Tag Archive for: california’s public employee pensions

California Cities in Critical Condition

The specter of California’s cities and counties becoming insolvent is nothing new. Three major California cities have already declared bankruptcy, Vallejo in 2008, Stockton and San Bernardino in 2012. In October 2019, the California State Auditor’s Office reported on the fiscal health of 471 California cities.

On what the California State Auditor’s office describes as a “Local Government High Risk Dashboard,” they identified 18 high risk communities: Compton, Atwater, Blythe, Lindsay, Calexico, San Fernando, El Cerrito, San Gabriel, Maywood, Monrovia, Vernon, Richmond, Oakland, Ione, Del Rey Oaks, Marysville, West Covina, and La Habra.

This so-called “dashboard” includes data for all the 471 cities on financial variables such as liquidity, debt, reserves, pensions and other retirement benefits. It also provides an excellent map. On this zoomed in segment, the financially troubled cities of (from north to south) Richmond and El Cerrito (contiguous), and Oakland can be seen highlighted in red.

Southern California also has its share of financially troubled cities, as shown on the next map segment taken from the California State Auditor’s dashboard. Clockwise, starting from the top, the most financially endangered cities are Monrovia, West Covina, La Habra, Compton, Vernon and Commerce (contiguous), and San Gabriel.

Back in October 2019 when the California State Auditor warned Californians about 18 cities in immediate financial peril, the overall economic situation looked very different than it does today. And at that time, articles that reported on the auditor’s warning published by Reason, Governing, and Associated Press all pointed to underfunded pensions as a primary cause of their financial distress.

Not long ago, but still prior to the events of the past few weeks, during a hearing in the California State Assembly on February 26, the California State Auditor requested authorization to conduct in-depth audits of the financial health of five California cities, Blythe, El Cerrito, Lindsay, San Gabriel, and West Covina.

The one financial threat that was mentioned in all five of the California State Auditor’s requests was pensions.

“Blythe has incurred substantial debt and increasing liabilities pertaining to its city employee retirement costs, which could result in the city needing to divert more of its general fund resources to cover these costs in lieu of providing essential public services.”

“El Cerrito has not developed a long-term approach to improve its financial condition and has not addressed its increasing pension costs.”

“Lindsay anticipates its pension and other post-employment benefit costs to at least double by fiscal year 2025-26.”

“My office identified San Gabriel as the eighth most fiscally challenged city in California primarily because it has insufficient cash and financial reserves to pay its ongoing bills and it faces challenges in paying for employee retirement benefits.”

“West Covina’s unfunded pension liability is very high compared to its annual revenues, and it has only set aside a portion of the funding it will need to pay for the pension benefits already earned by its employees. Its growing pension costs will also put additional pressure on its finances.”

The Market Correction Will Affect More Than Pension Payments

It’s interesting to wonder why California’s State Auditor selected five relatively small cities for the scrutiny of a state audit. The most troubled of the five, Blythe, was number three on the auditor’s ranking by overall financial risk, behind Compton and Atwater. The City of West Covina was number 17. So why not big cities? Why not Oakland, ranked number 13, or San Jose, ranked number 23, or big Los Angeles, ranked number 32? When the denominator is 471, being ranked 32 is not good – that puts Los Angeles in the worst seven percent.

But now what? Now that the economy is slowing, and the value of investments are correcting dramatically downward?

No matter what position one may take on the financial wisdom of offering defined benefit pension plans to public employees, one point needs to be reiterated at a time like this: While it is true that an 80 percent funded status is considered adequate for a pension fund, it refers to an average across the business cycle. It does not represent what should be necessary at the end of a bull market. California’s public employee pension funds, a few weeks ago and at what we now know was the end of an 11 year bull market, were only about 70 percent funded.

