California's Pension Crowding Out Effect?

Adam Ashton of the Sacramento Bee reports, Pension costs ‘crowding out’ spending on parks, schools and social services, report says:
California governments likely will make do with fewer teachers, parks employees and other public workers while they struggle to absorb fast-rising pension costs in the next few years, a former state lawmaker argues in a study released this week through Stanford University.

Read more here:

Former Democratic Assemblyman Joe Nation projects that many cities, counties and school districts will double their spending on pensions by 2030, “crowding out” their ability to fund public services.

The trend is an acceleration of the swelling pension costs that most California governments have recorded since the dot-com crash in the early 2000s, when pension plans that had been over-funded suddenly had to catch up with investment losses.

“As painful and as steep as these increases have been since 2003, my best estimate is that we are only about half way through these increases,” said Nation, who is now a researcher at the Stanford Institute for Economic Policy Research. “If you’re a public agency and you went from paying $1 million a year to $10 million a year, that’s an enormous increase. You’re likely to go from $10 million to $20 million by the year 2030.”

The new report assesses pension spending for a sampling of 14 California government agencies, including state government. Nation wrote that state spending on pensions is expected to rise from $8.5 billion this year to $17.3 billion in 2029-30.

Nation found pension costs outpacing growth in projected revenues across the board. That leaves government agencies less room for amenities like parks, social services and, in some cases, the ability to hire new employees to replace retiring workers.

For the city of Sacramento, pension costs are expected to climb to $150 million by the 2022-23 budget year, up from $42.4 million in 2008-09 and $88 million this year.

“Our revenues cannot keep pace with these cost increases,” said Sacramento Finance Director Leyne Milstein. So far, she said, the city has not had to leave vacancies open because of the rising retirement expenses.

Nation’s report adds to a drumbeat of recent complaints from local government leaders about rising pension costs. They’ve been more vocal since the California Public Employees’ Retirement System last year lowered its projected investment return rate, a decision that required its member governments to pay more to fund their workers’ pensions.

Last month, representatives from a dozen cities attended a CalPERS board meeting and complained that rising pension costs are becoming a “gradual strangulation” on public services.

“In three to four years our cash flow is going to be gone,” Oroville Finance Director Ruth Wright told the CalPERS board. “We don’t even know how we are going to operate past four years. We have been saying the bankruptcy word, which is not very popular.”

School districts also are ramping their spending on pensions to make up for shortfalls at the California State Teachers’ Retirement System. Both CalPERS and CalSTRS are underfunded, with each holding about 68 percent of the assets they’d need to pay benefits they owe to current workers and retirees.

Visalia Unified School District, an example in Nation’s study, spent $10.8 million on pensions in 2009-10. It’s projected to spend $46 million in 2029-30.

Nation also looked at two California cities that declared bankruptcy during the recession. In Stockton, pension costs are expected to hit $88 million in 2029, up from $41.5 million today. In Vallejo, they’re on track to reach $52 million in 2029, up from today’s $24.7 million.

Nation’s work was funded partly by the Laura and John Arnold Foundation, a nonprofit organization created by former hedge-fund manager John Arnold. The organization has funded pension-reform efforts around the country.

Dave Low, chairman of the union-supported Californians for Retirement Security, said CalPERS and CalSTRS are slowly digging themselves out of the losses they suffered during the recession. As a result, they’re asking public employers to kick in more money for pensions.

Historically, spending on pensions has fluctuated, bottoming out in the dot-com boom when CalPERS was so well-funded that many employers took a holiday from contributing to their employee pension plans.

Low suggested that local governments struggling with pension costs take their concerns to their unions, where the two sides could negotiate ways to save money until the retirement plans are on better footing.

“You don’t recover from the Great Recession in two or three years. It takes decades,” he said. “We happen to be in the up cycle right now. The question is, because we’re on the up cycle, do we take pensions away?”
CBS KPIX 5 in San Franscisco also recently reported, California Pension Crisis An Increasing Drag On Cities, Counties:
Cities and counties across the U.S. are going broke trying to keep up with public pension debt. The pension crisis was the topic of a Stanford University media workshop that KPIX 5 attended this week.

“It’s the albatross around the necks of cities and counties,” Stanford Professor of Public Policy Joe Nation said about public employee pensions. “Unless we do something the system may not survive.”

The biggest system in the country is in California, the public employee retirement system known as CalPERS. The problem is the pension fund doesn’t have nearly enough money to cover the cost of current and future employee pensions. It’s short according to some estimates by a trillion dollars. “That’s equivalent to eight years of the entire state budget,” said Stanford Professor of Economics Jeremy Bulow.

Critics say CalPERS has been hiding the enormity of the problem the same way a gambler hides their losses – by assuming that in the future, there will be huge and unlikely returns on their investment. Officially, CalPERS assumes a 7.2 percent annual rate of return on their investments -but most economists believe 3 to 4 percent is more realistic.

“What you were hearing a bit today are folks saying that the return rate should be lower,” said Richard Costigan, who sits on the CalPERS Board of Administration. Last December the CalPERS board voted to cut the assumed return from 7.5 percent to 7 percent.

But a smaller amount from investments means more has to come from governments and employees. “This is the difficulty,” said Costigan. “If you lower the discount rate you push up the contribution level of employers and employees to address the unfunded liability.”

