The Glass Jaw of Pension Funds is Asset Bubbles

February 26, 2015 By Ed Ring 4 Comments

“CalPERS argued that the California constitution’s guarantee of contracts shielded pensions from cuts in bankruptcy. The fund also asserted sovereign immunity and police powers as an ‘arm of the state,’ including a lien on municipal assets.”

–  Wall Street Journal Editorial, “Calpers Gets Schooled,” February 8, 2015

If you want powerful evidence of crony capitalism at its worst, look no further. In the Stockton bankruptcy trial, the pension fund serving that city’s employees threatened to seize municipal assets to pay pension fund contributions. They’ve made similar threats to other cities that protest against the escalating contribution rates. And they’ve made the cost to exit pension plans confiscatory. It is hard to imagine a bigger or more blatant example of collusion between business interests and government employees at the expense of ordinary private citizens.

In the Stockton bankruptcy case, judge Christopher Klein’s ruling left pensions untouched, but at least the judge was openly disgusted with CalPERS, stating “CalPERS has bullied its way about in this case with an iron fist insisting that it and the municipal pensions it services are inviolable. The bully may have an iron fist, but it also turns out to have a glass jaw” (ref. San Jose Mercury Editorial, February 18, 2015.

Much has been made of the CalPERS’ “glass jaw,” referring to Klein’s contention that cities do have the legal right in bankruptcy to reduce pensions – even though he did not allow pension benefit reductions in this case. But there is another “glass jaw” facing CalPERS and all pension funds, the biggest “glass jaw” of all. They rely on annual returns of 7.5% per year to stay solvent, and as a result, sooner or later, the investment markets are going to deliver these funds a knockout punch.

Professional investors claim they can always beat returns of 7.5% per year, and many of them can. But public sector pension funds control over $4.0 trillion in assets, which makes them too big to beat the market. And the idea, courtesy of pension fund managers, that the investment market can deliver a long-term average return of 7.5% per year implies that 7.5% per year is a “risk free” rate.

For a quick reality check, here are the “risk free” rates of return currently available to investors in the United States:

Even in the cases where cities failed to make some of their annual pension payments, the financial impact was trivial compared to the primary cause of insolvency, which is that pension funds are not required to make “risk free” investments that are actually risk free. Because if they did, they would project low single digit annual rates of return instead of high single digit annual rates of return. It’s that simple.

A little over one year ago, the California Policy Center released a study “Are Annual Contributions Into CalSTRS Adequate?,” which utilized formulas provided by Moody’s investor services for that purpose. Using those formulas, the following table shows how lower rates of return impact CalSTRS:

Impact of Lower Rates of Return on CalSTRS
Based on 6-30-2012 Financial Statements, $ = Billions

CalSTRS chart

Just in case this is all merely abstruse gobbledegook that savvy political consultants recommend politicians avoid since nobody understands it anyway, pay particular attention to the columns on the far left and far right. The left column’s top row shows the official rate of return used by CalSTRS, 7.5%, and the right column’s top row shows how much they should contribute each year based on that official rate of return. Never mind that CalSTRS, like nearly all pension systems, uses creative accounting to avoid making an adequate payment to reduce their unfunded liability. In FYE 6-30-2012, for example, CalSTRS only made an unfunded contribution of $1.1 billion, not $7.0 billion (column five, top row) which would have represented a responsible payment against their unfunded liability.

It’s worth noting that for CalPERS, we can’t even get data on how they break out their normal contributions and their unfunded contributions because doing so would require sifting through the financials of every one of their participating entities. But there is nothing uniquely troubling about CalSTRS. As calculated in a more recent California Policy Center study, released last week “California City Pension Burdens,” in 2014 all state and local government pension funds in California, on average, were only 75% funded.

Imagine what would happen if CalSTRS had to pay $25 billion per year (column six, row five), instead of what they actually paid in 2012, $5.8 billion? Replicate these methods with nearly any pension fund in California, and you will almost always get similar results. And anyone who thinks a rate of return of 3.5% (column one, row five) is overly pessimistic should refer to the actual “risk free” rates of return shown in the previous bullet points. Better yet, consider this:  The federal funds lending rate today, the amount the federal reserve charges to banks, is 0.25% – that’s one-quarter of one percent. This is free money. That money is essentially being given to banks rates to turn around and loan at very low rates to corporations and consumers who use the cheap credit to buy things which, temporarily, stimulates the economy which causes asset values to rise – we are repeating 2008 all over again.

Pension funds depend on continuously expanding debt fueled asset bubbles for solvency. That is how they earn high returns that are anything but “risk free.” That is their glass jaw. Hopefully, when the bubbles pop and the glass jaws shatter, as an “arm of the state,” with “police powers,” CalPERS, CalSTRS, and every other pension fund in California won’t seize every municipal asset we’ve got and impose genuinely punitive taxes, so they can keep on paying those benefits.

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

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What’s the Real Reason for Police Understaffing in San Diego?

January 23, 2015 By Ed Ring 6 Comments

Whenever there is a shortage of police personnel in a California city, a common reason cited is inadequate pay. When officers at a particular agency are paid less than their counterparts at some other agency, so the theory goes, they quit in order to start working where they can make more. This seems to be sound logic. But is it supported by facts? According to a new study “Analysis of the Reasons for San Diego Police Department Employee Departures,” released last week by the California Policy Center, the answer to that question is a resounding “no.” Authored by Robert Fellner, research director for the Transparent California project, the study’s findings contradicted the conventional wisdom. They were:

  • Claims that SDPD officers were leaving to join other departments misrepresented the data on attrition, by focusing on the 10% who left to join other departments, instead of the 60% who retired.
  • These claims also misrepresented the overall data regarding staffing and recruitment, focusing on approximately 20 people leaving in a department of nearly 1,800 while ignoring the fact that there were 3,000 applicants for open 25 positions.
  • In support of these claims, a misleading study, funded by the city of San Diego, only analyzed base pay, the only category of pay San Diego didn’t boost in their 2014 pay raises for the SDPD.
  • This same study compared San Diego to one of the most expensive cities in the world – San Francisco and other totally different markets, instead of comparing SDPD pay to rates of pay in neighboring cities.