This cannot be stressed enough, because it puts into proper perspective what has to be faced today. A healthy pension system at the end of over a decade of extraordinary investment returns should be overfunded. Perhaps it is credible to be sanguine about falling a bit short of the 80 percent threshold after ten years of investment doldrums, but it is absurd, and dangerous, to pretend such a level of funding is adequate after ten or more years of spectacular investment gains.

And it isn’t just pensions, anymore, that are going to affect the financial health of cities across California, from San Jose and Oakland in the north down to Los Angeles in the south. The recent and long overdue correction in the stock market was triggered by a global pandemic that is going to paralyze huge segments of the U.S. and global economy for the next several weeks, if not months. This will cause sales tax revenues to crater for as long as “social distancing” mandates remain in place, and afterwards, even an extraordinary rebound is unlikely to make up for the loss.

The impact of investment losses will impact the pension funds in two ways. Obviously they are going to have to require more from taxpayers to cover their losses, and they were already phasing in a near doubling of their required contributions – which California’s cities and counties had no idea how they were going to pay for. But the other impact, lower revenue, will pose a much bigger challenge, affecting the ability of cities and counties to pay for anything, including the pension funds.

Not only will sales tax revenue falter, but state income tax revenues will fall. California’s state government is highly dependent on income tax revenue from the wealthiest Californians. As reported by Cal Matters, “California’s tax system, which relies heavily on the wealthy for state income, is prone to boom-and-bust cycles. While it delivers big returns from the rich whenever Wall Street goes on a bull run, it forces state and local governments to cut services, raise taxes or borrow money in a downturn.”

California’s state and local governments have had over a decade to get their financial house in order. Instead, they have largely ignored the pension problem, with even Gov. Jerry Brown calling the PEPRA reforms of 2014 an inadequate compromise offering only incremental improvements. They have continued to make punitive demands on businesses, increasing taxes and spending at every opportunity. They have enacted regulations that make affordable housing and energy financially impossible for private sector interests to develop. They have emptied the prisons and opened the borders, putting additional stress on public services. They have created a state where one little push will end the good times.

That push has come.

Even the nonreligious may find an apt parable for today’s dilemma in Genesis chapter 41, verses 17 through 33. During good years, you prepare for bad years. Too bad the wisdom of the ages emphatically does not apply in woke California.

This article originally appeared in the California Globe.

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How Wall Street Bought the Public Employee Unions

Earlier this week, on December 7th, 2011, as reported by the San Jose Mercury, the “San Jose City Council votes 6-5 to place pension reform on June ballot.”

This plan is drawing fierce resistance, but there are two financial considerations that most critics of pension reform don’t take sufficiently into account when making their arguments:

(1) Pension contributions are very sensitive to how much the fund can earn. A pension that earns 3% per year, i.e., allows someone who works for 30 years to retire with a pension equivalent to 90% of their final salary, will require a 10% increase in annual required contributions (as a percent of pay) for every 1.0% the earnings on the pension fund drop. That is, if the contribution to a firefighter’s pension is currently 35% per year (based on employer and employee contributions combined), and CalPERS lowers their expected rate of annual return by just 1.0%, from 7.75% to 6.75%, then the required annual contribution as a percent of salary goes up to 45% per year.

(2) The rate of return being currently maintained by most pension funds, 7.75% per year, is much higher than can be sustained going forward. A key reason for this is because equity growth over the past 20-30 years, and especially over the last 10-15 years, was fueled by increasing debt. By enabling massive borrowing – consumer, commercial and government – more consumer spending was in-turn enabled, which increased corporate profits which increased equity values. Now global debt has reached its maximum, we are going to deal with slower growth and hence lower rates of return for pension funds. The other key reason for the inevitability of lower pension fund returns is demographic. With baby-boomers now beginning to retire, and with public sector workers now retiring with these far more generous pension plans (they were only raised about 10 years ago), there are more people selling equities than ever before in order to finance retirements. Equity values are a function of supply and demand, and public sector pensions are going to be doing a lot more selling to finance pension payouts than ever before. The chances that the major pension funds in the United States can continue to earn 7.75% year after year are virtually zero.

