Tag Archive for: meg whitman

Pension Funding & Rates of Return

In a March 18th interview (view video), California Gubernatorial candidate Meg Whitman expressed the problem with pensions quite accurately, stating “there is a current period cost of pensions, and that cost is only going to increase.” Whitman went on to say that CalPERS may lower the long-term rate of return they use for their pension fund earnings projections. One of the solutions Whitman offered to California’s pension crisis was to suggest California’s non-safety employees defer retirement from the current age 55 to age 65, and also for California’s non-safety employees to contribute 10% of their salary to their pension fund instead of 5%. How much will this help?

If we assume these reforms are applied at the local level as well – since most public employees in California work at the local level – the calculation of savings based on doubling the average employee contribution from 5% to 10% is fairly straightforward. There are about 1.6 million non-safety, non-federal public employees in California, and their average salary is $60,000 per year. If you take 5% of that, $3,000, and multiply by 1.6 million, you get nearly $5.0 billion per year in savings to the taxpayer. Is this significant? Will this help?

To answer this question, the biggest variable by far is what rate of return you calculate for the pension funds themselves. To illustrate this, consider the impact of Whitman’s other proposal, to raise the retirement age from 55 to 65 years old. As the table below indicates, if we were confident that CalPERS official inflation-adjusted rate of return of 4.75% were possible, these two reforms – raising the retirement age by 10 years plus doubling the employee contribution to their retirement fund – would nearly solve the problem. Raising the retirement age saves nearly $7.0 billion per year, and doubling the employee contribution throws another $5.0 billion into the pot. Suddenly pension funding for 1.6 million non-safety employees in California’s state and local governments only costs $7.0 billion per year, instead of $20 billion per year. Problem solved? Perhaps. On the other hand, when Pippin asked Meriadoc why they couldn’t just run back to the Shire to drink beer, tend their gardens, and smoke pipe-weed, Meriadoc said “Pippin, there isn’t going to be a Shire.”

Let’s suppose you can’t assume long-term real rates of return of 4.75% for the following reasons: (1) trillion dollar funds can’t appreciate faster than the rate of general global economic growth, which over the past 60 years has averaged about 3.0% per year, (2) public equities over the past 85 years have appreciated at a real annual rate of 2.8% per year, (3) central banks are flooding the world with currency to stave off deflation, (4) money market funds are only returning 1.0% per year, (5) the stock market has been flat for the last ten years, (6) household and consumer debt is still at unsustainable levels and nobody is buying anything, (7) banks are holding foreclosed residential real estate assets to avoid further drops in asset values, (8) the commercial real estate market is hanging by a thread, (9) the bond bubble is about to pop, (10) we can’t extract abundant reserves of natural resources because environmentalists have successfully legislated or litigated development to a standstill, (11) the business community has given up and has decided the government is their new customer, and (12) public sector unions have taken over our state and local governments in California – demanding wages and benefits that are bankrupting us – and they are successfully exporting that model to other states and to Washington DC, guaranteeing the tax burden on job creating businesses will go up, not down.

If all that isn’t enough, there is the simple demographic fact that we live in an aging world. The ratio of workers to retired people everywhere on earth is going to go up, inexorably, for decades to come. There are two ways to finance retirement security under these conditions – retire later in life, and increase worker productivity through innovation. CalPERS and CalSTERS are not going to game the system and escape this reality because they are too big. If the twelve factors just noted that are hampering economic recovery are addressed, productivity will accelerate its upward march, and everyone can enjoy a secure retirement. But today CalPERS and CalSTERS, because of the unrealistic projections they make and the impossible demands those projections enable, are part of the problem.

For these reasons, the chances we’re going to see inflation-adjusted 4.75% annual rates of return on trillion dollar investments are about as likely as Sauron deciding he’ll stop catapulting the heads of captured knights over the walls into the citadel of Gondor, and instead will instruct his armies of Orcs to plant flowers and learn how to play soccer. But if the fantasy saga of Middle Earth dealt in harsh realities, the actuaries at CalPERS are apparently still drinking beer under the party tree in Hobbiton.

