If you’re a lefty, you might be inclined to dismiss this first story, since it’s posted at BIGOVERNMENT.COM, and so biased to the right (although lefties continue to trust the New York Times and the LA Times… funny, that). But the second story, below, is based on a Standford University study…. and we all know what a hotbed of ultra-rightwing radicalism is found at Stanford.  I hate that the state has done this, because I have some family members who are counting on the state system to work properly.  That is, however, what comes of trusting Democrats to run a budget, let alone make financial projections into the next decade.

» California Admits to Almost $1 Trillion in Unfunded Pension Obligations

 

The three largest California public retiree plans (CalPERS, CalSTRS, and UCRS) that administer pensions of approximately 2.6 million State and Local public current and retired employees have been under tremendous scrutiny since last year’s release of the Stanford University Institute for Public Policy report: “Going For Broke”. The study concluded that California retirement plans liability was under-funded by over $500 billion.

The report blamed most of the shortfall on the pension plan’s expectation of future annual investment returns of 7.75%; versus a realistic expectation of a 4.14% annual return. The cabal of California politicians, bureaucrats, and crony consultants that justified granting lucrative benefits to employees while failing to contribute enough to support the true pension costs; solemnly dismissed the Stanford report as unsophisticated reflections by academics. But now that a swarm of local governments want to abandon the floundering retirement trusts; the State plans are only willing to credit a 3.8% expected return. If the California State pension plans adopted the same 3.8% rate they are only willing to credit when participants want to leave; their published $288 billion in pension shortfall would metastasize into an $884 billion California State insolvency.

It doesn’t take a Stanford MBA to realize producing consistently high investment returns since 2007 has been a difficult in the extreme. The California State pension plans that currently control $432 billion in assets, suffered a $109.7 billion in losses during the 2008 to 2009 recession. Pension plans normally require employers and their employees to mutually increase contributions to make up pension shortfalls. But public pension plans are notorious for not requiring employees to make significant contribution. California police, prison guards, firemen, and lifeguards can retire at age 50, but have never been required to contribute to fund pensions. With headlines that California plans are in big trouble; many government agencies applied to withdrawal from the State plans. But as calculated below; compounding investments at 7.75% grows to more than three times the amount of compounding investments at a 3.8% rate of return.

When I was elected as Orange County, California Treasurer in 2006, I was flabbergasted to discover that the County’s $8 billion of retirement investments was covertly leveraged up by $22 billion of derivatives. I quickly learned that many unions see pension benefits as contracted rights; and pension investing as a no risk crap-shoot for extraordinary returns.

 

If the pension investment returns sky-rocket, the unions will bargain for increased benefits. If the pension investment returns crash; the public employees are protected by rock-solid contract law that prevents any reduction in benefits. In 2007, I was fortunate to gain the support of enough OC Pension Trustees to reduce speculative derivative use by 90%. At the time, Trustees for the California public pension plans solemnly dismissed Orange County as unsophisticated. Shortly thereafter the stock market crashed and the State Pension Trustees stopped making comments.

Once famous as the Golden State for leading the nation in high tech growth industries that provided excellent wages; California is now tarnished for having the second highest unemployment and worst state credit rating in the nation. Forbes recently quoted a top venture capitalist that compared the California business climate to France: “I try not to hire here, and I certainly would not launch a company here. But the wine is good.” Tripling of the burden for under-funded pension liability to almost $1 trillion will probably ruin the taste of California wine for most taxpayers.

 

California state pension funds going broke, Stanford study finds

L.A. Cicero
 

 

Students Howard Bornstein and Lisha Wang spoke with reporters after a news conference where they and the other members of their research group announced their findings about the state retirement system.

BY GWYNETH DICKEY

California public employee pension systems are worse off than anyone previously projected, according to a new report generated by five graduate students in Stanford’s graduate Public Policy Program. The result could be greater pressure on the state budget and a shortage of pension funds in the future.