One thing that is not in serious debate is the fact that the San Diego Police Department is understaffed, like many other police departments in California. But the reason they are understaffed is a result of poor recruitment efforts. Fellner writes:

“The City’s ability to recruit new candidates would be seriously compromised when budget decisions in FY 2009 and FY 2010 resulted in the City cutting its quarterly academy class sizes from 50 to 25. In FY 2011 the City cancelled all but one academy class, a decision that ‘resulted in a lost opportunity to add approximately 57 additional recruits.’ And what did happen after the hiring freeze of 2011 ended? The SDPD received over 3,000 applicants for just 25 positions in its first academy class of 2012, according to 10News. This is symptomatic of a larger trend – a tremendous, unmet demand to work in law enforcement in the San Diego area. For example, the following year the nearby San Diego County Sheriff’s Department received over 4,000 applicants for their 275 deputy positions.”

There is no shortage of people who want to work in law enforcement in San Diego. Surely a few hundred of these many thousands of applicants are qualified to do the work.

While the facts don’t support the assertion that San Diego is losing police officers to other departments, the facts do support an alarming loss of officers to retirement, a problem that is getting worse. But if recruitment isn’t a problem, what difference does it make if officers retire in great numbers? The problem is the cost for these retirements take away funds that could be used to pay for more police academy classes, and more active officers on the force. To fund an adequately staffed police force, San Diego could have reduced retirement formulas to the levels they were back in the 1990’s – i.e., reducing them back to levels that are fair and financially sustainable. Instead, to induce veteran officers to delay retiring, San Diego joined several other California cities in implementing “DROP,” which stands for “Deferred Retirement Option Program.”

In general, the way DROP works is this:  A retirement eligible employee agrees to freeze their retirement benefit accrual and continue to work, usually for five more years. Then, while they continue to work for the city and get paid as an active employee, the pension they would be earning if they had retired is paid into an interest bearing account. When they retire, the entire amount accrued in that pension account is paid to them in a lump sum, and from then on they begin to directly collect their pension.

Take a look at Transparent California’s listing of San Diego’s pension payouts in 2013. Nearly all of the top pensions are police and fire personnel who received massive lump sum payments under the DROP program. This is a scandalous waste of money. The primary reason SDPD officers leave their department is to retire. So instead of investing in recruitment efforts to replace retirees, the San Diego implemented the DROP program, at staggering expense, to retain veterans a little longer.

As always, the power behind these distortions of logic and perversions of policy are the government unions. Unlike the police officers themselves, who almost invariably want to serve their communities and make a positive difference in people’s lives, government unions thrive on fomenting resentment and alienation. The more anger they can manipulate their members into feeling, the more righteous indignation those members will bring to city council meetings, and the more dues they will willingly pay to purchase candidates for local office. Ultimately, what government unions thrive on is the failure of government, because the worse things get, the more money they will demand to fix the problems.

Inadequate pay is not the reason SDPD has a staffing shortage. Excessive pensions, the staggering expense of DROP, and a failure to fund recruitment efforts are the reasons why. The unions would have you think otherwise.

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

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Conservatives, Police Unions, and the Future of Law Enforcement

January 8, 2015 By Ed Ring 5 Comments

Conservatives in America are at a crossroads. They face a choice between greater freedom or greater security. While striking this delicate balance has required ongoing policy choices throughout history, recent events involving law enforcement have brought these choices into sharp focus. Here’s how Patrik Johnson, writing last month in the Christian Science Monitor, described the choice:

“Police forces nationwide are being pulled between two opposite trends: more empathetic, community policing and an increasingly militarized response to crises.”

How conservatives, on balance, weigh in on this choice has far reaching consequences. On one hand, conservatives can support suggested reforms that embrace the value of empathy, minimize violence, alleviate tensions, and pave the way for 21st century policing appropriate to a free republic. Here is a key reform advocated by the protesters in Ferguson, Missouri, in reaction to the tensions in that city following a police shooting:

“A comprehensive review by the Department of Justice into systematic abuses by police departments and the development of specific use of force standards and accompanying recommendations for police training, community involvement and oversight strategies and standards for independent investigatory/disciplinary mechanisms when excessive force is used.”

Conservatives may scoff at some of the other demands – such as guaranteed “full employment for our people,” which, for starters, goes well beyond police reform. But conservatives better think twice before deciding there is no merit to any of the concerns of activist groups who have been animated, across the nation, by alleged excessive use of force by police.

Because there is a dark, shamefully pragmatic alternative course for conservatives. They can choose to fan the flames of racial animosity and fear, secure in believing that excessive force may never touch their communities. But excessive use of force by police is not primarily a racial issue. Ask the families of Kelly Thomas, or David Silva, or Kevin Hughey, or hundreds of others.

The issue, bigger than race, is this: Are we going to evolve into a nation where police are trained to use nonlethal force, trained to practice “empathic, community policing,” or not? And are we going to be a nation where police are held accountable if they cross the line, or not?

Which brings us to the fact that most law enforcement agencies in the United States today are unionized. These unions are politically active, and they tend to lean conservative in their political contributions. The practical choice conservatives face is stark: Do they want to take money from police unions not just in exchange for ignoring the serious financial challenges caused by their excessive pension benefits, but also in exchange for ignoring calls to better regulate use of excessive force?