Pension reforms such as San Jose Mayor Chuck Reed’s proposal should be supported.

The San Jose proposal may actually do enough to restore financial solvency to a public employee pension plan. Eventually raising the employee’s withholding to as much as 25% of their pay begins to contribute enough money to fund these plans, especially when combined with accruing benefits at no more than 2.0% per year, and deferring retirement to age 57 or higher.

Here are a few questions and answers about public sector pensions:

QUESTION: Aren’t pension critics, or “reformers,” if you will, trying to ignore the contractual commitments they made as taxpayers, simply because they become more costly than originally expected?

Nobody “agreed” to these contracts as they have turned out. When pension upgrades were sold to politicians by Wall Street lobbyists they were represented as being nearly free to taxpayers because market based returns would cover the costs. Politicians didn’t understand the financial risks and voters were never told about it. To be fair, even the union leadership had no idea what they were getting themselves into.

Let’s put it this way – if somebody sold you a car, and said the payments would be $250 per month, then five years later said the payments would be raised to $1,000 per month, then five years after that said the payments would be raised to $2,500 per month, would anyone “like” that? And how would the holder of the loan appear – when they say “a deal is a deal” and try to force you to pay up?

In any event, opponents of pension reform should review the two financial points made earlier, because bankruptcy will void these contracts, and bankruptcy is staring every city and county in California in the face.

QUESTION: Everyone agrees that some kind of public pension reform is unavoidable, and that is exactly what is underway now. But can people who want to change public sector pension benefits legitimately claim that Chapter 9 is a magic bullet that will suddenly relieve everyone of the legal obligations that have been made on their behalf by their elected representatives?

Now that the bill for pension obligations is coming due, wouldn’t reneging on these obligations constitute theft?

ANSWER: “Theft” is how public sector unions have stolen our democracy and “negotiated” these unsustainable pensions with politicians they elected. Public sector pensions, on average, are five to ten times better than social security. The arcane and onerous details of pension obligations were buried in the fine print of these “contracts.” To imply that taxpayers are somehow the thieves for wanting to reduce pension costs down to the levels they were originally ignores the sheer scale and generousity of these financially unsustainable pensions. The 2010 annual reports from CalPERS and CalSTRS document that the average pension for a newly retired government worker in California after 30 years of work is nearly $70,000 per year. If every Californian over the age of 55 received that much in retirement it would cost $700 billion per year, nearly 40% of the entire GDP of the state! It’s impossible. It can’t go on. It is oppression and a recipe for economic ruin.

The bottom line is this – public sector unions and Wall Street are now in bed together, betting trillions of dollars in the markets with their pension funds, trying to eke over-market returns through aggressive fund management, with the taxpayers forced to pay up when they can’t hit their numbers.

From the CalSTRS Annual Report, page 135:

CalSTRS participants who retired during the 12 months ending June 30th, 2010 (the most recent data), earned pensions as follows:
25-30 years service, average pension $50,772 per year.
30-35 years service, average pension $67,980 per year.
35-40 years service, average pension $86,736 per year.

From the CalPERS Annual Report, page 151:

CalPERS participants who retired during the 12 months ending December 31st, 2009 (the most recent data), earned pensions as follows:
25-30 years service, average pension $53,182 per year.
30+ years service, average pension $66,828 per year.

QUESTION: Isn’t it true that the longer someone works in any pension system, the higher their eventual benefit is likely to be? Doesn’t it work that way with Social Security, up to the cap?

ANSWER: The social security cap is about $31K per year after 40+ years of full time work, which equates to well less than 20% of the payee’s annual income. There is no cap on public sector pension payments, which are averaging nearly $70K per year, and they are averaging over 66% of the payee’s annual income, after only 30+ years of work.

