April 27, 2010

A modest proposal for solving the California pension problem

The facts are stark, as relayed by the Los Angeles Times:

The state of California's real unfunded pension debt clocks in at more than $500 billion, nearly eight times greater than officially reported.

That's the finding from a study released Monday by Stanford University's public policy program, confirming a recent report with similar, stunning findings from Northwestern University and the University of Chicago.

To put that number in perspective, it's almost seven times greater than all the outstanding voter-approved state general obligation bonds in California.

Why should Californians care? Because this year's unfunded pension liability is next year's budget cut to important programs. For a glimpse of California's budgetary future, look no further than the $5.5 billion diverted this year from higher education, transit, parks and other programs in order to pay just a tiny bit toward current unfunded pension and healthcare promises. That figure is set to triple within 10 years and -- absent reform -- to continue to grow, crowding out funding for many programs vital to the overwhelming majority of Californians.

How did we get here? The answer is simple: For decades -- and without voter consent -- state leaders have been issuing billions of dollars of debt in the form of unfunded pension and healthcare promises, then gaming accounting rules in order to understate the size of those promises.

This report was immediately attacked by CalPERS and other California employee pension managers on a number of substantial grounds. First, the report originated at Stanford. The gravamen of this criticism is, to wit, those people at Stanford think they're so smart. Alas, they are pretty smart, which is why the second argument is perhaps more substantial: it's just damn embarrassing to be talking about such a thing in public.

One might say that California has a problem with "shadow inventory," along lines similar to the housing bubble. In my own county, the local rag reported that, effectively, the payroll for current employees must be multiplied by 1.5 to get a sense of the true obligation, and this means that the county is way, way underwater. The unfunded medical expense obligations for retirees is so astronomical that the county pension managers convinced the actuaries not to include the figure ($348 million) in official calculations of the shortfall, lest we frighten the children and small animals. All of this is occurring at a time when real property taxes are in decline, a principal source of state and local funding, because of the magic of Proposition 13, which permits homeowners to keep apace of their declining house values by petitioning for a decrease in taxes. And, of course, California has the highest official unemployment rate in the country, another drag on revenue. Ah, it's a hardy witches' brew we've got on the cauldron here in the Golden State!

Some recovery in the pension funds has been achieved over the last year courtesy of the gamed stock markets, whereby the Federal Reserve lends money to Primary Dealers at ZIRP for them to place bets in the market and buy the spread of Treasuries (earning, say, 3% by lending the Fed's money back to the Treasury), in a defiance of Perpetual Motion Machine Theory. This delusionary market has escaped serious scrutiny so far because it's just complicated enough to defy Senatorial scrutiny. Plus, who wants to play the part of Alice at the Mad Tea Party? (Speaking of which, I did not think it was possible to make Goldman Sachs look good on national TV, but the Senate panel managed to do so. I'm now thinking along the lines, thank God we have smart investment bankers because we sure have stupid legislators. In essence, the Senatorial inquisition, led by the orotund Carl Levin, appears to argue only that Goldman should never short any security in a proprietary trade where it sells a long position to a "customer." This is the only point the Senators can wrap their heads around, because they read it in Matt Taiibi. This is just stupid, and a misunderstanding of securities law. )

But back to California - the solution is obvious. For each area of state activity that is short-changed by diversion of current budget to pensions, a pension recipient, where able-bodied, will volunteer to serve in the afflicted area, compensated by an existing pension. For example, retired Department of Motor Vehicle employees (to the extent that one can tell when they're "retired") will teach Classics and European Diplomatic History at the Berkeley or Los Angeles campuses of the University of California. Libraries will be kept open by drawing on the ranks of retired Department of Transportation truck drivers, who will choose new books for the stacks and serve as librarians. State parks can be staffed by retired Franchise Tax Board employees, who could use the fresh air. This crazy quilt approach, I would predict, will result in no decline in the overall quality of service, and will be colorful and exciting.

It might seem impracticable, of course. Yet I think, in the long run, it is far more reasonable than the alternative, which is to heavily raise taxes in order to continue paying for retired employees. That will result in a general taxpayer revolt, which is why the cowardly legislature and pension managers choose to shoot the messenger (Stanford in this case, admittedly an inviting target) rather than deal with reality, which is extremely unpalatable.

As an actuarial, mathematical, exponential matter of fact, however, it seems highly doubtful that California's pension plans can possibly cover the massive shortfalls through investment acumen alone. It's going to be a real mess, but that's why I'm here. To be in the solution, not the problem.

1 comment:

  1. hammerud6:27 AM

    I learned a new word from your article -- "gravamen." I had to look it up. It made me think of why everything in California, the country overall, and the entire world seems to be in such a mess. The gravamen of the issue, unfortunately, is human nature. Job asked, "Who can bring a clean thing out of an unclean? Not one." Things can, and will, only be a mess because of the reality of our human condition, which is why my hope is in God and His Word, pointing to a brighter day when Christ reigns. BTW, I just watched Religulous, bill Maher's movie. I'm glad I am not as smart as him. I haven't figured out there is nothing to "God," although I have figured out there is a lot of religious nonsense out there. Anyway, back to the point, the gravamen of our problems is human nature.