Are Public Pensions Bulletproof?

Mary Williams Walsh of the New York Times reports, $1.6 Million Bill Tests Tiny Town and ‘Bulletproof’ Public Pensions:

Until the certified letters from Sacramento started coming last month, Loyalton, Calif., was just another hole in the wall — a fading town of just over 700 that had not made much news since the gold rush of 1849. Its lifeblood, a sawmill, closed in 2001, wiping out jobs, paychecks and just about any reason an outsider might have had for giving Loyalton a second glance.

“It’s a walking ghost town,” said Don Russell, editor of the 163-year-old Mountain Messenger, a local newspaper that refuses, fittingly, to publish on the web.

But then came those letters, thrusting Loyalton onto center stage of America’s public pension drama. The California Public Employees’ Retirement System, or Calpers, said Loyalton had 30 days to hand over $1.6 million, more than its entire annual budget, to fund the pensions of its four retirees. Otherwise, Loyalton stood to become the first place in California — perhaps in the nation — where a powerful state retirement system cut retirees’ pensions because their town was a deadbeat.

“I worked all those years, and they did this to me,” said Patsy Jardin, 71, who kept the town’s books for 29 years, then retired in 2004 on an annual pension of about $48,000. Now, because of Loyalton’s troubles, Calpers could cut it to about $19,000.

“I couldn’t live on it — no way,” she said. “I can’t go back to work. I’m 71 years old. Who’s going to hire me?”

Public pensions are supposed to be bulletproof, because cities — unlike companies — seldom go bankrupt, and states never do. Of all the states, experts say, California has the most protective pension laws and legal precedents. Once public workers join Calpers, state courts have ruled, their employers must fund their pensions for the rest of their careers, even if the cost was severely underestimated at the outset — something that has happened in California and elsewhere.

Across the country, many benefits were granted at the height of the 1990s bull market on the faulty assumption that investments would keep climbing and cover most of the cost. And that flawed premise is now hitting home in places like Loyalton.

There and elsewhere, local taxpayers are paying more and more, and some elected officials say they want to get off the escalator. But Calpers is strict, telling its 3,007 participating governments and agencies how much they must contribute each year and going after them if they fail to do so. Even municipal bankruptcy is not an excuse.

The showdown in Loyalton is raising the possibility that California’s pension promise is not absolute. There may be government backstops for bank failures, insurance collapses and pensions owed to workers by bankrupt airlines and steel mills — but not, apparently, for the retirees of a shrinking town.

“The State of California is not responsible for a public agency’s unfunded liabilities,” said Wayne Davis, Calpers’s chief of public affairs. Nor is Calpers willing to play Robin Hood, taking a little more from wealthy communities like Palo Alto or Malibu to help luckless Loyalton. And if it gave a break to one, other struggling communities would surely ask for the same thing, setting up a domino effect.

Some see a test case taking shape for Loyalton and for other cities with dwindling means. “Nobody has forced this issue yet,” said Josh McGee, vice president for public accountability for the Laura and John Arnold Foundation, which focuses in part on sustainable public finance, and a senior fellow of the Manhattan Institute.

When Stockton, Calif., was in bankruptcy, for instance, the presiding judge, Christopher M. Klein, said the city had the right to break with Calpers — but it could not switch to a cheaper pension plan without first abrogating its labor contracts, which would not be easy. Stockton chose to stay with Calpers and keep its existing pension plans, cutting other obligations and pushing through the biggest sales tax increase allowed by law.

Loyalton — which sits in a rural area of Northern California near the Nevada border, less than an hour’s drive from Reno — severed ties with Calpers three years ago. It has no labor contracts to break. Though the town is not bankrupt, its finances are in disarray: It recovered more than $400,000 after a municipal employee caught embezzling was fired. But a recent audit found yet another shortfall of more than $80,000.

“If a city doesn’t have the funds to pay, it’s just completely unclear how the legal plumbing would work,” Mr. McGee said. “I don’t know what would happen if the retirees sued.”

The retirees say they are open to filing a suit but cannot afford to hire lawyers for a titanic legal clash with Calpers.

“Nobody does squat for you with Calpers,” said John Cussins, Loyalton’s retired maintenance foreman, who now serves on the City Council. “I contacted every agency possible. To me, it’s just unbelievable that there isn’t some kind of help out there with the legal side of things. It leaves us at the mercy of the city and Calpers.”

