The Pension Fund That Ate California
Comment of the Day

February 12 2013

Commentary by Eoin Treacy

The Pension Fund That Ate California

Thanks to a subscriber for this interesting article by Steven Malanga for which may be of interest to subscribers. Here is a section
That frenzy to expand benefits took place even though the air was already coming out of the economy. The tech-stock bubble deflated in the spring of 2000, shattering the NASDAQ market and driving down the Dow Jones Industrial Average. The American economy plunged into recession the following year, a slowdown made far worse by the terrorist attacks of September 11. By the close of trading on September 17, 2001, the Dow stood at 8,920.70, down nearly a quarter from its early-2000 all-time high of 11,722.

CalPERS has the exclusive power to determine the size of state and local governments' contributions into the fund. As its investments tanked, it quickly boosted those contributions to compensate. By mid-decade, local officials were frantically telling the California press that the contributions were squeezing out other forms of spending. Glendale, a Los Angeles suburb, watched its annual pension bill rocket from $1.3 million in 2003 to $13.7 million in 2007—nearly a tenfold increase. San Jose's tab almost doubled, from $73 million in 2001 to $122 million in 2007, and then rose even faster over the next three years, hitting a jaw-dropping $245 million in 2010. San Bernardino's annual pension obligations rose from $5 million in 2000 to about $26 million last year. The state budget took a massive hit, too, its pension costs lurching from $611 million in 2001 to $3.5 billion in 2010.

Even those sums understated the problem. As a backlash grew to the larger bills that it was sending to municipalities and the state, CalPERS used a series of fiscal gimmicks to limit the immediate impact on balance sheets. Typically, to protect governments from violent swings in contributions every year, pension funds like CalPERS average their investment returns over three years, hoping that good years offset bad years. In 2005, CalPERS extended the performance average to 15 years, an extraordinarily long period that blended the fund's losses in the 2000s with its gains way back in the 1990s—thus reducing state and local governments' immediate costs, which remained overwhelming nevertheless. Then, in 2009, CalPERS told governments that they could pay off the higher bills from the previous year's scary market drop over the next three decades, pushing the bill for the financial meltdown to the next generation. The pension fund made a similar move in 2011: after revising downward its absurdly optimistic predictions of future investment gains, it gave governments 20 years to finance the higher resulting costs.

Eoin Treacy's view In one way it is gratifying to see that European governments are not the only ones to have been held hostage by the pay and pension demands of public sector unions over the last couple of decades. These are issues which a wide number of governments now have to deal with because payouts are verging on the ridiculous as a proportion of government income.

The financial crisis thrust the need for public sector reform on European governments with pay and pensions being at the top of the list or targets. However, the Fed Reserve's role in boosting liquidity and making limitless credit available via the discount window has shielded both the US government and many states from the necessity of public sector reform.

The sequestration scheduled for March 1 st , if it is put in place as scheduled, will not, as far as I can see, affect pension liabilities for current employees. Despite the impact it would have on numbers employed these actions do not seem to tackle the need for work practice reform to create productivity gains and pension reform to help balance budgets. Therefore while the melodrama of Congress's manoeuvring continues to attract media attention the root issues that affect budgets have not been tackled.

The SPDR Lehman California Bond Fund is worthy of mention in this regard. It encountered resistance in the region of $25 a month ago and a sustained move above $24.50 will be required to question top formation development.

Back to top