California Rumblings?

Jim Christie of Reuters reports that Los Angeles' budget gaps may force dramatic change:

Los Angeles must take dramatic steps in coming months to bring its budget back into balance, including measures to slim the size of its government and reduce how much it spends on pensions for retired employees, the city's top budget official said on Wednesday.

Los Angeles, California's biggest city, is seeing a steep drop in revenues fueled by the state's 12.5 percent unemployment rate, a slump in consumer spending, an uncertain housing market and a weakening commercial real estate sector.

Fitch Ratings has grown so concerned about Los Angeles' budget woes that on Tuesday it downgraded the city's general obligation debt to AA-minus from AA.

Fitch said it expects the city's economic decline to impede financial recovery. Among problems it cited were high unemployment, sales tax weakness, assessed value losses, high home foreclosure and negative amortization mortgage exposure.

Miguel Santana, the city's administrative officer, said he was not surprised by the downgrade. He is intimately aware of how the city's finances are faring, and they're in dire shape, he told Reuters in a telephone interview after briefing the city council on options for balancing the city's books.

Officials must close a nearly $100 million gap in the city's current-year budget, and are likely to use reserve funds to do so, Santana said.

"Next year we're expecting a $400 million deficit," he said.

"We really need to prioritize our programs," he added, noting that tapping reserve funds next year would be imprudent.

Instead, difficult choices about the size of Los Angeles government should be made. "Next year we'll have to find some real structural adjustments," Santana said.

Those adjustments may include layoffs and shifting some work done by the city to the private sector to shave costs.

They may also include a new pension benefit structure for city employees -- the so-called "two tier" system that many local officials around California are mulling.

The system would basically have new public employees hired after a certain date receive fewer pension benefits than current employees.

New public workers may also have to contribute more from their paychecks to their retirement accounts.

"We're looking at everything," Santana said.

Fitch in its statement underscored its concern about how much Los Angeles may be spending on pension benefits.

"As rising pension costs contribute significantly to the future financial needs, the city cites pension reform as necessary to achieve fiscal balance and has already begun discussions with some labor groups. However, Fitch views the ability to achieve savings in this expense as uncertain in both amount and timing, especially since any change to the police and fire retirement systems requires voter approval," the credit rating agency said.

What's going on in Los Angeles will soon be going on across the US and developed world. Don't think for a second that tough fiscal measures won't be taken to shore up public finances. And this will certainly mean curtailing pension benefits for new and existing public sector employees.

Elsewhere in California, Reuters reports that Calpers may dump Blackrock as an adviser:

Calpers, the biggest U.S. public pension fund, is considering dumping asset manager giant BlackRock Inc as one of its real estate investment advisers, a person familiar with the matter said.

The California Public Employees' Retirement System is also investigating why two outside pension advisors were managing its $6.8 billion hedge fund portfolio two years after their contracts had lapsed, the Los Angeles Times reported on Wednesday.

Calpers, which has suffered major losses on private equity and real estate during the credit crisis, recently informed BlackRock and other advisers that it was reviewing the relationships and would decide whether to continue or sever ties.

BlackRock, one of the world's largest money managers and a company that has thrived during the crisis, nonetheless steered Calpers into investing $500 million into Peter Cooper Village and Stuyvesant Town, a sprawling 11,000-apartment Manhattan apartment complex.

That investment, inked near the height of the real estate boom, is now widely considered worthless, the Wall Street Journal said on Wednesday, citing unidentified sources. The housing complex is owned by Tishman Speyer Props LLC and BlackRock.

BlackRock declined to comment on the Calpers review, citing a policy against discussing client activity. Calpers paid BlackRock $12.6 million in real estate advisory fees last year, the Journal said.

The real-estate review began several months ago and could be completed during a meeting next month. Real estate advisers are expected to learn the results of the review in January, said the person briefed on the situation, who was not authorized to speak publicly about it.

Calpers spokesman Brad Pacheco told the Journal the $200 billion pension fund would not "speculate on the future of our real-estate relationships until the review is complete."

Calpers officials in Sacramento, California, could not be reached for comment.

BlackRock shares were up 0.4 percent at $230 in early trading.

The pension fund voted last week to reduce its exposure to fixed-income investments managed by AllianceBernstein and PIMCO, a unit of Allianz . Still, the pension granted one-year contract extensions with the two firms.

HEDGE FUND ADVISERS

In related news, Calpers placed an official who oversees its $5.8 billion of hedge fund stakes on leave, the Los Angeles Times said, citing people briefed on the matter.

The advisers have been working with the pension fund since 2003, but their contracts lapsed two years ago, the newspaper said. Calpers officials found these advisers were paid $36 million.

A Calpers' spokesman told the paper that it was investigating dealings with outside advisers, but declined to discuss the disciplinary action further.

"We recently discovered that certain Calpers controls and procedures were not followed in the last two years," Pacheco told the Times.

Certain Calpers controls and procedures were not followed? Damn, what a shocker! I have seen or heard about lax internal controls countless times. From front-running currencies in personal accounts to shady side dealings with investment managers. You name it and I've seen or heard about it.

I will repeat this again, these large public pension funds need a thorough performance, operational and fraud audit conducted once a year by independent experts and the results should be publicly posted on their websites. Let's put some teeth into the meaning of fiduciary duty or else we can expect one disaster after another.

Happy Thanksgiving to my US readers.