Tag Archive | "public pensions"

California municipal bankruptcies threaten public pensions

The coming battle in public pensions is between CalPERS, the biggest public pension fund in the country, and bond insurers who want pension payments made by bankrupt municipalities to CalPERS cut. This could mean that pension contracts made with bankrupt cities could rendered void.

Public pensions in California are supposed to be sacrosanct and untouchable. The assumption is that public pension agreements are unalterable. However, recent California municipal bankruptcies now threaten public pension contracts and perhaps could even break them. If that happens, then any struggling municipality could target public pension agreements and benefits. We are at the beginning of a serious battle between deep-pocketed players to determine who is first in line for money from bankrupt cities and what cities must do to fulfill their bankruptcy plan.

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California ignores growing public pension crisis

The two major California public pension funds have a combined unfunded liability of about $72 billion (PDF- Pg. 41). Yet Gov. Brown just postponed a pension reform ballot measure and instead is making vague promises about how change will come while offering no concrete proposals.

A Field Poll says voters are not too concerned about pension reform, favoring mild changes and opposing eliminating collective bargaining. However, voters in San Jose and San Diego recently overwhelmingly approved pension reform, including eliminating benefits for existing workers (or making them pay more for them). Thus, the issue of pension reform is beginning to get major visibility in California, a trend that will continue as the crisis grows.

More on IVN, including discussion of how California public pensions can force the state and municipalities to cover their shortfalls, except perhaps when municipalities file bankruptcy. Three California cities have done so in the past two weeks.

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San Jose and San Diego to vote on divisive public pension reform

Credit: sanjoseca.gov

Voters in San Jose and San Diego will decide on Tuesday whether to approve measures to lower public pension costs by reducing benefits. These elections are critical to the public pension reform movement, with many across the nation watching these bellwether votes. If the measures pass, they will provide momentum for other municipalities to use similar tactics to reduce public pension costs. Public unions are understandably opposed to radical change in pension plans even as they, and most, acknowledge that some changes are needed.

The collapse of the real estate bubble damaged the financial health of many cities. Despite this, public pension costs continued to rise steadily. Municipalities are caught in a relentless downward spiral of less revenue and increasing costs.

More at IVN

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Politicians and unions hide liabilities for public pensions

California Gov. Brown proposes solutions but doesn't include assumed rate of return. Credit: latimes.com

Public pensions across the country generally calculate future liability by assuming an 8% rate of return. “The problem with that is the 8 percent assumption is totally bogus,” says Connecticut columnist George Gombossy, noting that that public pension returns there have averaged just 5.7% for the past ten years. Most other states have similar problems with overly rosy projections that do not track reality. When that happens, pension funds have funding shortfalls. Assuming 8% but getting 5.7% means you will be 20% short at the end of ten years.

More about public pension liabilities at IVN.

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CalPERS earned just 1.1% in 2011

The California Public Employees’ Retirement System (CalPERS) announced a disappointing 1.1% return on their investments for calendar year 2011. By their own estimates, they need to average 7.75% a year to meet current and future obligations to its about 1 million members and 500,000 retirees. Some years, like in 2009 and 2010, they did better than the average. But when the real estate bubble popped in 2008 they had severe losses.

The big problem that CalPERS (and all pension funds) face is the amount they must pay out in pensions and medical benefits is generally increasing steadily while their income fluctuates. In addition, more than a few think a 7.75% return year after year is unrealistic, that trying to meet than means taking unnecessary and possibly quite costly risks. We are talking retiree’s money here after all. CalPERS isn’t a hedge fund nor should it be run that way.

In the past ten years there have been two stock market bubbles then collapses. The dot com implosion singed many but had no systemic effects. However the real estate implosion took down the economy with it, and we’ve yet to recover. The entire Eurozone with its ever-looming sovereign debt crises are another example of how assuming a specified return can be difficult in normal times and near-impossible in shaky times like ours now. Even if CalsPERS owns no sovereign debt, others do. Wobbly financial times impact everyone.

But CalPERS and the other big public pensions can by law force the State of California to make up any funding shortfall it has. Even in 2010, when CalPERS returned 12.6%, the State of California made contributions of several hundred million to CalPERS and CALSTRS (the teacher pension fund.) This year it will be over $3 billion. Private pensions can only dream of such guaranteed funding. And where’s the incentive to conservatively manage retiree pension money when the State can be told to make up any shortfall?

Private pensions also have much stricter accounting rules than public pensions. Forbes explains:

States and localities [can] assume they will benefit from the high returns of having part of their portfolio invested in equities, without accounting for the increased risk. This allows public pensions to hide the true cost of public pensions from taxpayers, contributing to the massive pension funding crisis which we now face in the U.S.
If public pensions had to follow the same rules as private pensions, their ability to meet obligations would be questioned by many. This begs the question. Why are public pensions allowed to operate under much looser standards than private pensions?