Nearly everyone in America was purchasing more than they could afford during the internet/housing bubbles, but lobbyists hired by public sector unions, alongside lobbyists hired by Wall Street, are trying to make our politicians enshrine the pension liabilities – sold by Wall Street lobbyists to union-backed politicians – permanently into our tax code. And together, Wall Street and public sector unions have made public sector agencies collection agents for Wall Street. Wall Street hedge funds now bypass brokerages to manipulate market liquidity and asset values, and public sector pension funds are the biggest players on Wall Street. This is a corrupt system and cannot be fixed until taxpayer backed pension funds that can extract by “contract” 7.75% returns – either from investment returns or from taxpayers – are dissolved. And why shouldn’t public sector pension funds be the biggest players on Wall Street? Not only do they control about $4.0 trillion in assets, but they have the full backing of the public sector unions, the politicians they control throughout America’s states, cities and counties, and the taxpayers as the final guarantors.

Public sector pension funds and the social security fund should be all merged into a single fund, and the combined assets should be systematically moved into either cash or treasury bills, eliminating the speculators, eliminating most of the expensive financial bureaucrats of all stripes, and getting the government and Wall Street out of the business of fleecing taxpayers. And one, uniform and financially sustainable retirement incentive formula would be offered to ALL retired American workers, public or private.

For much more on the benefits and the feasibility of merging all public employee pension funds with social security, read “Merge Social Security and Public Pension Funds.”

How Much of California’s Budget is Personnel Costs?

An influential blogger in Orange County, California, made the following claim on January 25, 2011 in a post “Busting The Myths About Public Employee Pension Costs,” “For California’s budget, salaries represent 7.5 percent of the total state budget. The costs for healthcare and pension benefits are another 3.7 percent.” If only this were true.

Because this claim is being repeated as if it were fact, such as by guest columnist Nick Berardino in the Orange County Register, who on February 4th, 2011 in a “Reader Rebuttal” accused that newspaper of having “continued its misleading and irresponsible assault on public employees,” it is important to take a closer look. Using core data, as well as some studies funded by union-friendly think-tanks (hopefully to avoid accusations of bias), here are some numbers:

As a baseline, the California Governor’s Budget Summary for fiscal 2011 shows projected revenues and expenditures balanced at $89.6 billion. Using straightforward multiplication, if salaries and benefits only consume slightly more than 10% of California’s state budget, this means salaries, healthcare and pensions should cost (.075 + .037) x $89.6 = $10.4 billion. So how much does California’s state government actually spend on total employee compensation?

According to California’s own state government payroll records, in March of 2008 there were 393,989 full-time workers employed by the state of California, and their payroll for that month was $2,235,947,296 (ref. http://www2.census.gov/govs/apes/08stca.txt). This equates to an average of $5,675 per employee per month, or $68,102 per year. So by using data that is nearly three years old and assumes zero increases to compensation since then, in aggregate, just payment of salaries to workers employed directly by the state of California totals $26.8 billion per year.

In percentage terms, this figure would suggest that just wages for California’s state workers consume $26.8 / $89.6 = 30% per year. But there’s much more – benefits. If you read the definitions section of the U.S. Census Bureau Data, “gross payroll” is defined as “all salaries, wages, fees, commissions, and overtime paid to employees before withholding for taxes, insurance, etc. It also includes incentive payments that are paid at regular pay intervals. It excludes employer share of fringe benefits like retirement, Social Security, health and life insurance, lump sum payments, and so forth.” How much do benefits cost the state?

To short-circuit a war of battling studies, let’s use a supposedly authoritative study recently produced by the U.C. Berkeley Center on Wage and Employment Dynamics, Institute for Research on Labor and Employment, entitled “The Truth about Public Employees in California: They are Neither Overpaid nor Overcompensated” where they calculate an average overhead cost for California’s state and local workers at 36% of total compensation. That is, they claim 36% of total compensation is benefits overhead, and 64% is actual pay. 36% of total compensation equates to a 56% overhead rate, i.e., [ 1 / (1 – .36) ] = .56. The Berkeley researchers, who did a very comprehensive study, had no motivation to overstate the benefits overhead paid to public employees. It is likely the actual overhead is probably much higher than 56%, because it is unlikely the Berkeley researchers included an amount any higher than the current official rates for the necessary pension fund contribution, because the conventional wisdom still adheres to higher rates of investment fund returns than are probably out there over the next 20-30 years. But when you apply a 56% overhead rate – which is probably on the low side – to an average base salary of $68,102, you arrive at a total compensation estimate for the average state government worker in California of $106,239 per year.