Challenging the agenda of police unions will not only cost politicians their financial support. In some cases it can even earn their active retaliation. A troubling article by Lucy Caldwell, in a National Review article entitled “Police Unions Behaving Badly,” documents how a local politician in California was harassed after standing up to them in contract negotiations. And as Caldwell notes, “police unions are able to operate with absolutely no transparency because they are classified as private entities not subject to public-records laws.”

There are many reasons government unions, especially law enforcement unions, are problematic in a democracy. But when the teachers union in California went on record deploring the education reforms upheld in the Vergara decision – everyone, liberals and conservatives alike, saw them for who they are – a lobbying group that is more concerned about protecting bad teachers than they are about educating children.

Members of law enforcement themselves, perhaps even more than teachers, ought to be, and usually are, highly motivated to make a contribution to society. They have a strong sense of right and wrong, and justifiably feel there is a moral worth to the jobs they do and the profession they’ve chosen. So why are they letting their unions fight reforms that will weed out bad cops, and implement training and oversight programs that will result in fewer lives lost and lowered tensions in the communities they serve?

Conservatives can seize this opportunity to find the strength of their most enlightened convictions. They can join with liberals to reform and evolve law enforcement in the U.S. And in so doing they can help liberals to see how the agenda of government unions is in inherent conflict with the public interest – in law enforcement as well as in education. And they can start to work towards broader reforms as part of a powerful new coalition.

Alternatively, conservatives can revert to an ugly, divisive, racially tinged, belligerent message, endorsing security at any cost. They may reap short term political and financial gains from such a strategy. But they will further divide this nation, and in the long run, discredit themselves irrevocably.

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

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An Economic Win-Win For California – Lower the Cost of Living

December 9, 2014 By Ed Ring 1 Comment

A frequent and entirely valid point made by representatives of public sector unions is that their membership, government workers, need to be able to afford to live in the cities and communities they serve. The problem with that argument, however, is that nobody can afford to live in these cities and communities, especially in California.

There are a lot of reasons for California’s high cost of living, but the most crippling by far is the price of housing. Historically, and still today in markets where land development is relatively unconstrained, the median home price is about four times the median household income. In Northern California’s Santa Clara County, the median home price in October 2014 was $699,750, eight times the median household income of $88,215. Even people earning twice the median household income in Santa Clara County will have a very hard time ever paying off a home that costs this much. And if they lose their job, they lose their home. But is land scarce in California?

The answer to this question, despite rhetoric to the contrary, is almost indisputably no. As documented in an earlier post, “California’s Green Bantustans,” “According to the American Farmland Trust, of California’s 163,000 square miles, there are 25,000 square miles of grazing land and 42,000 square miles of agricultural land; of that, 14,000 square miles are prime agricultural land. Think about this. You could put 10 million new residents into homes, four per household, on half-acre lots, and you would only consume 1,953 square miles. If you built those homes on the best prime agricultural land California’s got, you would only use up 14 percent of it. If you scattered those homes among all of California’s farmland and grazing land – which is far more likely – you would only use up 3 percent of it. Three percent loss of agricultural land, to allow ten million people to live on half-acre lots.”

So why is it nearly impossible to develop land in California? The answer to this is found in the nexus between financial special interests, who benefit from asset bubbles, and powerful environmentalist organizations who apparently view human settlements as undesirable blights that should be minimized. In the San Francisco Bay Area, to offer a particularly vivid example, the Santa Cruz mountains are being targeted to be cleansed of human habitation. Instead of creating wildlife corridors, they are eliminating human corridors. Is this really necessary?

20141203_Ring

If you are familiar with the San Francisco peninsula, you will see that the area proposed for the “Great Park of the Santa Cruz Mountains” encompasses nearly the entire mountain range. A coalition of environmentalist organizations and government agencies are proposing to create a park of 138,000 acres, that’s 215 square miles, in an area that ought to make room for weekend cabins, mountain dwellers, and vacation communities. Why, in a region where homes cost so much, is so much land being barred to human settlement? The pristine stands of redwoods in Big Basin and Henry Cowell State Park were preserved a century ago. There is nothing wrong with preserving more land around these parks. But do they have to take it all?

This is far from an isolated example. Urban areas in California, primarily Los Angeles and the San Francisco Bay Area, have been surrounded by “open space preserves” where future development is prohibited and current residents are harassed. Ask the embattled residents of Stevens Canyon in the hills west of the Silicon Valley, if there are any of them left. Once you’re in a “planning area,” watch out. Backed by bonds sold to naive voters, endowments bestowed by billionaires, and the power of state and federal laws that make living on any property at all increasingly difficult, the relentless land acquisition machine continues to gather momentum. Anyone who thinks there isn’t a connection between setting aside thousands of square miles in California for “habitat” and the price of a home on a lot big enough to accommodate a swing set for the kids needs to have their head examined.

It doesn’t end with open space that is actually purchased, cleansed of humanity, and turned into government ran preserves for plants and wildlife, however. Acquiring permits to build on any land is nearly impossible in California. Land developers who fight year round to try to build housing for people shake their heads in disbelief at the myriad requirements from countless state, federal and local agencies that make the permit process take not months or years, but decades. And it isn’t just farmland, or wetland, or special riparian habitats where development is blocked. It’severywhere. Even semi-arid rangeland is off limits for housing unless you are prepared to spend millions, fight for decades, and have the staying power to pursue multiple expensive projects simultaneously since many will never, ever get approved.

What is the result? Here is an aerial photo of a subdivision in the Sacramento area, one that every hedge fund billionaire turned environmentalist in California – especially one who runs cattle on his own special 1,800 acre fiefdom in the Santa Cruz mountains on a property that just happens to be in a “non-targeted area” – might consider living in for the rest of his life in order to understand the human consequences of his ideals – cramped homes on 40′ by 80′ lots, at a going price in October 2014 of $250,000. Notwithstanding being condemned to a claustrophobic existence at a level of congestion that would drive rats in a cage to madness, $250,000 is a pittance for a billionaire. But for an ordinary worker, $250,000 is a life sentence of mortgage servitude. And even this, the single family dwelling, is under attack by “smart growth” environmentalists and public bureaucrats who prefer density to having to divert payroll and benefits to finance infrastructure. The excess! The waste! Stack them and pack them and let them ride trains!

