduct” applicable to California lawyers.

This is the first expository article, specifying the unusual lengths gone to by law firms to aggressively interpret the law to help government agencies, like a county, to protect hundreds of millions of dollars of illegally adopted pension increases.

The Sonoma pension increases were documented by the civil grand jury in 2012. The Marin civil grand Jury report was issued in 2015. On March 9, 2016 a Marin citizen, David Brown, sued the Marin County board of supervisors for its failure to take action to remedy the illegalities found by the grand jury.

On March 23 and March 28 The Marin Independent Journal, the dominant paper in Marin County, printed an article and an editorial, respectively, on the topic.

Pension critic calls for court review of grand jury’s pension probe,” by Nels Johnson, Marin Independent Journal

Marin IJ Editorial: Pension critic doesn’t deserve county’s rebuke,” Editorial, Marin Independent Journal

This analysis specifies how these pension increases almost certainly violated the law, but more importantly, and for the first time, how outside law firms provided questionable legal opinions to protect the illegally granted benefits.

Legal Background

The California Rules for statutory construction clearly show that Government code 7507, herein “7507,” was and is mandatory. Compliance by the Agency legislative body prior to increasing pensions “shall” and “must” occur,  or the increase is void or voidable. Section 7507, as it read from 2000 to 2009 had three distinct mandates.

Mandate one:  The legislature and local legislative bodies (the board of supervisors for counties) shall secure the services of an enrolled actuary to provide a statement of the actuarial impact upon future annual costs before authorizing increases in public retirement plan benefits.

Comments on mandate one:

  • Per Government code section 14 “Shall” is mandatory and “May” is “permissive.” Permissive is another way to say “directory.” “Shall” is used three times in the statute, and without qualification or limitation of any kind.
  • It is the “legislative body” (board of supervisors, city council, district board) that must obtain the actuarial report, not the retirement administrator or board, or even the agency.
  • See also Govt. code 31516: “The board of supervisors shall comply with Govt. code 7507 before… etc.” Govt. Code 31516 was added in 1995 to make certain that CERL retirement administrators required board of supervisors’ compliance before agreeing to accept a new retirement increase.
  • According to Govt. code 14, if the legislature had intended permissive and not mandatory, it would have used “may,” but it clearly did not.

Mandate two: The ‘future annual costs’ shall include, but not be limited to, annual dollar increases or the total dollar increases involved when available.

Comments on mandate two:

  • Govt. code 7507 deals not with “costs,” but increased “annual costs.” If the cost of 2%@50 was $10M a year and it was increased to 3%@50, and the cost of that increase was $5M a year, then the total cost would be $15M a year. The annual cost estimate of the new benefit was $5M.
  • If the new benefit was retroactive for time served, another annual cost for that determination was required.
  • In order to determine the annual costs, the actuary needed the salary and actuarial data for members of each group receiving the increase. For example, if the increase related to both fire and sheriff, salary and actuarial data was required for both groups.
  • The annual cost increases must be stated in “dollar” sums for “any” pension increase.

Mandate three: The future annual costs as determined by the actuary shall be made public at a public meeting at least two weeks prior to the adoption of “any” increases in public retirement plan benefits.

Comments on mandate three:

  • “Any” is clear. Every separate increase for an affected group of members must comply with 7507.
  • The reason for 7507 is to inform the board of supervisors and the public of the budget dollar cost of a new pension benefit; a transparency issue. But also to assure that the constitutional debt limit is not violated by the increase; and, on a common sense level, to see if the new benefit is sustainable.
  • There are statutory requirements for describing agenda items. California Govt. Code Section 11125(b) requires, “The notice of a meeting of a body that is a state body shall include a specific agenda for the meeting, containing a brief description of the items of business to be transacted or discussed in either open or closed session. A brief general description of an item generally need not exceed 20 words.” See also California Govt. Code Section 54954.2(a)(1)(seventy two hour notice). It is insufficient to refer to an agenda or other report to meet the notice requirements. Whether in an open or closed session, a minimum agenda notice regarding pension enhancements would provide as follows: “Item provides annual dollar increase in costs, as determined by an actuary, for retirement increases for X employee categories.

In 2009, the legislature attempted to close loopholes that agency lawyers had devised to evade the “annual cost” revelations required by Govt. code 7507. It amended it to prohibit the use of consent agendas and henceforth required the chief administrative officer of the agency to certify compliance with Govt. code 7507. Like govt. code 41516 of CERL, CalPERS had always required such certification, but not necessarily by the chief administrative officer. The 2009 amendments are persuasive evidence of the mandatory nature of the statute; otherwise, why would the legislature bother to strengthen it?

In both Sonoma and Marin County’s Code of Ordinances there is a code provision mandating that “shall” means mandatory. Like Govt. code 14, the mandated rule of interpretation was not referenced in county obtained legal opinions. That was a travesty. Outside counsel had a duty to reveal that “shall” as used in interpreting the government code was mandatory

The Sonoma County Pension Scandal

In 2012, in response to citizen’s complaints, the Sonoma county grand jury, investigated massive pension increases initiated in 2002 (by 2013, the Stanford Pension Tracker reported that the Sonoma pension deficit has grown to $2.2 billion, including about $500M in pension bonds). At the conclusion of its investigation, the grand jury report concluded: “The CERL requirements for approving the county pension in 2002 do not appear to have been followed.”

Not very dramatic? Right? Well Sonoma County’s response to the grand jury report was spectacular – arguably it was a total confession: “Documents could not be located to demonstrate that the County made the actuarial cost impacts public at a public meeting at least two weeks prior to the adoption of the enhanced retirement benefits.”

But in spite of that admission, the county response, based on a shameless outside legal opinion stated that while the county did not notice and provide the annual cost in dollar terms at a public meeting two weeks prior to approving the retirement enhancements, it had “substantially complied with 7507. In effect, the lawyers said zero compliance equaled substantial compliance.

The outside legal opinion agreed that a 7507 actuarial report had not been made public, and had not even been obtained by the board of supervisors as required by 7507; it referred to two actuarial reports from the files of the Human Resources department (not the board of supervisors as required by 7507) and made the incredible conclusion that those internal records, never shown to the board of supervisors or the public, equaled “substantial compliance” with 7507.

The history of the Sonoma County 2002 pension increases is critically important to prove the concerted power of county staff, unions and board of supervisors to illegally enrich their group by non-adversarial, precise, agreed upon tactics. This is the usual method of so-called collective bargaining in California government.

At the turn of the century there was an open dispute about what determined “pensionable compensation” in CERL agencies like Sonoma County. The California Supreme court cleared up the issue in “The Ventura Decision.” But the Sonoma county lawyers saw a billion dollar opportunity. A “Ventura Decision” law suit was pending in Sonoma County, but of course all of the issues had been decided by the supreme court in the Ventura case.

Eventually, all of the members of the county pension plan (beneficiaries) were made parties to the suit. Plaintiffs and defendants made a detailed written lawsuit settlement that substantially increased pensions, both going forward and retroactively, for every plaintiff and defendant group, including the board of supervisors.