“This is a really dire situation,” graduate student Howard Bornstein said today at a press conference at the Stanford Institute for Economic Policy Research (SIEPR), which is publishing the students’ findings. “If we don’t do something now, we’re going to have major issues in just a few years.”

Bornstein and his fellow graduate students examined public records of past performance of three pension funds – the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS) and the University of California Retirement System (UCRS), which together administer pensions for approximately 2.6 million Californians.

The students ran computer simulations to predict the unfunded liabilities of the pension funds over the next 16 years.

Major investment needed

“The simulation shows that the state would need to invest more than $200 billion, and possibly as much as $350 billion, today to return the fund to a minimum responsible level of funding,” said Bornstein, who noted that the figure is approximately four times the current state budget.

“It’s an enormous number,” said Joe Nation, a public policy lecturer at SIEPR and the adviser for the research team. He said it’s important to look at the shortfall relative to state resources. Pension funds fluctuate with market performance, but state employees are guaranteed a fixed pension regardless. If the market performs poorly, the state is obligated to step in and provide the missing pension funds. That takes money away from other public projects, such as education and healthcare, Nation said.

“The students did an amazing job providing a better sense of unfunded liability for those three pension funds, and I hope observers out there will begin to understand that this is a financial train wreck that is not very far down the tracks,” Nation said.

In the report, Bornstein and his fellow graduate students suggest policies to fix the shortfall and prevent a similar one in the future.

They propose that the managers of the pension funds project more realistic rates of return, which would indicate higher liabilities in the future.

“The whole approach that the state currently uses is inherently flawed. They look at averages as opposed to a fan of outcomes,” said Bornstein. “If you instead look at the range of outcomes in the future, you’d see there’s over a 60 percent chance of a deficit greater than $250 billion for CalPERS alone. This is something that really scares us.”

The students suggest that the minimum level of caution should be for the pension systems to aim for an 80 percent probability of having at least 80 percent of the funds necessary to cover the pensions. They also advocate investing more conservatively, taking fewer risks.

“Funds in other parts of the country are in similar situations, and they are beginning to invest in riskier assets,” Nation said. “That’s exactly the wrong thing to do. If the market doesn’t perform well, the taxpayer ends up paying.”

Suggested fixes

The students suggest either reducing pension benefits or moving to a hybrid system in which retirees receive a smaller fixed pension combined with a 401(k)-style plan. This would relieve some of the burden on the state and give employees more responsibility for their retirement. Two-thirds of Californians would support such a plan, according to a poll by the Public Policy Institute of California.

“The biggest challenge with this is making sure elected officials understand the severity of the problem,” Nation said. “It’s a political hot potato and most politicians shy away from the issue because you offend a lot of the constituencies by acknowledging the problem exists.”

But, he said, citizens and institutions are increasingly aware of the situation and are speaking out.

“The University of California is engaged in this debate because they finally understand that as pension fund benefits grow, there will be fewer dollars for higher education,” Nation said.

The report was prepared for the Office of Gov. Arnold Schwarzenegger as part of the Graduate Practicum in Public Policy, a two-quarter sequence required for master’s degree students in the Public Policy and International Policy Studies programs.

In addition to the masters’  program in Public Policy, Bornstein will earn his Masters in Business Administration degree this June.

SIEPR conducts research on important economic policy issues facing the United States and other countries. SIEPR’s goal is to inform policymakers and to influence their decisions with long-term policy solutions.

What’s funny is the heading above, “major investment needed.”  The left wants to make a major investment, alright.  An Obama-style investment, called enormous tax hikes to fund impossible promises made to public employee unions.

Something will have to give.  Higher taxes to fund impossible-to-fulfill promises will just postpone the disaster, and not by very long.  A complete, structural, top-to-bottom readjustment is needed, and people have to lose the idea that they can work for 30 years and retire at the age of 55 and still get paid till they die at 95.