Mr. Cussins said he had a severe stroke last year and was recently told he had Parkinson’s disease. He needs continuing care and said he might not be able to afford his health insurance if his pension were cut. Every time the pension issue comes up at City Council meetings, he is told to leave because, as a retiree, he is deemed to have a conflict of interest.

“I’d like to see somebody go to jail for this,” he said.

Calpers has total assets of $290 billion, so an unpaid bill of $1.6 million would hardly be a deathblow. But if Calpers gave one struggling city a free ride, others might try the same thing, causing political problems. Palo Alto may have lots of money, but its taxpayers still do not want to pay retirees who once plowed the snow or picked up the trash in far-off Loyalton.

“I think this is all about precedent setting,” Mr. McGee said.

In September, Calpers sent “final demand” letters to Loyalton and two other entities, the Niland Sanitary District and the California Fairs Financing Authority. The Niland Sanitary District has struggled with bill collections, and the fairs financing authority was disbanded several years ago when the state cut its funding. Both entities stopped sending their required contributions to Calpers in 2013 but have continued to allow Calpers to administer their pension plans.

In Loyalton, the City Council voted in 2012 to drop out of Calpers, hoping to save the $30,000 a year or more that the town had previously sent in, said Pat Whitley, a former mayor and a City Council member. (She is not one of the four Loyalton retirees but earned a Calpers pension through previous work on the Sierra County Board of Supervisors.)

“All our audits said that our benefits were going to break the city,” Ms. Whitley said. “That’s exactly why we decided to withdraw. We decided it would be a perfect time to get out, because everybody was retired.”

Loyalton did not plan to offer pensions to new workers, she said. And it had been paying its required yearly contributions to Calpers, so officials thought its pension plan must be close to fully funded.

But Calpers calculates the cost of pensions differently when a local government wants to leave the system — a practice that has caught many by surprise. If a city stays, Calpers assumes that the pensions won’t cost very much, which keeps annual contributions low — but also passes hidden costs into the future, critics say. If a city wants to leave, Calpers calculates a cost that doesn’t rely on any new money and requires the city to pay the whole amount on its way out the door.

That is why Calpers sent Loyalton the bill for $1.6 million.

“I never dreamed it was going to be that, ever. Ever!” Ms. Whitley said. “It defies logic, really.”

Loyalton’s expenditures for all of 2012 were only $1.2 million, and much of that money came from outside sources, like the federal and county governments. Local tax collections yielded just $163,000 that year, according to a public finance website maintained by the Stanford Institute for Economic Policy Research.

Ms. Whitley said Calpers had snared Loyalton in a Catch-22. The agency would not tell the town the cost of terminating its contract until the contract was ended, she said. But once that was done, it was too late to go back.

“We were very confused about why we owe $1.6 million, and why didn’t they tell us that before we signed all the papers,” she said.

Mr. Davis, the Calpers spokesman, said that since 2011, Calpers had been giving its member municipalities a “hypothetical termination liability” in their annual actuarial reports, so there was little excuse for not knowing.

Ms. Whitley disagreed. “It’s just too confusing,” she said. “I looked at what’s been happening with all the other entities, and I saw that eventually it’s got to collapse. It’s almost like a Ponzi scheme.”

The bill was due immediately, but Loyalton did not pay it. It has been accruing 7.5 percent annual interest ever since.

Meanwhile, Calpers has continued to pay Loyalton’s four retirees their pensions. But at a Calpers board meeting in September, some trustees said it was time to find Loyalton in default and cut the pensions. The board is expected to make a final decision at its next meeting, in November.

In Loyalton, Mr. Cussins, the retiree and City Council member, said he was so frustrated about being barred from the council’s pension discussions that he and another former town worker drove to Sacramento to attend Calpers’s last board meeting.

The trustees were cordial, he said, but they held out little hope.

“We had a bunch of them come and shake our hands,” he said. “I said, ‘We need some guidance.’ They told us the city could apply to get back into Calpers next spring. But they made it very clear that they will not allow the city to get back into Calpers until that $1.6 million is paid.”

First, let me thank Ray Dragunas for bringing this article to my attention on LinkedIn. Second, while many of you would dismiss this as an inconsequential "small town USA" case of a few retirees who will end up seeing their pensions slashed by CalPERS, you are gravely mistaken.