Here is a link to the Ventura Settlement agreement enacted by the Sonoma County Retirement Association’s Board of Directors who do not have the authority under the law to increase pension formulas. That can only be accomplished with a Board of Supervisors resolution adopting the new formulas. Item 8 in the agreement increased benefit formulas for Safety employees and Item 9 increased benefit formulas for General employees.

The board of supervisors did not obtain an actuarial report as required by 7507; therefore it was impossible to notice a public meeting to make the annual cost known to the public prior to adopting the increases, also as mandated by 7507. There is absolutely no case law suggesting even by hint, that 7507 could possibly be “permissive” (directory). As I will show, there was and is substantial case law confirming that 7507 was/is mandatory.

I have been actively observing governmental pension and compensation history since about 2008. The approach used to design the Sonoma county pension scandal is a precise representation of union bargaining in California governmental agencies. Everyone at the table benefited from unanimous compensation increases. In response to the grand jury finding, the successors of the same beneficiary groups that designed the scheme, stuck to the scheme by ignoring the facts and the law, and engaged law firms to provide them legal interpretations that defended their actions, as exemplified in the responses to grand jury findings of substantive compliance with 7507.

Hopefully, this analysis will spark an interest in pension reform in Sonoma county.

The Marin County Pension Scandal

In April 2015, the County of Marin civil grand jury issued a comprehensive report entitled: “Pension Enhancements: A Case of Government Code Violations and A Lack of Transparency.” The report was a precise factual demonstration of 23 violations of the requirements of 7507 by the county.

In particular, the grand jury report focused on the County’s failure to obtain actuarial reports and the failure to notice public meetings to reveal the annual costs of the increases to the public, as required by section 7507. In addition, I note that the facts indicate that not only the public, but the “legislative body” (board of supervisors) was not provided a 7507 estimate of the future costs of  “any” increase as required by 7507 and government code 31516.

The grand jury report indicated that as of its April 2015 publication the most recently available county unfunded pension deficit was $536.8M. The County also had over $100M in pension obligation bonds outstanding.

Citizens for Sustainable Pension Plans (CSPP), a Marin pension reform group, hired attorney Margaret Thum to provide a legal brief outlining the law related to the facts set forth in the grand jury report. The county hired the law firm of Meyers Nave to advise it about its required response to the grand jury report. The Thum opinion was totally honest and accurate, but the board of supervisors refused to read it or to even make it part of the public record. It is debatable, at best, to assert that the Meyers Nave opinion argued for the interests of the county of Marin, its client. An objective reading of the Meyers Nave opinion might instead find that it misrepresented the law and facts and omitted critical statutes and cases.

A review of the Meyers Nave legal opinion makes it clear that it agreed the county had failed to obtain an actuary report setting forth the “annual costs” of  “any” retirement increase discussed in the grand jury report. It admits that no public meeting was noticed or held, where the “dollar amount” of the annual cost for each new benefit was reported to the public, or even to the board of supervisors as required by 7507 and 31516.

But despite these acknowledgements, Meyers Nave argued that the County had “substantially complied” with the statutory requirement. Its contention on the facts was that in 1999 and 2001, the “Mercer” actuarial firm provided the county Human Resources Department (not the board of supervisors or the public as required per 7507) with actuary reports about the proposed increases. I note that the latter of the reports stated that it relied on calendar year 2000 data in making its estimates.

Here is why that is important. In the fiscal year 2001-2002 there was a tech stock market crash. Both PERL and CERL pension plans lost approximately 7% of the value of their assets and failed to earn their 8% assumed rate of return at the time. Generally CERL plans thereby fell short of their target return by 14%. So the use of 2000 data would have substantially understated the cost of any new benefit after 2001-2002. In addition the rate of retirement, salary increases etc. after 2000 would have increased the annual cost of the new benefit. That is why it was necessary to obtain a current actuary report – one that used the most recent data from the past year to provide a report that that produced an accurate “annual cost” dollar amount.

I am not an actuary, but I have reviewed dozens of 7507 actuarial reports. Every one of them provided that after June 30 of a designated year (e.g.2000) the report was no longer valid because the data from the last year was now finalized and available for a current and accurate analysis. That is what actuarial standards required.

Keep in mind that as the grand jury, as did the Sonoma grand jury, found there were no bona fide 7507 actuary reports; only the Mercer reports (which neither the public nor the board of supervisors saw). The board of supervisors did not obtain a valid actuary report setting forth the annual costs in dollar sums for “any” pension increase, and that information was not revealed to the public at a public meeting, so there was NO compliance with 7507. Yet, a law firm conjectured that there was “substantial compliance” when, arguably, there was NO compliance. Did that firm breach its duty to the client, if the client, ultimately, was the citizens of Marin County? It appears that the firm advocated for the staff, unions, and the board of supervisors, the continuing beneficiaries of the illegally adopted pensions, and contrary to the interests of the client.

Follow the Attorneys:

In pension enhancement cases, the process  to comply with 7507 is as follows:

  • The unions ostensibly negotiate with the county for a pension enhancement,
  • they agree on the increased pension and execute a contract (MOU) setting forth the terms,
  • the board of supervisors adopts the MOU,
  • the county informs the Retirement board of the new benefit,
  • the board of supervisors obtains a Govt. code 7507 report determining the annual dollar cost for each new benefit.
  • the county notices a public meeting by an agenda notice that describes that at the meeting the county will reveal the annual dollar cost of each (any, per 7507) pension increase set forth in the MOU’s,
  • that meeting is held at least two weeks prior to adoption of the new benefits,
  • if approved, the county enters into a new or amended agreement with the Retirement Board for the administration of the new pension enhancements.

In the case of “Voters for Responsible Retirement v. board of supervisors, (1994) 8 Cal. 4Th 765, the California supreme court clarified the moment at which the MOU’s that increased pensions were valid contracts. It said: “..section 7507 provides that the local legislative body, before adopting increases in public retirement benefits for its employees, must obtain actuarial evaluations of future annual costs of the plan, and make that cost information public “at a public meeting at least two weeks prior to the adoption of any increases in public retirement plan benefits.”

In the 1994 ruling, the court made it clear that the county, by its board of supervisors could refuse to pursue the new benefit if the 7507 report indicated that the cost was not acceptable to the board of supervisors. Additionally, the court noted that if the board of supervisors refused to adopt the benefit after receiving the 7507 report, the MOU’s were not final because the condition subsequent to validity had not occurred and it was back to the negotiating table to start anew.