Priced to Sell at $250,000 – Housing for Humans on 40′x80′ Lots

201402_Sacramento-500px

When public employee union leadership talk about the importance of paying their members a “middle class” package of pay and benefits, they’re right. Government workers should enjoy a middle class lifestyle. But they need to understand that the asset bubbles caused by high prices for housing are not only making it necessary to pay them more, but are also creating the inflated property tax revenue that they rely on for much of their compensation. They need to understand that the phony economic growth caused by everyone borrowing against their inflated home equity is what creates the stock market appreciation that their pension funds rely on to remain solvent. And they need to understand that all of this is a bubble, kept intact by crippling, misanthropic land use restrictions that hurt all working people.

There is another path. That is for public employee union leadership to recognize that everyone deserves a chance at a middle class lifestyle. And the way to do that is not to advocate higher pay and benefits to public employees, but to advocate a lower cost of living, starting with housing. One may argue endlessly about how to regulate or deregulate water and energy production, essentials of life that also have artificially inflated costs. But as long as suburban homes consume less water than Walnut orchards – and they do, much less – build more homes to drive their prices way, way down. There’s plenty of land.

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

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California’s New, Big, Nonpartisan Political Tent

December 4, 2014 By Ed Ring Leave a Comment

“In politics, a big tent or catch-all party is a political party seeking to attract people with diverse viewpoints and thus appeal to more of the electorate. The big tent approach is opposed to single-issue litmus tests and ideological rigidity, conversely advocating multiple ideologies and views within a party.”

–  Wikipedia, “Big Tent”

Something is happening in California. An unstoppable movement for reform is building, attracting support from conscientious Californians regardless of their age, income, race, gender or political ideology. The metaphor of a “big tent” aptly describes the approach that reform leaders are finally embracing.

The fabric of this big tent is supported by two poles, one representing restoring quality education, the other representing restoring financial health to California’s public institutions. But the big tent metaphor breaks down somewhat if it describes a political party. Because most of California’s reform leaders no longer care who gets it done, or what political party takes credit. They just want to Californian children to get quality educations, and they just want to restore economic opportunity to ordinary citizens.

For years, the powers that oppose education reform and fiscal reform have painted reformers as either Republican fanatics, bent on dismantling government, or Democratic traitors, beholden to “Wall Street Hedge Funds.” But this argument is wearing thin. On the topic of education reform, here are three reasons why Californians, all of them, are waking up:

(1) The Vergara Decision:  This case pits nine Oakland public school students against the State of California, arguing that (a) granting tenure after less than two years, (b) retaining teachers during layoffs based on seniority instead of merit, and (c) the near impossibility of dismissing incompetent teachers, is harming California’s overall system of public education, and is disproportionately harming public education in low income communities. Earlier this year, in a Los Angeles Superior court decision, the judge wrote: “The evidence of the effect of grossly ineffective teachers on students is compelling. Indeed, it shocks the conscience.” In return, the California Teacher’s Association had this to say in an official press release:

“All along it’s been clear to us that this lawsuit is baseless, meritless, and masterminded by self-interested individuals with corporate education reform agendas that are veiled by a proclamation of student interest” (ref. CTA press release).

Watch the plaintiff’s closing arguments in the Vergara case. Note how the plaintiff’s legal team was actually able to use the testimony of the defendant’s expert witnesses to support their own case.

(2) Parent Trigger Laws:  In 2010, the California State Legislature signed into law the “Parent Empowerment Act.” This law enables parents in failing schools to (a) transfer their child to a higher performing school, (b) permits parents to change policies at an underperforming school if 50 percent of parents sign a petition, and (c) requires the California Dept. of Education to regularly publish a list of the 1,000 worst performing schools in the state. Former State Senator Gloria Romero, the liberal Democrat who is largely responsible for getting passage of the Parent Empowerment Act, writes this week in UnionWatch about how the Los Angeles Unified School District tried and failed to exempt themselves from the law. But government employee unions in California are incredibly powerful, collecting and spending over two billion dollars in taxpayer funded dues per two-year election cycle. They literally can be in all places at all times. Read the slime job someone sympathetic to the union machine entered on Romero’s Wikipedia profile:

“Romero leads the California chapter of Democrats for Education Reform, an interest group funded by Wall Street hedge fund managers who support charter schools.”

(3) Charter Schools:  Here is an example of why claims that “Wall Street hedge fund managers” are somehow hoping to profit from private schools or charter schools (which are not private) are absurdly unfounded. The Alliance College-Ready Public Schools in Los Angeles is a network of 26 high schools, located throughout Los Angeles, which, like nearly all charter schools, consistently delivers superior educational outcomes at a fraction of the cost of union controlled public schools. But the Alliance network is a nonprofit. The capital investments necessary to launch these schools are funded by donations. There is no return on investment. And the benefactors of these schools have no political agenda – they are Democrats, Republicans, and independents. They are a perfect example of California’s new, powerful, big tent.

Financial reform issues are the other pole that supports the big tent. Despite accusations of “hedge fund managers” and “Wall Street” getting behind allegedly phony reform proposals for public education along with fiscal issues such as runaway pension costs, it is actually corrupt financial interests that join with government bureaucrats to perpetuate the abuse and prevent reform. The reason government services are being cut and infrastructure spending is neglected is because unionized government workers receive excessive pay and benefits, crowding out funding for everything else. Wall Street firms underwrite the bonds to cover the deficits and finance deferred maintenance. Wall Street firms (including hedge funds) invest the pension fund assets. People are connecting the dots.