As Mary Williams Walsh astutely remarks in her article, Loyalton has been thrust onto center stage of America’s public pension drama and this showdown is raising the possibility that California’s pension promise is not absolute. This is particularly worrisome given California's pension gap is widening and could bring about major changes to public sector pensions there.

And while Loyalton lacks the resources to fight CalPERS, if other cases develop where public sector retirees get screwed on their promised pensions, don't be surprised if we get massive class action lawsuits (think Erin Brockovich) against retirement systems all over the United States.

I'm not kidding, California has the most protective pension laws and legal precedents, but this case clearly demonstrates public pensions are not bulletproof.

Of course, none of this surprises me. I started this blog back in June 2008 right in the midst of the financial crisis and foresaw the sinking of the pension Titanic in the United States and elsewhere.

These poor residents of Loyalton California just got a little taste of what happened to Greek pensioners when Greece narrowly escaped a total collapse but in return had to implement draconian austerity measures which included slashing public and private sector pensions.

However, the United States isn't Greece, it's the richest, most powerful nation on earth which prints the world's reserve currency, so it's hard to envision a massive and widespread public pension crisis where millions of public sector retirees see their pensions slashed.

But never say never. Politics drives a lot of these changes in policy, and it's not always in the best interests of the country. You have former Fed chairman Alan Greenspan banging the table on entitlement spending run amok, but he and others fail to realize the dangers of rising inequality, which the pension crisis will only exacerbate, and its detrimental effects on aggregate demand.

Nobody really cares if Loyalton retirees see their public pensions slashed, but they should because if  slashing public pensions becomes far more widespread, it will add fuel to America's ongoing retirement crisis and impact aggregate demand and growth for a long time.

This is why in my recent comment on the malaise of modern pensions, I discussed intellectual influences that shaped my thoughts on pensions and why we need to rethink their important role for the overall economy:

Quite simply, in a ZIRP & NIRP world where ultra low rates and the new negative normal are here to stay, the pension Titanic will keep sinking but some pensions, defined-contribution (DC) plans in particular, will sink much further and leave millions struggling with pension poverty while others, like large well-governed defined-benefit (DB) plans, will offer workers the ability to retire in dignity and security.

So, when I expose the brutal truth on defined-contribution plans and explain why Canadians are getting a great bang for their CPP buck, somewhere behind that message lies the influence of Chuck Taylor and a more just society.

Enhancing the Canada Pension Plan makes great sense for all Canadians and I'm sure Quebec will follow suit.

As far as the United States, it too needs to rethink its solution to its retirement crisis and I'm not talking about the revolutionary retirement plan being peddled right now. Private pensions have crumbled and public pensions are crumbling, and the situation is going to get a lot worse over the next ten years.

The next US president needs to set up a task force to carefully evaluate the pros and cons of enhancing Social Security for all Americans based on the model of the Canada Pension Plan Investment Board, but to do this properly, they first need to get the governance right.

Public pensions are not bulletproof but nor are they the problem. If stakeholders get the governance and investment assumptions right, introduce risk-sharing, then public pensions are part of the solution and will allow millions of people to retire in dignity and security which will benefit the economy over the long run.

Below, I embedded part 1 of the latest CalPERS Board Investment Committee (all parts are available on YouTube here). Listen carefully to CalPERS's CIO, Ted Eliopoulos, discuss why the "path or returns" is consequential if they want to make up the shortfall over time but warned "a significant drawdown would be particularly painful given the current funded status is less than 70%" (minute 16).

Also, Alan Greenspan appeared on Fox News a few months ago and weighed in on the 2016 race, urging entitlements to be the central issue of the presidential debate.

I agree with Greenspan, developed and developing nations will struggle with a long-term problem of low economic growth, especially if  a prolonged period of debt deflation sets in. Where I disagree with him is on his dire warning on bonds and that entitlement spending is the root cause of secular stagnation.

Sure, entitlements (public pensions figure into these) are the "third rail of American politics" and in many cases where abuses are rampant, they need to be curtailed, but the biggest problem impacting long-term economic growth is rising inequality which is exacerbated by the ongoing retirement crisis.

In other words, the focus should be on tackling rising inequality and bolstering aggregate demand, not curbing entitlement spending. But my intellectual influence is Charles Taylor, not Ayn Rand, so I understand why Greenspan harps on entitlement spending run amok. I just don't agree with him.

And while public pensions aren't bulletproof, the United States needs to adopt reforms that bolster them for all Americans or it will risk adding fuel to this long-term stagnation Greenspan warns of.