Bottom line: cities, counties, school districts and ultimately taxpayers are footing a much bigger and likely more realistic bill. CalPERS estimates about a third of local and state budgets go to pay for public pensions. Experts at this recent pension workshop estimate it’s closer to 60 percent and growing. “Retirement spending has doubled in the last five years, and you ain’t seen nothing yet,” said Stanford public policy lecturer David Crane.

That could bankrupt some local governments. But San Jose’s former mayor Chuck Reed, who pushed hard for pension reform, says it’s a bitter pill that we all have to swallow. “You’ve got to put more money in,” said Reed. “All of these solutions … you’ve got to put more money in.”
California's pension gap keeps getting wider and wider but now that the "crowding out" effect is starting to take a real bite out of public budgets, people are starting to take notice.

First, you can read Joe Nation's entire Stanford study here. It's actually well written but I must warn you to be a little weary and read it critically as it was funded by former hedge-fund manager John Arnold and his foundation.

Here is John posing with his wife Laura whose name is on the foundation they both founded:

Who is John Arnold? He is an ex-Enron trader who made a killing there trading natural gas derivatives before moving on after that company collapsed to found a commodity hedge fund Centaurus where he made more money and likely accepted money from public pensions he's now fighting against.

Arnold was once considered one of the world's top commodities traders before losing his edge. He signed the Bill and Melinda Gates and Warren Buffett giving pledge to donate a majority of his wealth away (Bill Gates and Warren Buffett don't really like public pensions. Buffet thinks they're incompetent and Gates has publicly decried how pension costs are impacting spending on education).

Anyway, all I know is John Arnold is the most hated man in Pensionland, so I take anything his foundation funds with a grain of salt knowing full well he has a right-wing agenda to destroy public unions and pensions. All you need to do is follow which outfits receive money from the John and Laura Arnold foundation (click on image):

Don't get me wrong, I too think public-sector unions need to share the risks of their pension plan, but some billionaire whose roots go back to Enron posing with his wife sporting her Louboutin shoes setting up a foundation to "educate" people on the soaring costs of public-sector pensions takes away from the study's credibility, even if Stanford University is behind it (always ask yourself who is funding these reports and what's their angle?).

When it comes to public pensions, there is a lot of right-wing and left-wing nonsense out there and you need to read everything with your BS filter to really understand what is going on.

Here are some key points I want you to understand:
  • US pension storms from nowhere aren't going to magically disappear. The pension storm cometh and if deflation hits the US, rates plunge to record lows and we get the worst bear market ever, it's game over. What is going on in Kentucky can easily happen in Illinois, New Jersey and elsewhere in the US, including California. So, we need to come to grips with the global retirement reality and address a looming crisis. 
  • The problem with a lot of right-wing outfits who say they're fiscal conservatives is they want to shift everyone over to "cheaper" 401(k) plans. Never mind the brutal truth on defined-contribution plans which shift retirement risk entirely onto employees, leaving them exposed to pension poverty, as long as John Arnold pays less taxes so his wife can buy more Louboutin shoes and whatever else her heart desires, he's a happy camper. 
  • The big problem -- and I've said this plenty of times -- is no matter what you do, the pension crisis is getting worse and it is deflationary. Yes, these are long-term liabilities, but when the funded status of US pensions keeps deteriorating as they get squeezed on private equity and hedge fund fees, soaring pension costs start impacting state and local budgets. 
  • Something is wrong at US public pensions and in my opinion, they're not run well, they have the wrong governance and there is way too much political interference. On top of this, state and local governments haven't been topping them up and unions and governments were all too happy taking contribution holidays in the glory tech bubble days (make contribution holidays illegal).
  • Say what you want about Canada's pensions piling on leverage but they've got the governance and risk-sharing model right here which is why most of our large plans are fully-funded or close enough to being fully-funded. 
  • Some people think fully-funded US pensions aren't worth it, and while they raise valid (left-wing) points, the truth is many US public pensions are chronically underfunded and will not be able to sustain another financial crisis. At one point, public pensions need to get real on the assumed rate-of-return, public-sector unions and governments will have to raise contribution rates and if that's not enough, they will cut benefits and even raise taxes to make up the shortfall. Period, there is no getting around this. California and Illinois remind me a lot of Greece, and in some ways things are worse there. 
  • Until we reach the boiling point, the pension"crowding out" effect will continue taking a big chunk out of public budgets, leaving less money for governments to spend (fiscal austerity = more deflation).
The last point is what I want to hammer in, no matter what you do to slay the public-sector pension beast, it's deflationary, and with inflation in freefall, the long-term effects are self-reinforcing.

Let's all hope Janet in wonderland is right and low inflation is only a "transitory" problem. If stocks and more importantly, interest rates can keep going up, up, up, then US public pensions will have some more breathing room.

My fear is what happens if rates plunge to new secular lows and stocks plunge too and never make it back in time. Then we are all up you know what's creek.

Below, California's two major public pension systems are underfunded and are asking local governments to pay more. Critics want to reduce benefits, while others say policymakers should allow time for recent changes to take hold.

And counties across the US are going broke trying to keep up with public pension debt. The pension crisis was the topic of a Stanford University media workshop that KPIX 5 attended last week.

Make sure you watch the entire second clip which features an interview with Stanford professor Joe Nation after the first segment.