Two
weeks ago, in the aftermath of the February 5 volocaust, we quoted David Hunt,
CEO of $1.2 trillion asset manager PGIM, who said ignore the volatility
spike, the real financial timebomb was and remains public pensions:
"if you were going to look for what’s the possible real crack in the
financial architecture for the next crisis, rather
than looking in the rearview mirror, pension funds would be on our
list."
In a
brief discussion wondering what municipalities and states will do when local
tax revenues decline and unemployment worsens, Hunt said "we're worried
about those pension obligations.”
He is
hardly alone: having reported over and over and over (and over, and over) again that
public pensions are in deep trouble, two days ago none other than Steve Westly, former
California controller and Calpers board member - manager of the largest public
pension fund in the US, made a stunning admission, confirming everything:
"The
pension crisis is inching closer by the day. CalPERS just voted to increase the
amount cities must pay to the agency. Cities point to possible insolvency if payments
keep rising but CalPERS is near insolvency itself. It may be reform or bailout
soon."
Westly was referring to an editorial laying out "the
essence" of California’s pension crisis, exposed last week when the $350
billion California Public Employees Retirement System (CalPERS) made a
"relatively small change" in its amortization policy.
Specifically,
the CalPERS board voted to change the period for recouping future investment
losses from 30 years to 20 years. While this may not sound like much, the
bottom line is that it would require the California state government and
thousands of local government agencies and school districts "to ramp up
their mandatory contributions to the huge trust fund."
As author Dan Walters observes, with client agencies –
cities, particularly – already complaining that double-digit annual increases
in CalPERS payments are driving some of them towards
insolvency, the new policy - which kicks in next year - will raise those
payments even more.
“What we are trying to avoid is a situation where we have a city
that is already on the brink, and applying a 20-year amortization schedule
would put them over the edge,” a representative of the League of
California Cities, Dane Hutchings, told the CalPERS board before its vote.
CalPERS,
however, has no choice because as both Walters and Westly claim, America's
largest public pension fund itself is on the brink, "and
the policy change is one of several steps it has taken to avoid a complete
meltdown."
As we
have reported previously,
the Calpers system, once more than 100 percent funded, now has scarcely
two-thirds of what it would need to fully cover all of the pension promises to
current and future retirees. And that assumes it will hit an
investment earnings target of 7%per year, that many authorities criticize as
being too optimistic.
Last
In December we also reported that the increasingly panicked fund, decided to
boost its stock allocation to 50% in order to raise its future liability
discount rate to 7%, as any reduction in stock allocations would also lead to a
lower discount rate which in turn which would require more contributions from
cities, towns, school districts, etc. and could bring the whole ponzi crashing
down. Amusingly, one Calpers board member argued to raise the equity
allocation even higher, to 60%, so that the discount rate was greater than the
current 7% in order to make the books appears "better."
Ironically,
it was just a decade ago that Calpers' lofty equity allocation resulted in a
staggering losses, and the current dead end. The trust fund lost about $100
billion in the Great Recession and never has fully recovered. In December
2016, Calpers voted to lower its
earnings projection to 7.0% – it had been 7.5% – hoping to avoid
another disaster were the economy to turn sour; since then it has been taking
quiet steps to lever up its equity exposure once again.
Meanwhile, officials
fear that were it to experience another big investment loss, it would pass a
point of no return and never be able to pay for pension promises.
On
the other hand, "protecting" CalPERS means getting more money from
its client agencies, which could drive some of them into insolvency, as
Hutchings said. This is not a hollow threat: three
California cities have already gone bankrupt in recent years, in part because
of their ever-increasing pension burdens, and payments have escalated sharply
since then.
So on
one hand, CalPERS is doing what it has to do to remain financially solvent, but
on the other hand its self-protective steps threaten local government solvency.
That’s
the crisis in a nutshell.
As
Walters suggests, one way out would be to modify benefits in some way.
City
officials, for instance, have suggested reducing automatic cost-of-living
escalators in pensions over a certain mark, such as $100,000 a year.
However,
the CalPERS board, dominated by public employee organizations and sympathetic
politicians, has spurned such pleas: it is almost as if, once promised generous
retirement benefits, public workers would rather take the entire system down,
than see their own pensions reduced, even modestly.
“Our
members have expressed frustration that you keep coming to them asking for more
while at the same time not providing a lot of other options and assistance for
them,” Dillon Gibbons of the California Special Districts Association
told the board.
Alas,
the options boild down to either taxpayers get the shaft, or public employees
see their pensions reduced.
In
the end, it will likely be the worst of both worlds, as taxpayers are dragged
in to bailout CalPERS and other retirement funds, while retirees see huge cuts
to their benefits.
And
the next market crash will likely catalyze it.
Meanwhile,
everyone involved is waiting for the California state Supreme Court to rule on
pending pension rights cases, and were it to overturn the so-called “California
rule” that bars changes in benefits, it would open the door to pension
modification.
CalPERS
officials are also concerned that should it become insolvent, or pension
payments force some cities into bankruptcy court, it would revive long-dormant
plans for a statewide pension reform ballot measure.
* * *
As
Walters concludes, "This crisis will haunt California for many years to
come and will be a big headache for the next governor."
Unfortunately,
that is an optimistic outlook, because when the crisis really hits, it will
be all American taxpayers who are on the hook to
bail out the country's insolvent pension funds. It is also then that some of
the deepest fissures in US society: between public and private workers, between
taxpayers and benefits recipients, between the young and old, all bubble to the
surface at the same time, with very violent consequences.
