Tuesday, May 18, 2010

Calpers Dreaming of Dow 28,000,000?

David Crane of the WSJ reports, Dow 28,000,000: The Unbelievable Expectations of California's Pension System:

In 1999 then California Governor Gray Davis signed into law a bill that represented the largest issuance of non-voter-approved debt in the state's history. The bill SB 400 granted billions of dollars in retroactive pension boosts to state employees, allowing retirements as young as age 50 with lifetime pensions of up to 90% of final year salaries. The California Public Employees' Retirement System sold the pension boost to the state legislature by promising that "no increase over current employer contributions is needed for these benefit improvements" and that Calpers would "remain fully funded." They also claimed that enhanced pensions would not cost taxpayers "a dime" because investment bets would cover the expense.

What Calpers failed to disclose, however, was that (1) the state budget was on the hook for shortfalls should actual investment returns fall short of assumed investment returns, (2) those assumed investment returns implicitly projected the Dow Jones would reach roughly 25,000 by 2009 and 28,000,000 by 2099, unrealistic to say the least (3) shortfalls could turn out to be hundreds of billions of dollars, (4) Calpers's own employees would benefit from the pension increases and (5) members of Calpers's board had received contributions from the public employee unions who would benefit from the legislation. Had such a flagrant case of non-disclosure occurred in the private sector, even a sleepy SEC and US Attorney would have noticed.

Eleven years later, things haven't turned out as Calpers promised. While state employees have been big winners from the bet, the state budget has been, and will continue to be, a huge loser. Far from being "fully funded" as promised, Calpers has already required $15 billion more from the state budget than projected in 1999 and $3.5 billion is budgeted for this year, a figure that is more than five times the expense projected by the state legislature in its SB 400 analysis. Pensions are crowding out important programs like higher education, parks and health care, and the state will continue to whack away at those programs because the legislature refuses Governor Schwarzenegger's request to repeal SB 400 for new employees.

Of course, all of this might have been avoided had Calpers disclosed the risks and conflicts back in 1999. Indeed, legislators might have not passed the lavish pension pay-out had Calpers simply provided counter commentary from Warren Buffett and others who were saying its wagers were losing propositions.

The state's pension funds are still trying to dupe taxpayers. In response to a recent Stanford University study that concluded California's pension funds are understating liabilities by $400 billion, California's pension funds set up "spin" websites and attacked the study as "shoddy" and "faulty."

Recently, a Northwestern University professor projected that California's pensions will run out of cash in 2026, threatening even greater havoc to the state's budget, yet our pension funds have adopted a "don't worry, all is well" approach and refuse to provide the information necessary for the taxpayers– i.e., the people actually on the hook for these bets -- to make an independent analysis.

As other states consider pension reforms, California's current quagmire should serve as a reminder of the need to incorporate disclosure requirements.

Pension shortfalls are already costing California's taxpayers. Cathy Bussewitz of the Associated press reports, Calif pension fund asks state for additional $600M:

Facing massive investment losses, the board of California's giant pension fund voted Tuesday to make the state increase its contributions to employee retirement benefits by $600 million in the coming fiscal year.

The increase comes as California grapples with a $19 billion budget deficit and a threat by Gov. Arnold Schwarzenegger to eliminate its welfare program.

The contribution increase would be for one year starting in July, but the board is likely to require similar increases in future years. Local school districts, already facing their own budget struggles, also will see their pension contribution rates grow.

The development is driven largely by huge investment losses by the California Public Employees Retirement System, but also because people are living longer and retiring earlier.

CalPERS, the nation's largest public pension fund, lost $55.2 billion, or a quarter of its value, during the 2008-09 fiscal year.

"The biggest reason why we need increases is the investment losses," said Alan Milligan, interim chief actuary for CalPERS. "Quite frankly, there's more to come."

CalPERS sets a state contribution rate every year, which the state is required to pay. Milligan said the investment losses will continue to affect the state contribution rate in coming years because of the "smoothing methods" the board adopted to spread the losses over a longer period.

The governor says the pension system is unsustainable and drains money from other state programs. A Republican lawmaker has introduced legislation to reform the system, in part by reducing benefits to newly hired state workers.

CalPERS provides retirement and health benefits to more than 1.6 million public employees, retirees and families. The fund's value was $205 billion as of Friday.

California is on a collision course and there are reasons to be concerned as some feel the pension liabilities at these giant state pension funds are grossly understated. Rosy investment projections and reassuring talk of a "well diversified portfolio" only serve to mask deep structural problems that will likely get worse over the next decade.

It's time for Governor Schwarzenegger to "terminate" this nonsense. Cut these large pension funds in half, introduce better governance and compensation based on risk-adjusted returns. Pay senior managers who perform and fire those who underperform. These pension giants have grown out of control and left unchecked, they will sink California's budget into oblivion.

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