The behavior of powerful government unions, opposing education and fiscal reforms that virtually everyone else supports, is finally exposing them – along with their partners, corrupt financial interests and crony corporations – as the root cause of the most severe challenges facing Californians. This issue is nonpartisan and transcends ideology. The big tent is filling up.

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

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More Taxes and Tuition Buy Time for the Pension Bubble

November 27, 2014 By CPR Editors 1 Comment

“The ‘recovery’ is largely an illusion created by the effects of zero percent interest rates, quantitative easing, and deficit spending. The asset bubbles that have been created as a result of these policies have primarily benefited the owners of stocks, bonds, and real estate (the rich), while simultaneously deterring the savings and capital investment that is needed to actually create good paying jobs and increased purchasing power.”

–  Peter Schiff, EuroPacific Weekly, November 6, 2014

The question everyone should be asking, especially the managers of public employee pension funds, is how much longer our economy can run on zero percent (adj. for inflation) interest rates, quantitative easing and deficit spending.

When asked how we unwind all of this debt and deficits in a manner that doesn’t trigger a collapse of collateral and potentially catastrophic deflation, i.e., how do we create the preconditions for sustainable economic growth, respected economics blogger Charles Hugh Smith emailed back this answer:

“Those who foisted the debt off as safe have to absorb the losses, as did those who were conned. As it stands now, the hapless taxpayers are having to make the perps and their marks whole—that is wrong, morally and financially. The US has about $90 trillion in net worth. If $10 T were wiped off the books, it would be bad for the banks and those who trusted them, but it would not sink the country.”

Which brings us to the topic of this post.

As reported on November 16th in the Sacramento Bee:

This year, UC will pay about $1.3 billion to the pension fund, about 5 percent of its overall operating budget. UC officials want the state’s general fund to pick up nearly a third of the payment, which would cover the university’s portion of pension contributions for faculty and other employees who are paid from state funds. ‘Frankly, if the state were to pay that, we would not be proposing a tuition increase,’ said Nathan Brostrom, UC’s chief financial officer. ‘That is money that could go to other resources.’”

Like nearly every public employee pension fund in the U.S., the University of California’s pension system is underfunded. According to the Sacramento Bee, the system is 79 percent funded, which equates to a $7.2 billion unfunded liability.

What is going to happen to the UC System’s pension fund when these asset bubbles deflate?

The precariously low funded ratio challenging America’s public employee pension systems is itself based on the dangerous assumption that we are not experiencing unsustainable asset inflation. A healthy correction would lower asset values, making the basic necessities of life – housing and energy – affordable again. But a healthy correction in asset values would render pension systems insolvent because the value of their investments – already on the brink of inadequacy – would decline further.

In the public debate over this issue, there is another assumption at work, pernicious and misleading. That assumption is that faculty on the various UC campuses are making common cause with the students by insisting that state taxpayers pick up the tab for these pensions. But there is no common cause. Beneficiaries of public sector pensions are shareholders. From funds that control nearly $4 trillion in investments, this privileged class of state and local government workers collect pensions that – at least in California – average four times (or more) what someone with similar compensation (and similar withholding) can expect to receive from Social Security. And unlike ordinary shareholders, when the shares held by their pension funds decline, they are empowered to force taxpayers to cover their losses.

The faculty that populate the campuses of the University of California, and by extension, every public employee who collects a pension at taxpayer – and tuition payer – expense, have interests that coincide with the one percent of the one percent, and the biggest banks, and the hedge funds, and the Wall Street firms they love to demonize. They benefit from the asset bubble that is destroying the economic aspirations of the rest of America. When financial policymakers encouraged cheap interest rates so ordinary people could borrow more than they could ever hope to pay back, just so they could own a home, shareholders – including the biggest shareholder class in the U.S., pension funds – profited from the debt-fueled economic growth. When asset bubbles rendered a middle class lifestyle unattainable to most Americans, the public sector exempted themselves through automatic cost-of-living increases and enhanced pension benefits.

The solution to the University of California’s money crunch is to suspend cost-of-living increases, increase payroll withholding for pension benefits, and lower pension benefit formulas. Only then will the people who teach California’s youth truly be making common cause with their students.

As it is, the roadblocks to sustainable economic growth are those who benefit from debt fueled asset bubbles – super rich shareholders and their fully co-opted partners, government workers.

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

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The Amazing, Obscure, Complicated and Gigantic Pension Loophole

November 20, 2014 By Ed Ring 2 Comments

“The bottom line is that claiming the unfunded liability cost as part of an officer’s compensation is grossly and deliberately misleading.”

– LAPPL Board of Directors on 08/07/2014, in their post “Misuse of statistics behind erroneous LA police officer salary claims.”

This assertion, one that is widely held among representatives of public employees, lies at the heart of the debate over how much public employees really make, and greatly skews the related debate over how much pension funds can legitimately expect to earn on their invested assets.

Pension fund contributions have two components, the “normal contribution” and the “unfunded contribution.” The normal contribution represents the present value of future retirement pension income that is earned in any current year. For example, if an actively working participant in a pension plan earns “3 percent at 55,” then each year, another 3 percent is added to the total percentage that is multiplied by their final year of earnings in order to determine their pension benefit. That slice, 3 percent of their final salary, paid each year of their retirement as a portion of their total pension benefit, has a net present value today – and that is funded in advance through the “normal contribution” to the pension system each year. But if the net present value of a pension fund’s total future pension payments to current and future retirees exceeds the value of their actual invested assets, that “unfunded liability” must be reduced through additional regular annual payments.

Without going further into the obscure and complicated weeds of pension finance, this means that if you claim your pension plan can earn 7.5 percent per year, then your “normal contribution” is going to be a lot less than if you claim your pension plan can only earn 5 percent per year. By insisting that only the cost for the normal contribution is something that must be shared by employees through paycheck withholding, there is no incentive for pension participants, or the unions who represent them, to accept a realistic, conservative rate of return for these pension funds.