The Alleged Violations of Fiduciary Duty in Both Sonoma and Marin Counties

  • The most outrageous fiduciary breach by lawyers for the county in the Sonoma and Marin pension scandals was the evident by-pass of Govt. code 7507. On a risk reward basis it was apparently decided that it was better to risk non-compliance when compared to the knowledge that a 7507 actuary report would reveal. That is, the enhanced plan would reveal a violation of the constitutional debt limit, which would then require a 2/3 vote of the people;
  • The failure of a single county lawyer to advise that in the Voters case the California supreme court had ruled that MOUs between unions and the county granting pension increases were dependent upon board of supervisors compliance with 7507; otherwise there was no binding contract;
  • The assertion that no case law has found that 7507 was mandatory. Clearly the Voters case proves that it was mandatory.
  • In addition to the omission of “Voters” case, note how outside counsel explained Howard Jarvis Taxpayers’ v. Bd. of Supervisors (1996) 41 Cal. App.4th The law provided that a board of supervisors could withhold the power of its retirement board to define retirement eligible compensation that included “flexible payments.” If a board had not denied a Retirement Board the power to set flexible payments as a part of final compensation, then the Retirement Board had that power. That is what it did in this case. This was permitted because 7507 only applies to the legislature and legislative bodies and not retirement boards.
  • The court held that because the consent of the board of supervisors was unnecessary for the retirement board to set flexible payments, there was not a violation of 7507. If board of supervisors’ approval had been required there would have been a violation of 7507 invalidating the increases that resulted. If 7507 was not mandatory, there was no issue for the court to decide. At page 15 of its legal opinion Meyers Nave cites cases unrelated to the Govt. code where the court in those cases discussed whether “shall” as used in the contracts was mandatory. It omitted reference to Govt. Code 14 of the Govt. Code Rules of interpretation that states clearly that “shall” is mandatory.
  • Here is what Meyers Nave told the board of supervisors and citizens about the Howard Jarvis case to imply that it did not support that 7507 was mandatory. It repeated the facts, as I have above, and then said: ”Under the facts of the case, section 7507 was found inapplicable.” What Meyers Nave failed to tell the board of supervisors was that 7507 was inapplicable because it did not involve the board of supervisors, but that if it had, compliance with 7507 was mandatory. Here, let that court explain it: “However, the record demonstrates the change in the retirement system of which plaintiffs complain was not an ‘increase in public retirement plan benefits’ which the board of supervisors may authorize, AND WHICH WOULD SUBJECT IT TO THE REQUIREMENTS OF SECTION 7507 (emphasis mine), but rather a change in LACERA’S method of calculating “compensation earnable”……” What can I say? The omission of the court’s clear statement that 7507 was mandatory for board of supervisors adopted pension increases had the effect of misleading the public as to whether 7507 was mandatory. That gimmick benefited not the client, but the beneficiaries of the illegal pension: the staff, the unions, the board of supervisors. It financially hung the client and citizens out to dry.
  • The legal opinion also does another magical application to the case of California Statewide Law Enforcement v. Department of Personnel Administration 192 Cal. App. 4Th1 (2011). Again, the issue is whether 7507 was mandatory. In the case, CSLEA, a govt. union that had been classified as “miscellaneous” was granted “safety status” with higher pensions by the 1992 legislature. After it became law, the union claimed it was entitled to the new “safety” status retroactively for time served as miscellaneous employees. Arbitration ensued under the “Dills Act” and a judge then ruled that CSLEA was entitled to retroactive safety benefits. DPA appealed. Keep in mind that 7507 applies to the state legislature. It did obtain a 7507 actuary of “annual costs” of the new benefit going forward, but it did not request and did not receive a 7507 report setting forth the “annual costs” of the new benefit for prior service of the employees. Again, let the court say it: “the materials provided to the legislature regarding the bill did not state that the reclassification would be applied retroactively and did not contain a fiscal analysis of the cost of the retroactive application of safety member status for all employees in the unit….” Earlier in regards to what constituted fiscal analysis, the court said: This requirement necessarily includes the obligation to present the Legislature with a fiscal analysis of the cost of the agreement. (See section 7507, sub.(b) (1) “ before authorizing changes in public retirement benefits.” The legislature shall have a “statement of [their] actuarial impact upon future annual costs,…” In its opinion letter, Meyers Nave said: “The case does not address whether section 7507 is mandatory or directory.” In those precise words, no; but it clearly showed that 7507 was the financial information necessary for such action to be valid. The court held that the prospective benefit was legal because of 7507 compliance. Again, the Meyers Nave opinion misrepresented the court’s opinion to support its claim that 7507 was not mandatory.
  • At page 16 of its opinion, Meyers Nave has the nerve to have a whole section entitled: “2. The Legislature Did Not Make The Sections at Issue Mandatory.” It then listed the four Govt. code sections referenced in the grand jury report. This must have been an oversight by Meyers Nave. Govt. code section 14 specifically provides that as used in the government codes: “Shall” is “Mandatory” and “May” is “permissive.” What makes this claim so galling is that Meyers Nave and all of the appellate courts are aware of the Voters case, the Howard Jarvis case, the CSLEA case and Govt. code section 14 and in each and every case assumed without discussion that 7507 was mandatory. There has never been an appellate case where a California attorney had the guts to argue that 7507 was directory. Why? Because such a baseless claim would properly make the firm liable for sanctions. But out of house lawyers hired by cities and counties routinely advise that 7507 is directive and therefore the staff, unions and board of supervisors can continue receiving pensions that were illegally adopted. Then, when a pension reform group like CSPP obtains an honest opinion, the board of supervisors will not even make it part of the record.

The Future for Reform in Sonoma and Marin Counties

I have not spent as much effort discussing the Sonoma Scandal. That is because the staff, unions and board of supervisors in Sonoma have very little opposition to their enjoyment of the Ventura pension gambit. The county has such great pension and other benefit debt, that another serious market downturn will likely force it into a chapter 9 bankruptcy. Then it may renegotiate its debts, reject its defined benefit plans and initiate a plan in bankruptcy that provides reasonable but affordable pensions. But there will be more suffering before that occurs.

In Marin, the situation is quite different. While it does have a pension and other benefit structure that is unsustainable, it has a vibrant pension group, the CSPP and a will to reform. But more importantly it has a gold plated grand jury report that clearly established that massive pensions were granted illegally.

Marin has a local press that has not sold out to the governing agency and is demanding that the grand jury report be given respect. A citizen has filed a civil complaint in Superior court in an attempt to keep the findings of the grand jury from being kicked down the road. He is in pro per and from that point of view is in over his head. But he does have a case. If a couple of local law firms would band together and represent him in the case I believe they would be richly rewarded under the private attorney general theory which provides for attorney fees for any success in the case.

Meanwhile citizens of Marin should hold accountable the present board of supervisors for its part in what I have argued was a bad faith effort to cheat Marin citizens out of the benefits of the grand jury report. They should be replaced by a new board of supervisors which should then terminate the present county administrator and county counsel and replace them with experts who will be contractually bound to truthfulness, transparency and undivided loyalty to the citizens of Marin by carrying out substantial reforms, such as a freeze on salaries until deficits are eliminated.

Conclusion

In my view, there is a serious flaw in the process by which a county hires outside counsel. The law is clear that the client is the county, not the county agent who interacts with the outside law firm. That means that the law firm has an exclusive duty to diligently apply the laws of the state and the county codes when advising the board of supervisors about legal matters. There is a fiduciary duty to do so. The California Rules of Professional Conduct require counsel to advise the client of all facts and law material to the legal matter. Instead, the out-of-house opinions invariably support the staff, unions and board of supervisors, all of whom, in this case, are beneficiaries of the illegally acquired pension enhancements.