To verify this, earlier this week I checked with an official at CalPERS to ask him whether or not they were going to lower their earnings projections. This is what he wrote in reply:

“These were only rumors that were circulating.  Every three years the CalPERS Board reviews the asset allocation and only if they elected to change to a much more conservative asset mix would there be a change in assumption.”

This is an illuminating response, because it suggests CalPERS is still holding off on lowering their real (inflation adjusted) long-term projected return, which currently is 4.75% per year, and also because it suggests they have not moved their assets to a “much more conservative” mix of investments. This is consistent with a March 9th 2010 report by Leo Kolivakis, in his post entitled “Public Pension Funds Doubling Up to Catch Up,“ where he wrote:

“So what are public pension funds doing? Cranking up the risk, investing in failed banks, leveraging up, shoving more money in private equity and hedge funds, whatever it takes to achieve that insane 8% average annual return they’re all still fixated on.”

So how much will Whitman’s reforms matter if CalPERS can only earn 3.0% on their funds – after inflation? In the table below the same results are reported, based on a 3.0% real rate of return.

When you use a rate of return of 3.0%, the estimated annual pension cost for California’s state and local non-safety employees is not $19.7 billion per year, as it would be using a rate of 4.75%, but $33.1 billion per year, nearly twice as much. It is difficult to overstate the financial impact of lowering this projected rate of return. This is best case, by the way, because these figures were calculated under the assumption that pension assets are fully funded today, and it also assumes the age of workers in California’s state and local governments are evenly distributed between those entering the workforce and those about to retire. In reality, California’s public employee pension funds are already underfunded and have to play catch-up, and the workforce is skewed towards a disproportionate number of workers who are nearing retirement. For these reasons, if you go with a 3.0% rate of return, the $33.1 billion annual cost is still understated. And nowhere in this analysis are the costs considered for state and local employees engaged in public safety. They comprise 13% of California’s state and local public sector workforce, and their retirement packages are significantly more generous than the non-safety employee packages discussed here.

The solution to California’s deficits is not to raise taxes. As housing prices shot upwards at a rate far exceeding inflation over the past 20 years, revenues from property taxes rose accordingly. Government tax revenues in California, from corporate taxes, individual income taxes, property taxes, sales taxes, and countless fees, total about $400 billion per year. This is plenty of money to run our state and local governments, if public employee pay and benefits are scaled back by about 20% across the board. For more, read “California’s Personnel Costs.” The benefits to the state’s economy would be immediate and profound.

If you want to know which California Gubernatorial candidate is most likely to make that prescription, flip a coin.

No Profits, No Pensions

California Gubernatorial candidate Jerry Brown knows he’s in a fight. His presumptive Republican opponent, Meg Whitman, not only is doing a good job presenting herself as a socially moderate, fiscally conservative candidate, but she has abundant personal wealth she can tap in order to finance her campaign. So Jerry Brown has to turn to the only reliable source of campaign cash out there, the public employee unions.

In Joel Fox’s report of March 22nd entitled “Brown Embraces the Public Unions,” Fox quotes Brown as saying “California’s fiscal problems are not the unions’ fault but that of Wall Street and corporations.” Get ready for a campaign season filled with more bashing of corporations. And here are some reasons why this rhetoric is absurd, nihilistic, corrosive, deceptive, utterly bankrupt, and at least to-date, tragically effective:

Public sector unions are by far the most powerful source of campaign cash in California. They can pretty much spend as much as they want to make sure their candidates get elected, and their opponents are defeated. Without these unions, Jerry Brown wouldn’t have a chance against Meg Whitman. But is Brown only singing the union song in order to get their financial support? After all, in late February 2010, in a closed meeting with a group of California business leaders, Brown admitted the single greatest mistake he made as Governor back in the 1970’s was his decision to sign legislation allowing public sector workers to unionize.

Public sector unions have successfully convinced Californians that Wall Street and corporations are basically to blame for all the problems in our society – from deficits to poverty, from bad public policies to social injustice. But public sector unions are in bed with Wall Street. In the United States, there is no source of new investment capital bigger than public employee pension funds – most of it flowing through Wall Street brokerages. The public sector unions, through their pension funds and through the state and municipal governments – which they control – worked with Wall Street and enabled Wall Street. It was Wall Street who packaged the investments that public pension funds purchased – and it was Wall Street and the public sector unions who, more than anyone, wanted to believe they could earn 8.0% annual returns forever.