This is an amazing and gigantic loophole, with far reaching implications for the future solvency of pension plans, the growing burden on taxpayers, the publicly represented alleged financial health of public employee pension systems, the impetus for reform, and the overall economic health of America.

Governor Brown’s Public Employee Reform Act (PEPRA) calls for public employees to eventually pay 50 percent of the costs to fund their pensions, this phases in over the next several years. But this 50 percent share only applies to the “normal costs.”

In a 2013 California Policy Center analysis of the Orange County Employee Retirement System, it was shown that if they reduced their projected annual rate of return from the officially recognized 7.5 percent to 4.81 percent, the normal contribution would increase from $410 million per year to $606 million per year. In a 2014 CPC analysis of CalSTRS, it was shown that if they reduced their projected annual rate of return from the officially recognized 7.5 percent to 4.81 percent, the normal contribution would increase from $4.7 billion per year to $7.2 billion per year.

The rate of 4.81 percdent used in these analyses was not selected by accident. It refers to the Citibank Liability Index, which currently stands at 4.19 percent. This is the rate that represents the “risk free” rate of return for a pension fund. It is the rate that Moody’s Investor Services, joined by the Government Accounting Standards Board, intends to require government agencies to use when calculating their pension liability. As can be seen, going from aggressive return projections of 7.5 percent down to slightly below 5 percent results in a 50 percent increase to the normal contribution.

No wonder there is no pressure from participants to lower the projected rate of return of their pension funds. If under PEPRA, a public employee will eventually have to contribute, say, 20 percent of their pay via withholding in order to cover half of the “normal contribution,” were the pension system to use conservative investment assumptions, they would have to contribute 30 percent of their pay to the pension fund.

Moreover, these are best case examples, because the formulas provided by Moody’s, used in these studies, make conservative assumptions that understate the financial impact.

In another California Policy Center study, “A Pension Analysis Tool for Everyone,” the normal contribution as a percent of pay is calculated on a per individual basis. One of the baseline cases (Table 2) is for a “3 percent at 55″ public safety employee, assuming a 30 year career, retirement at age 55, collecting a pension for 25 years of retirement. At a projected rate of return of 7.75 percent per year, this employee’s pension fund would require 19.6 percent of their pay for the normal contribution. Under PEPRA, half of that would be about 10 percent via withholding from their paychecks. But at a rate of return of 6 percent, that contribution goes up to 31 percent. Download the spreadsheet and see for yourself – at a rate of return of 5 percent, the contribution goes up to 41 percent. That is, instead of having to pay 10 percent via withholding to make the normal contribution at a 7.75 percent assumed annual return, this employee would have to pay 20 percent via withholding at a 5 percent assumed annual return. The amount of the normal contribution doubles.

This why not holding public employees accountable for paying a portion of the unfunded contribution creates a perverse incentive for public employees, their unions, the pension systems, and the investment firms that make aggressive investments on behalf of the pension systems. Aggressive rate of return projections guarantee the actual share the employee has to pay is minimized, even as the unfunded liability swells every time returns fall short of projections. But if only the taxpayer is required to pick up the tab, so what?

Adopt misleadingly high return assumptions to minimize the employee’s normal contribution, and let taxpayers cover the inevitable shortfalls. Brilliant.

Public employee pension funds are unique in their ability to get away with this. Private sector pensions were reformed back in 1973 under ERISA rules such that the rate of return is limited to “market rates currently applicable for settling the benefit obligation or rates of return on high quality fixed income securities,” i.e., 5 percent would be considered an aggressive annual rate of return projection. If all public employee pension funds had to do were follow the rules that apply to private sector pension funds, there would not be any public sector pension crisis. And when public employees are liable through withholding for 50 percent of all contributions, funded and unfunded, that basic reform would become possible.

This is indeed an obscure, complicated, amazing and gigantic loophole. And it is time for more politicians and pundits to get into the weeds and fight this fight. Especially those who want to preserve the defined benefit. Until incentives for public employees and taxpayers are aligned, pension funds will cling to the delusion of high returns forever, until it all comes crashing down.

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

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California’s New Coalitions Defy Conventional Definitions

November 7, 2014 By Ed Ring 1 Comment

The 2014 mid-term elections will be remembered for many things – pioneering use of information technology to comprehensively profile and micro-target voters, escalating use of polarizing rhetoric, historically low levels of voter turnout, and historic records in total spending. In California, in spite of all this money and technology – or perhaps because of it – the political landscape is probably not going to change very much this time around. But appearances can be deceiving. While Democrats will still control California’s state legislature and nearly all of California’s large cities and urban counties, new fault lines are forming within California’s electorate that defy conventional definitions of Republican and Democrat, or conservative and liberal.

Because as it is, California’s schools are failing, businesses and middle-income residents are fleeing, and the cost of living is the highest in America. Three powerful groups benefit from and perpetuate this arrangement with their money and their votes:  Wealthy individuals and crony capitalists, unionized public sector workers, and low-income residents who have become entirely dependent on government and are susceptible to their rhetoric. The terms of this alliance are financially unsustainable and even now, they harm low income residents more than they help them. It will crack as soon as a viable opposition coalesces. And that is happening.

Here are examples of how coalitions are forming that defy conventional definitions of Republican or Democrat, conservative or liberal:

(1)  Financial sustainability is a bipartisan issue.

California’s cities and counties, despite revenues from an unsustainable asset bubble that has bought them time, are on a collision course with financial insolvency. This reality has already confronted every big city mayor in California. Some, including Democrats like San Jose’s courageous mayor Chuck Reed, are trying to enact reforms to save their cities. Over 80% of the non-federal government spending in California is at the local level, and sooner or later, liberals and conservatives are going to join together to demand realistic financial reforms to restore financial health to California’s public institutions.