Collective bargaining by public employees for salaries and benefits has ruined a once great way of life in California. For those who take up political space by fooling around with pension reform initiatives, it is time to face the substantive issue: A state wide initiative is necessary to remove so-called bargaining for compensation and benefits from the government arena. As the Sonoma, Marin and Pacific Grove examples show, there is no action that is off the table by the lawyers for the government to pursue, protect and enlarge illegally adopted pensions and other benefits. In the meantime the one clear tool of pension reformers is salary control, but it is rarely used.

The idea that some White Knight is going to come along and solve the pension scandal is preposterous, yet that seems to be what everyone is waiting on.

It is so disappointing that government lawyers and law firms that practice in the government area have been willing to aggressively defend what evidence strongly suggests were substantial violations of due process. It will be telling to watch the county staff and board of supervisors unleash their attorneys on Mr. Brown in his meritorious law suit. With hundreds of millions at stake, the ruling group will throw everything at him. Will the citizens come to his aid? The grand jury clearly documented the illegality of the pension increases.

 *   *   *

About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34749) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.

Other work by John Moore:

The Mechanics of Pension Reform – State Actions
– Part 1, December 22, 2015

The Mechanics of Pension Reform – Local Actions
– Part 2, January 11, 2016

During 2015 author John Moore published the “final” chapter of “The Fall of Pacific Grove” in an four part series published between October 20th and November 9th:

The Fall of Pacific Grove – A Primer on Vested Rights
 – The Final Chapter, Part 1, October 20, 2015

The Fall of Pacific Grove – The City’s Tepid Defense of the Vested Rights Lawsuit
– The Final Chapter, Part 2, October 27, 2015

The Fall of Pacific Grove – The Judge’s Ruling
– The Final Chapter, Part 3, November 2, 2015

The Fall of Pacific Grove – The Immediate Future
– The Final Chapter, Part 4, November 9, 2015

During 2014 author John Moore published the first chapter of “The Fall of Pacific Grove” in an eight part series published between January 7th and February 24th. For a more complete understanding of the history, read the entire earlier series:

The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
 – Part 1, January 7, 2014

The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
 – Part 2, January 14, 2014

The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
 – Part 3, January 21, 2014

The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
 – Part 4, January 28, 2014

The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
 – Part 5, February 3, 2014

The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
 – Part 6, February 11, 2014

The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
 – Part 7, February 18, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand

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

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

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

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

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

20150721-UW-pensions1

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

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

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

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

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

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

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

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

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

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

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

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

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

*   *   *

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

CALIFORNIA POLICY CENTER PENSION STUDIES

California City Pension Burdens, February 2015

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

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

Evaluating Public Safety Pensions in California, April 25, 2014

How Much Do CalSTRS Retirees Really Make?, March 2014

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

How Much Do CalPERS Retirees Really Make?, February 2014

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

Are Annual Contributions Into CalSTRS Adequate?, November 2013

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

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

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

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

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

A Pension Analysis Tool for Everyone, April 2012

Has Sacramento really balanced the state’s budget?

Thanks to Proposition 30 with its retroactive tax increase and an improving economy, the state claims that it has balanced its General Fund budget.  This may be technically correct but ignores some very unpleasant realities.

Claiming to have balanced the budget ignores the growing unfunded liabilities associated with public employee pensions and other unfunded retirement benefits, mainly health care.  This also ignores the fact that the state has fallen behind in maintenance and expansion of its infrastructure.

Ignoring these liabilities is possible because state and local governments in California use cash accounting.  Except for very small companies, private sector businesses are required to use accrual accounting under which increases in liabilities are required to be recorded in profit and loss statements and major assets have to be depreciated with depreciation showing up on the profit and loss statement.

Under cash accounting, only the year’s actual cash outlays are recorded in the budget.  If the state or local government doesn’t make a pension payment, it is not recorded as part of the year’s expenses.  For retiree health care, these expenses typically aren’t even funded. Even though these obligations accumulate indefinitely and are the obligation of future taxpayers, they are not required to be recognized on public agency balance sheets as long term liabilities. Similarly, the cost of  deteriorating roads and other infrastructure aren’t recorded anywhere in state and local governments’ financial statements.  There aren’t any depreciation schedules and the accumulating costs of deferred maintenance and essential expansion of the state’s infrastructure are not recorded.

How bad is this problem?  Until recently, it’s been very difficult to find and summarize these financial problems.  However, as highlighted in a recent Los Angeles Times article by Marc Lifsher, California Pension Funds are Running Dry, there is a new data source thanks to the efforts of the California state controller John Chiang (who was just elected state treasurer).  The Controller’s office has assembled data from 130 state and local pension funds and other data at ByTheNumbers.sco.ca.gov.

The following are two charts from the state controller’s website under the heading “Interesting Charts.” They are annotated to illustrate the problems that should concern us.

Total California Public Pension Fund Assets
Change Between 2003 and 2013

20150114_Fletcher_Pensions-1

As can be seen on the above chart, statewide defined benefit pension fund assets suffered a loss of 30 percent in the 2008 recession. Five years later, they have not even recovered to their pre-recession values. During this time pension liabilities have continued to grow.  How big is this problem?

Total California Public Pension Unfunded Liabilities (Officially Recognized Amount)
Change Between 2008 and 2013

20150114_Fletcher_Pensions-2

This second chart, above, shows that during the five year period between 2008 and 2013 the official unfunded liabilities of these defined benefit pension funds has grown 200 percent from $65 billion to $198 billion.  This is almost twice the size of the state’s current year General Fund budget of $107 billion.

Even this total understates the problem.  For example:

(1)  The state’s pension funds assume an investment return of 7.5 percent per year or higher and also assume there will be no recessions such as in 2008.  Single-employer private sector pension funds assume a more conservative rate of return closer to 5.0 percent per year.  California’s unfunded pension liability would increase by another $200 billion or more if a more conservative investment rate of return is used such as 5 percent (ref. “Calculating California’s Total State and Local Government Debt“).

(2)  Retiree health care expenses are largely unfunded but are an obligation for the state’s taxpayers just like pension benefits.  The best estimate we’ve see for unfunded retiree health care is $150 billion, approaching the value of unfunded pension obligations.

(3)  What about infrastructure maintenance and expansion to meet the state’s growth requirements?  The current year’s value of these costs would be reflected as depreciation expenses under accrual accounting that is required for private sector financial statements. In 2012 the American Society of Civil Engineers estimated the current unfunded infrastructure requirement necessary to upgrade California’s roads, bridges, ports, rail, dams, aqueducts and other civil assets at a staggering $650 billion (ref. “2012 Report Card for California’s Infrastructure“).

In addition to these state obligations we can’t ignore unfunded entitlements for federal Medicaid and welfare payments.  These are beyond the scope of this article but add to the problem we’re concerned about, rapidly growing unfunded obligations that will bury future taxpayers and crowd out other essential public spending.