A new state advisory board is now including a “sensitivity analysis” in their projections for the public pensions. They factor in what the employer would have to pay given differing pension fund returns. If they hit that 7.75% mark, then employers pay 19.5% of pay. But if the fund should drop just 4% in the next few years, then employers would have to put up 28.9% of pay. These employers are public entities, so the amount will eventually come, in one way or another, from California taxpayers.

California has huge unfunded pension liabilities at all levels. These won’t go away by assuming perkily optimistic returns during unstable economic times.

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Rhode island city files bankruptcy, voids public worker contracts

The city said municipal workers must now pay 20% of their medical coverage and that everything was done to avoid this day but the unions wouldn’t budge.


Central Falls was bankrupt years ago and I said so repeatedly. The costs on taxpayers to delay this bankruptcy have been severe.

Once states realize that bankruptcy is not tantamount to statewide Armageddon, there will be a flood of city bankruptcies.

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Public pension accounting rules far laxer than private

Government pensions, including CalPERS and the other public pension plans in California, are permitted to use far laxer accounting standards than private pension plans. This allows them to greatly overstate how much money they have and to understate future liabilities, something which does not bode well for the financial health of the funds or for those relying on the money for retirement.

Yes, you got that right. Federal government rules allow their own pensions, as well as state and local pensions, to ignore rules that private funds must follow. This is almost as egregious as the federal government saying the Too Big To Fail banks (and them alone) do not have to mark to market and instead can price their often toxic assets at whatever they want. Thus, they can pretend that dicey mortgages and properties are worth what they were valued at when the deal happened and not what they are worth now, which is often sharply less. Thus, their financial situation can pretend to be far healthier than it actually is.

Public pensions can pull the same tricks, in effect cooking their books (and doing so quite legally.) But by doing so, they are also cooking the retirement plans of millions by pretending that money is there when it isn’t.

Private pensions can smooth market changes out for 2 years provided the fluctuation isn’t more than 10%. Public pensions can spread that out over 15 years with a 40% fluctuation allowed. They can amortize debt over 30 years instead of the 7 years allowed for private funds. It gets worse. Public funds can assume future rates of return that private pensions can’t. CalPERS assumes a 7.75% return, something Warren Buffett calls “crazy” and “nuts,” especially when you consider that CalPERS has averaged 4.3% for the past ten years.

Why is this “pretend and extend” bogus accounting allowed for public pensions but forbidden for private pensions? This is far more than just an alternate way of accounting. It permits public pensions to pretend they have far more money than they actually do and to extend the problems into the future for the inevitable day when someone besides them will have to deal with the mess of having their rickety, financial house of cards finally collapse.

Recently, CalPERS received $2 billion from California to meet their funding shortfall. Had they been required to follow private pension rules, the state would have had to give them $7 billion. What, you didn’t know CalPERS can force the state to give it money? Why yes it can, and the state can’t say no. Goodness, how cozy is that! Of course, this gives the state ample reason to play along with fantasy financial statements based on bogus numbers because then, they can pay less to CalPERS and the other state funds.

All of this is made worse by often inept ‘investing’ by CalPERS. They lost $500 million of retiree money on a disastrous New York City apartment investment in 2009 and recently lost 92% of their money on desert land in Arizona. Both deals were described as hugely speculative by real estate insiders. Investing in dicey real estate at the top of a bubble is not a responsible way to manage retiree money, nor is allowing lax rules for public pensions.

(crossposted from CAIVN)

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Utah pension reform could be model for other states, including California

California, along with many other states, has unfunded public pension obligations that it hasn’t the remotest possibility of being able to meet. A Stanford study last April determined California’s unfunded pension liabilities to be $500 billion. That’s right, California owes half a trillion dollars and it hasn’t a clue where the money will come from.

This sorry state of affairs is due to multiple factors. California public pension funds have been mismanaged for years and have used unrealistic estimates of future growth to pretend everything was fine, only to frantically revise those estimates when the inevitable reality pie hit them in the face. The stock market slump caused further damage to the funds. Incredibly, public pension liabilities are not even included in the state budget. Instead, they’ve been ignored and pushed to the side in hopes that perhaps a magic fairy will soon sprinkle pixie dust on the funds and then all will be well. That must be what legislators and fund administrators have been hoping for, because how else can one explain their deliberate and willful myopia and belief that if they ignore the problem long enough, it will fix itself? That game is now over. The magic fairy has announced she will not be coming to California and that the state will have to deal with the public pension shortfall all on its own.