(2)  Quality public schools is a bipartisan issue.

California’s public schools will not be improved by spending more money, they will be improved by making fundamental reforms to how schools and school districts are managed. The Vergara lawsuit, funded almost entirely by conscientious Democrats, proves how committed everyone is to restoring accountability to public education. The success of charter schools proves that superior educational outcomes can be had for less money than is currently made available to public schools.

(3)  The mission of public sector unions is inherently in conflict with the public interest.

Both of the examples just mentioned – quality education and financial health – are the priority of any civic minded private citizen, but are not the priority of the public sector unions who control California politics. The reason California’s schools are failing is because of union work rules that prevent innovation and accountability. The reason California’s government finances are perennially challenged is because for decades, public sector unions have pressured politicians to grant pay and benefit increases that have become unfair and unaffordable.

(4)  Private sector unions are fundamentally different from public sector unions.

The growing rift within Democrats, and the growing consensus among all California voters, is based on a fundamental fact: Criticizing, or even abolishing, public sector unions does NOT represent an attempt at a broader war on labor, working people, or private sector unions. There are serious issues relating to the role and optimal regulations for private sector unions, but they play a legitimate, vital part in American society. Public sector unions, on the other hand, should be abolished.

(5)  No party, platform, or person has all the answers.

This is not a new reality, but today in California it is being increasingly recognized by reformers across the political spectrum. And there is a new, unifying theme – the need for public sector union reform, fostered through education reform and fiscal reform. While politicians and citizens may disagree over the size of government and the role of government, they are agreeing, more than ever, that government unions have skewed this debate and taken options away. Can we improve and enhance government services, or invest in ambitious new infrastructure projects? No, because tax revenue must pay over-market compensation to government workers. Can we streamline and modernize a government agency or effectively manage a school? No, because of union work rules.

New coalitions are forming that will not accept failing schools, or cities and counties in a perpetual state of financial crisis. They will fight together for educational excellence and fiscal health. And because nothing matters more than our children and our ability to earn a living, they will recognize the unpleasant truth – to restore public education and public finance requires fighting public sector unions.

In California, the outcome of the 2014 election is sadly predictable. But change is coming.

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

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CA’s $12.3 Billion in Proposed School Bonds: Borrowing vs. Reform

October 29, 2014 By Ed Ring 5 Comments

“As the result of California Courts refusing to uphold the language of the High Speed Rail bonds, the opponents of any bond proposal, at either the state or local level, need only point to High-Speed Rail to remind voters that promises in a voter approved bond proposal are meaningless and unenforceable.”

–  Jon Coupal, October 26, 2014, HJTA California Commentary

If that isn’t plain enough – here’s a restatement: California’s politicians can ask voters to approve bonds, announcing the funds will be used for a specific purpose, then they can turn around and do anything they want with the money. And while there’s been a lot of coverage and debate over big statewide bond votes, the real money is in the countless local bond issues that collectively now encumber California’s taxpayers with well over $250 billion in debt.

Over the past few weeks we’ve tried to point out that local tax increases – 166 of them on the November 4th ballot at last count, tend to be calibrated to raise an amount of new tax revenue that, in too many cases, are suspiciously equal to the amount that pension contributions are going to be raised over the next few years. For three detailed examples of how local tax increases will roughly equal the impending increases to required pension contributions, read about Stanton, Palo Alto and Watsonville‘s local tax proposals. It is impossible to analyze them all.

As taxes increase, money remains fungible. More money, more options. They can say it’s for anything they want. And apparently, bonds are no better.

At last count, there are 118 local bond measures on the November ballot. And not including three school districts in Fresno County for which the researchers at CalTax are “awaiting more information,” these bonds, collectively, propose $12.4 billion in new debt for California taxpayers. All but six of these bond proposals (representing $112 million) are for schools. Refer to the list from CalTax to read a summary of what each of these bonds are for – “school improvements,” “replace leaky roofs,” “repair restrooms,” “repair gas/sewer lines,” “upgrade wiring,” “renovate classrooms,” “make repairs.”

To be fair, there are plenty of examples of new capital investment, “construct a new high school,” for example, but they represent a small fraction of the stated intents. On November 4th, Californians are being asked to borrow another $12.3 billion to shore up their public school system. They are being asked to pile another $12.3 billion onto over $250 billion of existing local government debt, along with additional hundreds of billions in unfunded retirement obligations for state and local government workers. They are being asked to borrow another $12.3 billion in order to do deferred maintenance. We are borrowing money to fix leaky roofs and repair restrooms and sewers. This is a scandal, because for the past 2-3 decades, California’s educational system has been ran for the benefit of unionized educators and unionized construction contractors who work in league with financial firms whose sales tactics and terms of lending would make sharks on Wall Street blush. These special interests have wasted taxpayers money and wasted the educations of millions of children. Their solution? Ask for more money.

Nobody should suggest that California’s public schools don’t require investment and upgrades. But before borrowing more money on the shoulders of taxpayers, why aren’t alternatives considered? Why aren’t educators clamoring for reforms that would cut back on the ratio of administrators to teachers? Why aren’t they admitting that project labor agreements raise the cost to taxpayers for all capital investments and upgrades, and doing something about it? If their primary motivation is the interests of students, why aren’t they supporting the Vergara ruling that, if enforced, will improve the quality of teachers in the classroom at no additional cost? Why aren’t they embracing charter schools, institutions whose survival is tied to their ability to produce superior educational outcomes for far less money? Why don’t they question more of these “upgrade” projects? Is it absolutely necessary to carpet every field in artificial turf, a solution that is not only expensive but causes far more injuries to student athletes? Is it necessary to spend tens of millions per school on solar power systems? Does every high school really need a new theater, or science lab? Or do they just need fewer administrators, and better teachers?