We should also note that state and local government pension systems are not covered by Employee Retirement Income Security Act (ERISA) that single-employer private sector pension plans must conform to.  ERISA has strict requirements for minimum funding of pension plans, defines what is a reasonable rate of investment return in valuing pension fund assets, and dictates actions that must be taken if pension fund assets drop below a certain level.  None of these rules apply to California’s public employee pension funds.  ERISA also requires that pensions be funded during an employee’s working years. The cost of benefits earned today cannot be passed on to future pension fund contributors or taxpayers as can happen with public employee pension plans.

There is also an equity issue.  Should future taxpayers be required to pay for retiree pensions and health care that were earned years earlier?  The earlier taxpayers got the benefit of the public employees services without paying the full cost of these services.  These future costs will crowd out spending on schools, infrastructure, and other items.

Are we anti-public employee for questioning the level of post retirement benefits or their underfunding?  That’s not our intention.  Politicians and unions are not doing these employees any favors by underfunding their retirements.  Future taxpayers will not be able to cover the costs of these underfunded benefits and also maintain the schools, infrastructure, and other government services they need.  There will be a day of reckoning when it’s clear that there isn’t enough money set aside for these obligations and we can’t raise taxes enough to cover the difference.  We’ll be forced to recognize that all our debts and unfunded obligations can’t be met.  There won’t be any winners when this day arrives.  Nationwide, the amounts of unfunded retirement benefits, debts, and entitlements are too large for a federal bailout.

There is also an element of “heads I win tails you lose” to this issue.  The true cost of public employee retirement benefits, pensions and health care, are understated by using optimistic financial assumptions and by passing on a significant portion of these costs to future taxpayers.  However, as it stands today, the bill for any shortfall is totally the taxpayers responsibility.

*   *   *

About the Author:

William Fletcher is a business executive with interests in public finance and national security. He retired as Senior Vice President at Rockwell International where most of his career was spent on international operations and business development for Rockwell Automation. Before joining Rockwell, he worked for Bechtel Corporation, McKinsey and Company, Inc., and Combustion Engineering’s Nuclear Power Division, and was an officer and engineer in the U.S. Navy’s nuclear program. His international experience includes expatriate assignments in Hong Kong, Europe, the Middle East, Africa and Canada. In addition to his interest in California’s finances, he is involved in organizations dealing with national security and international relations. Fletcher is a graduate of Tufts University with a BS degree in Engineering and a BA degree in Government. He also graduated from the U.S. Navy’s Bettis Reactor Engineering School.

Governor Brown – The Bailout King

“What a salesman,” he said, mockingly. “I guess that’s what you learned … selling that stock that went south.”
– California Governor Brown, to challenger Kashkari, during televised debate Sept. 4th, 2014 (ref. SF Gate)

If anyone wants to know what the theme of Governor Brown’s attacks on GOP candidate Neel Kashkari is going to be over the coming weeks preceding the November 4th, election, his remarks in their debate last week would probably provide accurate clues. At least a half-dozen times, Governor Brown smeared Kashkari with accusations of being beholden to his banker friends on Wall Street. You know, those guys who shorted the investments of millions of small investors and turned America into a debtors prison? The sharks at Goldman Sachs? The banker bullies who took taxpayer funded bailouts and then collected billions in personal bonus checks? It will play well.

But Governor Brown is the king of taxpayer bailouts. Because pension funds, the biggest players on Wall Street, are getting bailed out by taxpayers. And over the corrupt courts who deny activists their chance to get pension reforms onto the ballot, or deny voters who have passed pension reforms the chance to enforce them, Gov. Brown presides. Over California’s obscure but powerful Public Employee Relations Board, an entity that consistently overrules common sense details of proposed pension reform and compensation reform, Gov. Brown presides. And before the billions in taxpayer sourced public sector union dues that deluge every policy debate, every press briefing, every lobbyist’s bank account, or politician’s war chest, Brown bows down, beholden, and says – “your wish is my command.”

California’s state and local governments owe an estimated $1.0 trillion dollars (ref. CPC Study), about half of it in the form of unfunded retirement healthcare and pension liabilities for government workers, the other half for bonds and short-term borrowing to finance projects whose costs were inflated by unions, or deficits whose root cause is government union greed. Every dime of that debt benefit a public sector union agenda; every dime of it was facilitated by bankers. Unions and the bankers worked together to con voters into approving the myriad measures that lead to this fiasco, or, even more likely, pressured beholden politicians behind closed doors into enacting them without voter approval.

And Governor Brown presides over this entire, gigantic, exploitative joint venture between government unions and financial firms. Who will bail out California’s state and local governments from a trillion dollars of debt?

Taxpayers.

Who does Brown think will pay for the bailout, when government worker pension funds report too many of their investments were comprised of “that stock that went south?”

Taxpayers.

Who does Brown think benefits from obscenely inflated asset prices that make life unaffordable except to the super rich? Pension funds benefit, of course! Without asset bubbles, the pension funds would collapse overnight, just like subprime mortgage derivatives did back in 2008. The same corruption. And the same victims.

Taxpayers.

What a salesman. What a hypocrite. Governor Brown, the taxpayer bailout king.

20140909a_Brown-350pxJerry Brown – the bailout king of California.

Across California this November, voters will decide on local tax measures promoted as necessary to “keep teachers in classrooms,” and to “protect public safety,” when invariably the amounts being raised are roughly equivalent to the amounts by which pension funds are planning to raise contributions. CalPERS intends to increase their required annual contributions by 50% over the next five years. CalSTRS needs an additional $5.0 billion per year, or more. Jerry Brown is no dummy. He can connect the dots, but he’d better make sure the voters don’t.

The pension bankers and their union allies hide behind rhetoric that is transparent in its falsity, with a press that is either too innumerate, too busy, too biased, or too scared to challenge any of it. CalPERS claims their investments help California’s economy, when 90% of their investments are made out of state, and 16% of their retirees live out of state. Union officials claim their pensions are “modest,” citing “averages” of $25,000 or less, but not revealing how those averages include millions of people who only worked a few years for state or local government and barely vested a pension. The truth: For recent retirees who benefit from the “enhancements” of the past few years, the average non-safety pension plus benefits in California is over $60,000 per year; for safety retirees it is about $100,000 per year.

And Brown leads this chorus of deceit with abandon, claiming last week that thanks to his pension reform (AB 340), “government employees will pay 50% of the normal contribution,” conveniently neglecting to explain the “normal contribution” is deliberately underestimated via using hyper-optimistic rates of return when making the calculation, and ignoring the fact that the unfunded liability (caused by years of insufficient “normal” contributions) requires a much larger “unfunded contribution,” for which public employees, their unions, and the politicians like Brown who are controlled by the pension bankers and the unions, expect taxpayers to bear 100% of the cost.

Bond issuers earn billions on fees to enable California’s state and local governments to accumulate unsustainable debt. Pension funds pay billions each year to financial firms to speculate on global markets in a desperate attempt to prolong the nominal solvency of unsustainable government pensions. And when these bills come due, and when the investment returns fail to meet expectations, taxpayers fund the bailout.