What this means is the total direct employee costs for California’s state government is not $26.8 billion per year, based on salary alone, but 393,989 x $106,239 = $41.9 billion per year, which is 47% of the total state budget. And yes, there’s more:

If you take a look at the data from the U.S. Census bureau, referenced earlier, you can see the many job descriptions where salary expenditures are tabulated do not include K-12 education employees. This is because the state doesn’t pay these employees directly, but helps fund them through transfer payments to the local school districts. Returning to the California Governor’s Budget Summary for fiscal 2011, page 11, $36.2 billion is proposed for K-12 education expenditures. The skeptical reader is invited to study the details of this line item, but barring such analysis, it is a reasonable assumption that half of that money is going to be spent on compensation for K-12 education employees – another $18.1 billion.

When you add this all up, personnel costs for California’s state government are not somewhere barely above 10% of their total expenditures, as Prevatt asserts, but, doing the math, $41.9 (direct employees) + $18.1 (K-12 employees) = $59.96 / $89.6 = 67%. That is, using data taken directly from the state’s payroll records, combined with overhead calculations courtesy of an exhaustive study commissioned by an (arguably) sympathetic academic institute, along with very reasonable assumptions regarding transfer payments – not even considering transfer payments to localities for line items other than K-12 education – taxpayers are seeing at least 2/3rds of California’s state budget used to pay employee compensation.

Aside from overheated rhetoric and cherry-picked statistics, have those who still claim that public sector compensation isn’t a legitimate issue for civil discourse actually tried to run the numbers themselves? A final thought: When public entities are required to contribute into funds for retirement pensions and retirement health care at more realistic, lower rates of investment returns, the percentage of public sector budgets that are consumed by employee compensation will go up by 10-20% overnight. However comforting it may be for critics of these numbers to assert otherwise, it is hard reality, not wishful thinking, nor anti-public employee sentiment, that informs whatever bias may seep through this analysis.

Pension Rhetoric vs. Pension Reality

As  California’s public employee retirement system teeters on the verge of complete financial collapse, defenders of the current system continue to deny this, often accusing reformers of being “public servant bashers.” But politically motivated rhetoric will not change financial reality – or the pursuit of reforms so private workers don’t endure punitive taxation to sustain a privileged class of government employees. Last week the Sacramento Bee published a guest viewpoint written by Bruce Blanning, the Executive Director of the Professional Engineers in California Government. His commentary, entitled “State retirement benefits make an easy – and unfair – target,” invites a rebuttal.

The “real truth” about CalPERS, and other public employee pension funds, is they have consistently overestimated their long-term rates of return, adjusted for inflation. Currently CalPERS official rate of return, used for projecting the funds they will have available in the future, is 4.75%. This rate exceeds key long-term indicators that should govern these projections. For example, the inflation adjusted rate of return for the Dow Jones stock index for the period 1925 through 2008 averaged 2.8% per year. Similarly, the real rate of global economic growth for the period 1950 through 2000 averaged barely 4.0% per year, and this rate was skewed upwards by debt-fueled, unsustainable growth during the 1990’s. Even at a rate of 4.75% per year, CalPERS and the other pension funds are in a precarious state, because their asset values have been hammered in the last few years and will have to bounce back at rates in well in excess of 4.75% per year if they are to remain solvent (for more on these calculations, ref. Maintaining Pension Solvency).