Last year, Utah switched from defined benefit to defined contribution pension for its public employees after State Senator Dan Liljenquist determined their public pensions were nearing insolvency and spearheaded pension reform. A defined benefit plan is what California public employees have now. It specifies the amount of monthly benefits upon retirement. Investments made by the pension fund are assumed to be able to keep up with the amount owed, even though this clearly has not happened in reality. By contrast, a defined contribution plan specifies how much the employee and employer will contribute. The amount of future benefits is not guaranteed. However, employees control their own plan, can invest it however they want, can take it with them if they leave, and crucially perhaps, the state cannot attempt to loot it to pay for current obligations.

Under the Utah plan, new hires have a defined contribution plan with the state contributing a generous 10% of pay. They can also choose a defined benefit plan, but the state contribution remains the same at 10% and is not open-ended. This guarantees that Utah knows precisely how much it will have to pay. Even a stock market crash can’t force them to pay more, as happens in California now where CalPERS can mandate that the State of California fund their shortfall. Last year that was $3.2 billion. By contrast, Utah’s plan is eventually expected to cut their pension costs in half.

For better or worse, defined contribution plans for state employees are probably going to be adopted widely. Wyoming may be next and other states are interested too. A big problem with such plans is that it shifts the burden of investing wisely from a pension fund to the employee. But many employees have no expertise in investing and could easily make blunders. Of course a cynic might snarkily say they couldn’t do much worse than some of the public pension funds.

All of this also applies to municipalities, and that’s where the financial implosions and resultant bankruptcies will hit first. Some cities almost certainly will be filing for bankruptcy soon, and when that happens, public pension plans will be reworked. In fact, bankruptcy judges may have the power to break existing defined benefit plans and convert them to defined contribution. States can’t file bankruptcy under existing law, but that could be changing too.

Crossposted from CAIVN.

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On breaking unions, states filing bankruptcy, and public pension underfunding

During the Great Depression, Congress passed an act saying states and municipalities could file for bankruptcy. The law was challenged and part of it was overturned by the Supreme Court in 1936 in Ashton v. Cameron County Water Imp. Dist. Congress then rewrote the law so that municipalities could file bankruptcy. However, the Supreme Court specifically ruled that the federal government did not have the authority to “restrict the States in the control of their fiscal affairs” and that ruling still holds. In other words, it was a clear issue of states’ rights. Thus, there is no provision in federal law for states to file bankruptcy. Also, bankruptcy courts are federal, not state. Therefore, there is no way for states to declare bankruptcy.

This is obviously of more than academic interest as many states, including California, are facing severe budget deficits. Without bankruptcy, the only option, should obligations not be able to be met, is to default on bond payments as well as not meet other obligations.

Some Republican lawmakers want to change this. They want states to be able to file bankruptcy, and they also want to force states and municipalities to use stricter private pension fund accounting rules to determine their liabilities. Currently, public pensions are allowed to assume far more generous (and utterly unrealistic) rates of return than private pensions can. House members Devin Nunes, Darrell Issa of California, and Paul Ryan of Wisconsin have introduced a bill to mandate the more conservative rules. If the pensions refuse, they would not be allowed to issue tax-exempt bonds. This would directly impact all three of the major public pensions in California, including CalPERS.

Even liberals will have trouble arguing that public pensions should not have to follow the same accounting rules that private pensions do. However, they are also alarmed that such rules, along with states being able to go bankrupt, are actually a conspiracy to go after public unions and pension funds. Let me assuage their fears. It’s not a conspiracy at all but rather in plain view for all to see.

Here’s how it would work. California files bankruptcy. A federal judge oversees what comes next. Normally, bondholders go to the head of the line. A crucial part of a new bankruptcy law is that it must have a ‘cram-down” provision that forces bondholders to take pennies on the dollar and not allow them to protest and drag the process out for years (Without such a provision, such a new law would simply be a gift to investment banks and hedge funds, allowing them to grab most if not all of the money.) Here’s the crucial part. The trustee for the bankruptcy would also have the power to break or re-negotiate public pension agreements. This is where the coming brass knuckles fight in California will be, with public unions and their pensions fighting an attempt by conservatives to break their power, influence, and to re-do existing pension agreements.

Many liberal blogs and commentators are howling about this. If they want to prevent it, then they need to explain where the money for the state budget and its woefully underfunded public pensions will come from. This is not a made-up crisis. The money really isn’t there

Crossposted from CAIVN

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Public pensions. The new battleground

Pensions eat 70% of Decatur, Illinois’ budget; New York City’s $76 billion shortfall; Houston Mayor wants pension benefit cuts

The coming battles in 2011 over public pensions will be brass-knuckled death matches. Liberals, progressive, and unions howl that conservatives want states and cities to file bankruptcy so their public pensions can be re-negotiated. This is unquestionably true. But the pensions are unsustainable, with most pension plans being deeply in the red. Those who want to save the pensions better figure out where the money will come from, because it simply isn’t there now.

Me, I think it’s inevitable there will be many such bankruptcies and the entire public pension system will be re-done.

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