Neel Kashkari may or may not have some explaining to do. But Governor Brown, the bailout king, has no business calling anybody, anywhere, a tool of bankers.

*   *   *

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

Crony Capitalism vs. Public Pensions

A new union-sponsored study lowballs today’s pension costs by around two-thirds and overstates the net costs of corporate welfare.

The Washington Post’s Lydia DePillis recently reported on a new union-sponsored study from Good Jobs First that claims that corporate welfare payments from state governments dwarf the costs of public employee pensions.

To begin, we shouldn’t take this corporate welfare/public pensions link all that seriously. There’s no actual, causal relationship between them. If public sector pensions are excessively generous, they ought to be curbed, regardless of cost pressures. And, in my opinion, we should cut corporate welfare too — crony capitalism is no better than sweetheart deals for public employee unions.

But the Good Jobs First report is also wrong in how it compare costs. The report comes to its startling conclusion by a) understating the costs of public employee pensions; and b) overstating the net costs of corporate welfare.

Let’s start with pension costs. A government’s Actuarially Required Contribution (ARC) has two parts: first, the “normal cost,” which is the contribution the government makes to cover pension benefits accruing to employees in that year; and second, “amortization costs” to pay off unfunded liabilities accruing in prior years.

Both the normal cost and amortization costs are part and parcel of the pension’s costs. When a government promises employees a benefit, it is not just making a contribution today. It is taking on the contingent liability to increase contributions in the future if the plan’s investment returns come up short. But the Good Jobs First study counts only the normal cost of pensions. Amortization costs are excluded. (This wasn’t accidental; you have to know what you’re doing to pull these numbers out of pension reports.)

Let’s illustrate with Arizona, just to pick the first state in the report. In Arizona’s main state employee plan, the ARC including amortization costs is 1.6 times larger than the normal cost alone. So this is a pretty large misstatement.

The natural response from Good Jobs First would be that amortization costs aren’t a part of today’s pension costs, but just reflect unfunded liabilities from the past. Fine. But then in calculating today’s normal cost, you need to account for the risk that the plan’s investments won’t produce their assumed return (8 percent in Arizona’s case) and the state will need to pony up additional funds in the future.

Economists do this by recalculating the normal cost using a lower interest rate to reflect this guarantee made to pension participants. For example, if you assume a 4 percent yield for long-term U.S. treasury bonds, the normal cost of a pension would roughly triple versus using an 8 percent return assumption. That tripling reflects the full cost of the liability the state is taking on and the full value of the benefits promised to employees. This approach is used by the federal Bureau of Economic Analysis in analyzing state/local pension liabilities, and has been effectively endorsed by the Congressional Budget Office, the Federal Reserve, and the vast majority of professional economists. So roughly speaking, Good Jobs First is low-balling today’s pension costs by around two-thirds.

But Good Jobs First also exaggerates the costs of corporate subsidies. The reason that states offer such subsidies is because their benefits outweigh the costs, say, by attracting businesses and jobs to the state. Now, I’m very willing to accept that this isn’t the case, which is why I think we should eliminate most corporate welfare. But the Good Jobs First study assumes that the benefits of these corporate subsidies are zero, which almost certainly isn’t the case. Some jobs and businesses are created by corporate subsidies, even if the benefits aren’t worth the costs.

So yes, if you understate pension costs and overstate corporate subsidies, then pensions cost a lot less than corporate subsidies. I bow to no one in disliking corporate welfare, but the fact that the union-sponsored Good Jobs First had to go to such lengths shows exactly how expensive public employee pension plans have become.

About the Author:  Andrew G. Biggs is a resident scholar at the American Enterprise Institute.

Paradise Lost – California is not too big to fail

One early December morning, Las Vegas police moved in on the Silverton Hotel and Casino, just off the Strip and known for its 117,000-gallon aquarium. There, having located a getaway black Audi with no license plates, they arrested 31-year-old Ka Pasasouk—a Laotian immigrant with a violent history who had eluded deportation as well as imprisonment. The Dragnet-style work came less than 24 hours after police back in Northridge, a Los Angeles suburb known for a state university campus, discovered what they called a “very grisly tableau.”

Outside an overcrowded boarding house, described in press accounts as unlicensed, lay the bodies of two men and two women, whom Pasasouk has now been charged with murdering. The story captured attention up and down the already tense state, where the phrase “grisly tableau” could easily have found wide use in the ubiquitous conversations about California’s economic, political, and social decay. America’s promised land has turned dystopian.

Especially in the movies, Californians do love to imagine how the forces of darkness could bring an Armageddon-like end to their earthly paradise. That is because, as they leave the theater, it has always still been paradise. Lately, however, life outside the cineplex has also turned dark.

The image of idyllic California, as cable watchers from coast to coast know, took another devastating blow in mid-February, when the disgruntled former LAPD officer Christopher Dorner went on his wild, manifesto-driven killing spree. In the frantic, weeklong manhunt, during which police officers managed to shoot innocent civilians who stumbled in their way, a sense of unloosed anarchy descended.

Dorner and Pasasouk. The first a crazed ex-cop who, amid his quadruple murders, managed to tweak a race-troubled LAPD history into a PR campaign that stymied public information officers and even, appallingly, gathered a measure of public admiration. The second a near-perfect symbol of the breakdown of liberal institutions. Both accentuating the sense that everything is falling apart in the storied state.

A civic unease runs through California these days. Premonitions abound of terrible things ahead. Not the space invaders or blade-runners of cinematic imagination, but padlocked -public services, interminable DMV lines, closed classrooms, off-limits recreational areas, public employee strikes, inadequate or nonexistent police, fire, and medical responses.

Just days before the Northridge slaughter, San Bernardino city attorney Jim Penman addressed a crowded city council meeting in the wake of an elderly woman’s murder, telling residents of the bankrupt municipality to “lock their doors and load their guns.” Penman was not alone among California city officials forced to slash law enforcement budgets. Nor did he back down amid the predictable media tut-tutting: “You should say what you mean and mean what you say.”

California voters in November overwhelmingly pulled the lever for a one-party state. Democrats control the governorship, statewide offices, and veto-proof legislative majorities—all beholden to powerful state employee unions. If the recent standoffs with such unions in Wisconsin and Michigan seemed dramatic, just wait for the coming epic in California, a state known for manufacturing drama. No prospective Scott Walker or Rick Snyder, the governors of Wisconsin and Michigan, appears on the political horizon. But that doesn’t mean peace with the unions—the money to buy it doesn’t exist. So there will be a budget war of multiple battles and skirmishes. With Republicans already prostrate, some joke darkly—this, mind you, in the land of Reagan and “sunny optimism”—of adopting a Leninist approach: Let it all collapse .  .  . break the whole egg carton .  .  . build on the ruins .  .  . make lots of morning-after omelets. A dark scenario indeed, but name another more likely for Republicans.