That’s not all. In 2006, California’s legislature, controlled by public employees, enacted AB32, California’s “Global Warming Act.” Already, agencies and utilities throughout California are tacking “global warming mitigation” fees into their billings. And in less than two years, when AB32 takes full effect and California starts auctioning tradeable CO2 emission allowances, it is Wall Street firms who will broker these CO2 allowances, and it is Wall Street who will package all the CO2 “offset” prospectuses. Read the “scoping plan” from CARB, which lays out how AB32 will be implemented. You will learn how CO2 “offset projects” – which will receive the proceeds of the CO2 emission allowance auctions – will earn reimbursements by how much they reduce CO2 emissions. For example, by mandating even more draconian high-density than we already endure here in California, municipalities will be able to calculate the emissions they have saved relative to “sprawl,” and collect annual reimbursements. Pet projects that create jobs at taxpayers expense for union workers, such as light rail, will go in regardless of practicality, and also receive carbon offset funds calculated on the basis of their potential to reduce CO2 emissions. California’s global warming act, which will do nothing to address alleged global warming, is a scheme, hatched by public sector bureaucrats to transfer more money from taxpayers into the government. And Wall Street will stage-manage the entire process – making billions in fees.

When Jerry Brown, on behalf of public sector unions, demonizes Wall Street, he’s being a blatant hypocrite, but at least he has a point. In the case of industrial corporations who want to employ people and build actual products, however, Brown and the public sector unions have no point. According to Brown and the unions, if only corporations would behave themselves and pay their “fair share,” all of our problems would disappear. Where is the logical end-point of this nonsense? The last politician to tell the truth about taxes and corporations probably was Ronald Reagan, who correctly pointed out “corporations don’t pay taxes, because they pass the taxes through to the consumer as a cost – ultimately it is individuals who pay taxes.” The public sector union’s answer to this truth, observed by Reagan and confirmed by history, is for government to simply reduce corporate “profits.” If the corporations were forced to make less in profit, supposedly they could afford to pay higher taxes AND charge a fair price to consumers for their products. But profits are the life-blood of economic growth and wealth creation. Without profits, there is no reinvestment in equipment and upgrades, no research and new product development, no new job creation, no dividends to shareholders, and no stock appreciation which provides the return to public employee pension funds. No profits, no pensions. And in any event, corporations in California are beat down, intimidated by public sector unions and environmentalist attorneys, reeling from the effects of recession and the impact of excessive, punitive regulations. California’s business community has been practicing appeasement with the public sector unions and environmentalist attorneys for years – they cower like Théoden, King of Rohan, wasting away, corrupted by fear, waiting for Gandalf and Aragorn to awaken him before all is lost. But we live in California, not Middle Earth.

What public sector unions ought to know, and cannot admit, is that tax revenues they collect and allocate, especially through public pension fund investments, are the engine that fuels Wall Street, and they are as responsible as anyone else in this economy for the excesses and abuse of the financial sector in America. What they also should know, as they watch their pension funds crumble, is the fiscal policies they have forced onto compliant politicians are unsustainable and are cannibalizing the wealth of the country. To distract voters from this financial fact: that California’s public sector bureaucrats, on average, now make 50% more in base pay, 100% more in current benefits, and 200% more in retirement security – compared to the taxpayers who now serve them and pay for this hideous inequity – public sector unions and the candidates they control must preach the politics of resentment and envy, hatred of wealth and environmental panic, corporate demonizing and phony Wall Street bashing. They must brainwash our children in their union-dominated public schools, and bamboozle our electorate through their massive campaign advertising, so they can continue to feed for a few more years on the ailing carcass of what was once the greatest free-market economy in the history of the world.

For more on public sector unions and government solvency in California, read:

The Razor’s Edge – Inflation vs. Deflation, March 15th , 2010

Pension Rhetoric vs. Pension Reality, February 24th, 2010

California’s Union Ballot Initiatives, February 18th, 2010

Sustainable Pension Fund Returns, February 2nd, 2010

California’s Personnel Costs, January 24th, 2010

Maintaining Pensions Solvency, January 9th, 2010

Real Rates of Return, June 26th, 2009