And to acknowledge the biggest, sickest elephant in the room – that massive, teetering colossus called CalSTRS, should teachers, who only spend 180 days per year actually teaching, really be entitled to pensions that equal 75% of their final salary after only 30 years, in exchange for salary withholding that barely exceeds what private employees pay into Social Security? Thanks to unreformed pensions, how many billions in school maintenance money ended up getting invested by CalSTRS in Mumbai, Shanghai, Jakarta, or other business-friendly regions?

How much money would be saved if all these tough reforms were enacted? More importantly, how much would we improve the ability of our public schools to educate the next generation of Californians? Would we still have to borrow another $12.3 billion?

Here’s an excerpt from an online post promoting one of California’s local school bond measures: “It will help student academic performance, along with ensuring our property values. If you believe that strong schools and strong communities go hand in hand, please vote…”

Unfortunately, such promises are meaningless and unenforceable. The debt is forever.

*   *   *

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

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City of Stanton Proposes Higher Taxes Instead of Cutting Pay and Benefits

October 9, 2014 By Ed Ring 1 Comment

On November 4th, voters in Stanton, California, will be asked to vote on a 1 percent sales tax increase, which if approved will raise their sales tax to 9 percent – the highest in Orange County. Nestled in the heart of Orange County, tiny Stanton, a city of barely three square miles in size with a population in 2012 of 38,915 residents, is an unlikely candidate for the spotlight, when California’s local ballots are about to be inundated with over 140 local tax increases affecting many cities and counties that are ten times bigger. But Stanton is ground zero in a battle over how to manage municipal budget deficits, because if their voters approve this tax increase, cities throughout Orange County will follow suit.

We’re not talking small potatoes here. Stanton currently only retains 1 percent (one-eighth) of the 8 percent sales tax they currently collect. According to Stanton’s Consolidated Annual Financial Report for the fiscal year ended 6-30-2013 (page 9), their total sales tax revenue for that year was $3,683,199. If they increase their sales tax rate from 8 percent to 9.0 percent, they should double the amount of sales tax collections retained by the city. A spokesperson for the city of Stanton confirmed they project the new sales tax will add $3.1 million to their projected annual sales tax revenues. How does that compare to their spending?

According to Stanton’s “Measure GG,” the city “now faces a $1.8 million structural budget deficit.” This means the sales tax increase is expected to eliminate their budget deficit with $1.3 million left over. But if you evaluate Stanton’s expenditures, there is an alternative to new taxes. How does the city spend most of their money?

To answer this, again, look no further than the “Whereas” section of Measure GG. The third “Whereas” states “public safety is a top priority in Stanton and represents over 70 percent of the City’s General Fund budget, and without a local funding source the City will be forced to significantly cut public safety services.”

It’s quite clear that Stanton has already cut everything else. Based on information reported to the California State Controller’s Office, in 2012, the City of Stanton had 26 full-time non-safety personnel. Their average base pay was $74,146 per year, with negligible overtime, and “lump sum” payments averaging $4,700 per year, mostly to management. The lowest full-time regular rate of base pay was $42,359 for an administrative clerk. When you pile on the employer payments for retirement health care (average per year $8,691) and for their 2 percent at 55 pensions (average per year $15,693), the total pay and benefits for Stanton’s 26 non-safety employees in 2012 averaged $104,990. Nice work if you can get it. But it represents less than 18 percent of Stanton’s estimated direct personnel costs.

Finding information as to just how much Stanton pays for police and fire protection is not easy, but a reasonably accurate estimate is possible. According to Stanton’s city website under “Fire Services, we learn “there are a total of 21 firefighters who serve the City of Stanton.” Under “Police Services,” we learn “the Sheriff’s Department provides 44 staff members to the City of Stanton.” If we make just one assumption – that the rates of pay earned by the sheriffs and firefighters assigned to Stanton are representative of the rates of pay earned by all Orange County sheriffs and firefighters, we can estimate how much Stanton incurs in direct personnel costs for public safety. Pay for Orange County sheriffs can be found using 2012 data reported by Orange County to the CA State Controller. Pay for Orange County firefighters can be found from 2013 data recently obtained by the California Policy Center directly from the Orange County Fire Authority. Here goes:

OC Public Safety

Based on the data and assumptions as noted, on average, Stanton’s 21 firefighters earn a direct pay and benefits package of $217,956 per year; Stanton’s 44 sheriffs earn an average direct pay and benefits package of $186,682 per year. The source data used for these calculations and others cited in this post can be downloaded here “Stanton_2014_Statistics.xlsx” and readers are invited to point out any errors in calculations or reasoning therein.

There are a lot of takeaways here. For example, if Stanton were to join with other Orange County cities who contract for their police and fire protection and negotiate a 14 percent decrease to the average total pay and benefits their police and firefighters earn, they would eliminate their structural deficit of $1.8 million – and their firefighters would still earn average pay plus benefits, after the reduction, of $187,285 per year, and their sheriffs would still earn average pay plus benefits, after the reduction, of $160,412 per year. The average household income in Stanton during 2012 was $48,146.

A final observation – CalPERS has announced a 50 percent increase in required annual pension contributions, to be phased in between now and 2017. If Orange County’s independent pension system follows suit, and there is no evidence their financial imperatives differ significantly from CalPERS, then Stanton’s annual required pension contributions will increase by $2.2 million per year – nearly all of that for public safety. So even if Measure GG passes, the projected surplus of $1.3 million will probably be more than offset by increased pension contributions. Expect more taxes, or start cutting pay and benefits.

It is always important to emphasize that public safety employees deserve to be paid a premium to compensate for the risks they take to protect the public. But Stanton’s citizens and elected officials, and their counterparts in cities throughout Orange County, will have to decide where to draw the line on that premium. Perhaps the facts should speak for themselves.

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

 

 

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