To be sure, and before the joke is taken seriously, Lenin actively instigated disorder and turmoil, the better to erect his totalitarian structure and, yes, his one-party state. The gallows humor of California Republicans is strictly passive; they are resigned to let nature take its course, the better to dismantle failed structures and launch productive, pluralistic systems consistent with freedom. The state’s new political dispensation gives Republicans no alternative other than to be ready with workable proposals after the fall.

The grim conversations begin and end with public safety, but every conceivable policy issue—the economy, education, the environment—has made its way into the crucible, testing whether a state can survive with a prosperous, enlightened populace under the political left’s expensive, freedom-killing programs. Our Burkean libertarianism tells us that California’s current travails will prove it cannot.

Take Ka Pasasouk (please). Now charged with orchestrating four homicides, the Laotian had stuck his thumb in the eye of California’s criminal justice and immigration bureaucracies for more than five years. Charged with felonies ranging from auto theft and assault to illegal drug possession, Pasasouk, against probation department recommendations, last September was moved from jail to a drug diversion program by the Los Angeles District Attorney’s Office. Upon his release from state prison in 2008, authorities sought to deport him but failed to file requisite paperwork, the Southeast Asian thus becoming emblematic of government failure to serve and protect the public.

With California already under a U.S. Supreme Court mandate to relieve inmate overcrowding by multiple thousands, the Pasasouk case pricked the anxieties of a public already alarmed by what violent crimes may await them. At the end of the year the Sacramento Bee reported that gun sales had jumped dramatically—600,000 last year alone, up from 350,000 in 2002. Giving credence to the argument that more guns equal fewer crimes, gun injuries and deaths also plummeted over a corresponding period, the latter by 11 percent, though the Bee, not without an ideologically satisfactory explanation, attributes the improved numbers to “a well-documented, nationwide drop in violent crime.” Sure.

More recently, reports the San Francisco Chronicle, Oakland police last year arrested 44 percent fewer suspects on violent and other charges than in 2008—not because of shrinking crime rates but because of a triage policy adopted in the face of lower budgets. Notoriously, Oakland maintains the state’s highest crime rate. Last year saw “a 23 percent spike in murders, muggings and other major offenses.”

The political left may chortle that gun purchasers are panicking, but the reality is that more municipalities are likely to fall into bankruptcy (Moody’s warns of 30 more, joining Stockton and San Bernardino), severely cutting police, court, and jail budgets. State Treasurer Bill Lockyer, a man of the left, in December commissioned an economist and a research group to create a “default probability model” for city bonds.

Stirred into the state’s social instability are the swelling legions of school-aged youths now taking to the streets. Oakland-based Children Now’s research director Jessica Mindnich reports that, over the past dozen years, the number of young people neither in schoolrooms nor in workplaces has grown by 200,000, or 35 percent, disquieting to those who assumed that future generations, if cradled in good intentions, would surpass the achievements of their elders.

In a recent Google search of “prisoner release,” before we could finish typing the second, perfectly appropriate word, the screen suggested instead “prisoner realignment,” which is the Democrats’ euphemism for their response to the Damoclean order by the Supreme Court from May 2011. The idea was to shift “non-violent, non-serious, non-sex offenders” from the state’s prisons into already over-burdened county jails or alternatives such as home detention.

Some 9,000 prisoners were released under the program, with projections of more than three times that number to be freed. Over the nine months before the Public Safety Realignment Act of 2011 was enacted, according to law enforcement officials, property crimes had dropped 2.4 percent. In the nine months following its passage in early April of that year, property crimes rose 4.5 percent. Naturally, scholars are available to tutor the public on the difference between correlation and causation. The public—not to mention the law enforcement community—is not reassured.

Which brings us to the governor, 74-year-old Jerry Brown. Before defeating Republican Meg Whitman in 2010, Brown put in time as state attorney general and mayor of the aforementioned Oakland, not to mention two antic terms as governor back in the 1970s and ’80s—when many who voted for him this time around were not yet born. They might have heard about him as a colorful, iconoclastic, “Zen” chief executive who slept on the floor and dated a rock star, and who at least was not the dread millionaire Meg Whitman. But they knew little else and took the leap.

Unless they were public employees voting out of gratitude, the new-generation, low-information voters likely didn’t know it was Brown who, in his moonbeam years, allowed state workers to unionize in the first place, a decision that propelled the Golden State into decades of budgetary troubles and brought it to its current precipice. Besides placating unions, he also saddled businesses with a slew of environmental regulations and halted highway construction, the makings of a 30-year plague.

Let it not be said that Brown fails to tease and confound commentators, who need him to be fresh. Even in his first gubernatorial incarnation, as he marched to the left, he could come across as a kind of New Age conservative, pinstriped and looking for all the world like a young Churchill in the glow of a parliamentary speech. On alternate days he would make his “small is beautiful” philosophy seem to apply to state government, which to the sober-minded raised questions about his credibility.

In this January’s “State of the State” speech to the legislature, Brown, strangely complimenting his audience for their fiscal discipline, treated us to more of his philosophical eclecticism. He quoted the biblical story of Joseph, cited the Catholic principle of subsidiarity, and, as the pièce de résistance, offered this from Montaigne: “The most desirable laws are those that are the rarest, simplest, and most general; and I even think that it would be better to have none at all than to have them in such numbers as we have.”

Such messages may quicken the libertarian pulse, but only the most naïve could imagine the governor means to roll back big government rather than spread confusion about his direction. Last November, when voters approved his Proposition 30 to raise both income and sales taxes by $50 billion, he spread confusion to a national audience. CNN’s Candy Crowley, invoking the state’s property tax-limiting Proposition 13 of 1978, asked if he thought the birthplace of the tax revolt could now be “the start of a tax-increase sweep.” Brown answered:

Yeah, I do. I was here in 1978, when [the late Prop. 13 author] Howard Jarvis beat the entire establishment, Republican and Democrat, because the property taxes had just gotten out of control. Now the cutting, the cutting and the deficits are out of control. Our financial health, our credibility .  .  . as a nation that can govern itself, is on the chopping block.

Of course, he didn’t specify any “cutting” or “chopping” that he had in mind. Californians with long enough memories know that he was a ferocious opponent of the Jarvis amendment. Once voters overwhelmingly approved it, the “maverick” young governor miraculously remade himself into the measure’s chief exponent and champion. That sort of fast footwork made him legendary and, on occasion, a presidential contender, if usually too clever by half.

He’s still capable of the occasional magic act. A mere month after last fall’s election he announced—abracadabra!—a balanced budget. A “breakthrough,” he called it, pretending his ingenious abstemiousness had taken a giant step toward restoring California’s economic health. One Facebooking schoolteacher even suggested the governor was more frugal-minded than that notorious Republican budget cutter, Wisconsin representative Paul Ryan. Oddly enough, no disgruntled public employees emerged to produce a television spot of Governor Brown wheeling Grandma over a cliff.

