November 21, 2010

California's Pension Nightmare

I use inflammatory titles such as the above because it's a great way to stir up readership for the blog. In general my hit count increases by a factor of about 50 for any post which concerns pensions in California. This is a highly nerve-wracking subject for those directly involved, that is, state pensioners, because this guy Joe Nation and the Stanford Institute for Economic Policy Research just won't shut up about it, much as the pension managers and local politicos wish they would. Last spring, for example, Nation & SIEPR came out with a report on CALPers, the teachers' fund and the UC system which demonstrated that they were unfunded, using reasonable rates of return over the foreseeable future, to the tune of about 1/2 trillion smackers. Now Stanford is back with a study of local (county, city and district) pension systems in California which demonstrates that these smaller funds are also on the short side by about $200 billion. Adding it all up, we're missing about $700 billion in order to guarantee payment of all those pension promises, those Constitutionally-mandated contractual rights, those good-as-gold annuities signed with the sacred blood of John C. Fremont and Ishi, the California Yahi who walked out of the wilderness in 1911 and into the waiting arms of the University of California Anthropology Department.

Serious stuff, in other words. A fiscal nightmare. I couldn't quite follow what was going on with the report as described in headline versions in the Marin Independent-Journal (Marin is one of the worst-funded local governments in the state), which were so unbelievable they seemed like something out of Mad Magazine, so I read the actual report from SIEPR, and I still don't quite get it. But the idea seems to be that the pension funds are in such bad shape that the only hope is to devote large amounts of existing budgets equal to huge fractions of existing employee payroll to cover the pension obligations. Using an 18-year "amortization" approach (that is, an attempt to pull even over an 18 year period), on average local pensions at the city, county and district level will have to devote about 50% of "covered payroll" in order to meet pension obligations.

I can't find a clear definition of "covered payroll," surprisingly enough, since that is the denominator for computing the fraction. I guess it means the payroll for current employees in the pension system, which must be a very large percentage of the government work force.
"The average for all systems
in the 18-year scenario is 50
percent, suggesting that one-half
of future covered payroll will
be required to meet unfunded
pension and OPEB obligations.
It is important to emphasize
that this estimated share of
covered payroll reflects only that
required to eliminate unfunded
obligations; contributions to
fund ongoing pension and OPEB
costs are additional."
Local governments generally have to throw in another 15 or 20% to meet the ongoing pension obligations. Anyway, it's a helluva mess. It explains a few things for me. As a lawyer, I use a lot of county facilities, and things have gotten a little sketchy lately, I've noted. Things just don't happen the way they used to. The clerk's office in Marin County, for example, used to allow access to case files on a more-or-less instantaneous basis; now you phone ahead and maybe a week later they'll call you back, but probably not. The file staff is only there four hours a day.

It's pretty clear what's going on. The county is firing current employees because they need the money to pay people who used to work there. San Rafael is, along with San Diego, one of the worst political entities in the state in terms of unfunded pension and health care liabilities. The SIEPR estimates that in the 18-year scenario, San Rafael will have to pay an amount equal to 82% of its "covered payroll" to meet unfunded liabilities. With slightly worse returns on investment, and higher inflation in health care (both factors more likely than not), San Rafael may achieve that exalted status where it owes more to former employees than it does to current employees, if there are any left.

Ah, the Bubble Years, first the Dot Com bonanza and then the housing boom. It raised such lofty expectations about what was fiscally possible in the coming era. The pension formulas were all based on that Golden Age. Now you're lucky if you can earn 2.5% on a 10-year Treasury bond, the benchmark for pension returns. Yet to work, the funds need to earn 6 or 8% per year, which is why the Illinois teacher's pension, for example, has gotten into writing credit default swaps in an effort to make up massive shortfalls. It worked so well for AIG. This is only one step away from playing the lottery as an investment strategy.

Naturally, the local government entities are not going to go in for anything as logical and orderly as "18 year amortization" plans. That's the stuff of policy institutes, not real life. These are politicians we're talking about, and the first line of defense will be denial (San Rafael is already denying like crazy). When the mathematics become overwhelming, they'll resort to blaming someone else, most likely a predecessor. And finally, of course, like pension systems all across the country, the locals will wait for a federal government bailout. I think this is one of the reasons, in fact, that the Federal Reserve has been manipulating the stock market with "POMO" operations, the shell game by which the Fed slips printed money to Primary Dealers with which to play the market. If the damn stock market will just keep going up (despite the overall weak economy), the pensions can make up some of their losses and delay the inevitable bailout.

In the end, however, none of this can work, any more than Social Security can work or the Fed's other Ponzi schemes. Having "globalized" our economy, we can't just print without limit or we risk a ruinous debasement of the currency. Odd, isn't it, how a former city hall janitor's future solvency depends on what the People's Bank of China thinks about our monetary policy? Byzantine complexity - such a good idea in human affairs!


  1. Anonymous2:47 PM

    Yikes, and I'm one of those County government workers that's drawing a $12,000 a year pension. I say knock down the $200,000 pensions.

    But, alas, nothing is going to save California now. Hey, maybe let's go mine some gold. We're going down fast.

  2. Harry, You do a disservice to Ponzi Schemes. Such schemes are known for actually using REAL money whereas the Federal Reserve, for example, uses imaginary money for its recent dollar devaluation known as QE2.

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