Another “real truth” about public employee pensions is they currently collect benefits in retirement far in excess of what private sector workers can expect from social security. Public sector workers accrue retirement benefits according to a formula that grants them between 2% and 3% of their final year’s salary, times the number of years they worked. The 3% formula, for example, means that a public sector worker who spent 25 years in the workforce would receive a pension equivalent to 75% (3% times 25 years) of their final salary when they retire – with annual adjustments upwards for inflation. This benefit often begins when public sector workers retire in their early 50’s. An apples-to-apples comparison with social security provides for about 0.7% per year in retirement “pension” for private sector workers, which is at best one-third what a public sector worker receives – even though the private sector worker retires 15 years later! And social security doesn’t begin until one reaches their mid-sixties. When defenders of California’s public sector pensions – such as Blanning – reference an “average” pension for public sector workers of only $2,100 per month, they are not mentioning the fact that this number includes pensions for workers who were only in the public workforce a few years – and these workers would therefore also be receiving social security.

In the past, public sector workers received a pension that exceeded social security because they made less during the years they worked. But this has changed completely, and today, public sector workers, on average, make more than private sector workers. They also enjoy far more paid time off – they often get 26 paid days ala the “9/80” program (where they work 9 hours per day for 9 days, then get a paid day off, i.e., 26 paid days off per year), 12 “personal days,” anywhere between 10 and 20 vacation days, plus between 14 and 17 paid holidays. Find a private sector job that provides 75 paid days off per year. California is already one of the most heavily taxed states in the U.S., yet while roads and aqueducts crumble, taxpayer-funded public employees enjoy lives of inordinate privilege and security. And if public employees earned market rates of pay and benefits, like the rest of us, there would be no deficits (ref. California’s Personnel Costs).

Perhaps the most questionable of Blanning’s arguments was this one: “Of that $2,100 [the “average” monthly benefit of a retired public servant in CalPERS], only $1 of every $8 is paid by the employer, which means the taxpayer. The rest is paid through employee contributions and earnings on the investments.” If you dissect this, it is hard to follow exactly what Blanning is trying to say. Because if this means the state (on behalf of the taxpayers) is only paying 1/8th of the funding growth required by CalPERS for each worker for their portion of the retirement fund, this suggests the other 7/8ths is being covered either by the workers themselves through withholding from their paychecks, or by fund growth through investment returns. This, in-turn, suggests Blanning is saying that CalPERS expects virtually all of its funding to come from return on investments, since most public sector workers don’t even have half their retirement fund inputs withheld from their paychecks – which is what private workers contribute to social security via withholdings. Many public pension recipients don’t have anything withheld from their paycheck to go towards their pension fund.

If California’s public employee pension benefits are not dramatically reduced, hopeful rhetoric aside, the California taxpayer is liable. Pension fund managers were over-optimistic in their projections, and using more conservative scenarios their pension funds are already insolvent. Under the current arrangement, public employees, who pay very little of the costs of their future benefits in the form of withholding from their paychecks, are expecting to receive defined retirement benefits that dwarf anything a private sector worker can reasonably expect in their own retirement. And under the current arrangement, these taxpayers are supposedly going to pay – through even higher taxes (and fees) – the difference between what public employee pension funds expect to earn in the market, and what they actually earn in the market. Until the whole system is reformed, that is the reality in California today.

To suggest that the pay and retirement benefits that public employees currently enjoy is guaranteed by the California constitution or by “contract” is to ignore reality. California’s constitution can be amended by a citizen’s initiative. And the “contracts” that created these grossly inequitable and financially disastrous public employee benefits were the product of public sector labor unions exercising inordinate and unjustified influence over state and local politicians. This is the crux of the problem, and must be reformed along with reforms to reduce public sector pay and benefits. Public employees, through their unions, pour millions of dollars into political campaigns every year in California. They currently exercise nearly absolute control over California’s state and local governments. When the people collecting the benefits are controlling the politicians who grant the benefits, no contract should be considered inviolable – particularly when the alternative is bankruptcy.