Why not? Well, for one thing, Brown claimed that, while balancing the books, he had managed to find $2.7 billion more for schools and an extra $500 million for the university system while keeping a $1 billion reserve fund. Truly, a miracle worker. Moody’s, on record as expecting municipal meltdowns, was sufficiently impressed to keep the state’s ranking at A1—with the caveat that the presumed surplus would be used to pay down the debt. Standard & Poor’s upgraded its rating by a single notch.

Only one problem. The vanished deficit may be the least credible trick Jerry Brown has pulled in his cynicism-breeding career. Wyatt Buchanan of the San Francisco Chronicle explained the “convenient budget trick that helped make this possible.”

Over the past decade, lawmakers have balanced the state budget in part by borrowing money from special funds, revenue that’s raised by specific fees and taxes. Lawmakers have borrowed from those funds in the very lean times, and promised to pay them back.

Brown did this as well, and although he had planned last year to pay back special funds by $5.2 billion in the 2013-14 year, he now proposes to pay $4.2 billion. Turns out, says H.D. Palmer, spokesman for the California Department of Finance, that those special funds “had higher balances” or fewer needs than had been projected.

Buchanan also found a November projection by the Legislative Analyst’s Office that California would see a deficit in 2013-14 of $1.9 billion, “absent the lower debt payments to special funds.”

There remains, as the governor acknowledged, a “wall of debt” amounting to $28 billion. Brown straight-facedly presented a timeline, beginning this July and lasting into 2017, in which the wall would be knocked down in payment increments from $4.2 billion to $7.3 billion.

But that $28 billion, reported the Los Angeles Times, constitutes only a small, if delectable, appetizer to be served up to the Debt Monster over the next four years. The Times:

Numerous reports by state agencies, think tanks and academics have shown the wall of debt to be many stories higher than $28 billion—hundreds of billions of dollars over the next few decades. Brown’s repayment plan does not significantly reduce the sizable debt to Wall Street or account for promises the state has made to its current and future retirees but is not setting enough money aside to cover.

The amusing idea that Brown could play the moderate, or, in the words of the Orange County Register, put “a stop sign in front of his fellow Democrats in the California Legislature,” could turn grim, as disgruntled teachers and state employees, their guaranteed pensions suddenly in doubt, grab their pitchforks and pivot in the direction of the septuagenarian wonderboy. There’s still time to produce those TV spots of Grandma at the cliff, with Brown pushing.

It will not take much for the state union leadership to ally with the more ideologically committed legislators, of whom there are many, to create dramatic tensions and turmoil in Sacramento. And those of us who want to restore California’s fiscal health, not to mention the California dream, cannot count on a Scott Walker-style standoff. There is no Scott Walker, only Jerry Brown, who, loving to confound, could conceivably stand his ground. But that scenario strikes us as pure Hollywood. Brown does owe his political life to the unions, after all.

The governor’s giddy idea that his successful tax increase could sweep the nation runs up against another, more disturbing, trend: The looming municipal meltdown is not just a California problem but one faced by all the big-spending, high-taxing states, such as Illinois, Connecticut, Maryland, and New York. A day of reckoning is likely “at the national level,” according to University of Chicago economist Brian Barry, “no matter what happens to federal taxes or health care spending.”

We’re talking about as much as $4 trillion in unfunded pension liabilities courtesy of these financially troubled big states, whose governors doubtless hope to pass on their woes to Washington. The ever resourceful conservative idea man Grover Norquist, picking up on Barry’s prediction, suggests congressional Republicans exact from acquiescent Democrats a trade. He would exchange for bailout funds a plan to block-grant Medicaid and other entitlements to the states, thereby eliminating the costly, one-size-fits-all federal requirements that so bedevil state budget-makers. It could help.

As could a plan circulated by renowned supply-side economist Arthur Laffer, who would, among other solutions, have California march back to the Jarvis era, reversing Brown’s tax-hike bandwagon. He would moreover have California—in some rankings the worst state in which to do business—leave the 26-state bloc of forced unionism and join the 24 right-to-work states, many of which enjoy higher productivity, personal income, and population growth than their progressive counterparts. Sacramento as currently constituted won’t allow any of it.

Meanwhile the malaise. The once-Golden State now has the country’s highest poverty rate, more than 23 percent. Also depressing: California, whose population is 12 percent of the nation’s, is home to a third of the country’s welfare recipients. A hardened underclass, as Chapman University urbanologist Joel Kotkin has put into uneasy relief, is emerging as a source of social, economic, and political strife.

Laudably, Kotkin wants to see the unemployed raised up via a blue-collar boom, with housing, infrastructure-building, and energy, where the promise of undeveloped natural gas fields could lead the way. Again: Not bloody likely if Sacramento has any say.

Already, as Kotkin points out, the once-prosperous middle class has shrunk essentially to state retirees and those still living in homes protected by the Proposition 13 property tax limits. Allergic as they have historically been to class analysis and warfare, Republicans must answer by showing how a vigorous, free-enterprise economy can jump-start growth, spread prosperity, and lessen the chasm between the hyper-successful creative class on the coasts and the lumpenproletariat left behind on public assistance.

When multimillionaire golfer (and Republican) Phil Mickelson grumbled about his tax burden and threatened to leave the state, he found little sympathy among the suffering Californians who, their personal finances far more modest, are thinking of joining the growing out-migration of middle-class producers. A rebuilding GOP of necessity will have to direct its message to them and to ethnic groups, from the inner cities to the Central Valley, for whom the California dream of self-advancement still resonates.

The class anxieties were forced into relief when Texas’s Republican governor Rick Perry, in radio spots and personal appearances, put the welcome mat out for struggling businesses. As Perry knows, enclaves of California expats are mushrooming in Dallas and Austin suburbs. With exquisite symbolism, the national financial newspaper Investor’s Business Daily announced its plan to relocate its production facilities to the Lone Star State—not the first business to do so.

Brown’s inelegant response? Perry’s ad was but a “fart.” California’s glorious coastline, majestic mountains, and fair climate, reasoned the governor, would keep businesses slaving under his spell. But Perry, the bumbling cowpoke of last year’s presidential debates, has outfoxed him, perhaps having taken Benjamin Franklin’s counsel to “fart proudly.” Let the coastal breezes do their work.

What then, as Lenin might say, is to be done? We may dream that this rhetorically gifted performer might retire, perhaps to join his predecessor, Arnold Schwarzenegger, in a box-office stinkaroo. He does have plenty of experience with make-believe crime-fighting, always a Hollywood favorite.

Other than that, the political choices are excruciatingly limited. Republicans can marshal the constructive ideas of the Laffers and Kotkins while rebuilding an opposition party, but it will require quiet patience and resolve not to join the multitudes of out-migrants. The California we love always offers the most sensual solaces; Brown is not wrong about its natural glories. We must cherish them. That, and sit back serenely in our cushioned movie-house loges, popcorn at the ready, and watch as the horror show unfolds.

Shawn Steel, a former chairman of the California Republican party and current member of the Republican National Committee, is an attorney in Los Angeles. K. E. Grubbs Jr. is a longtime California journalist, now based in Washington, D.C. This article originally appeared in the Weekly Standard and is republished here with permission from the author.