Pension Crisis

California Still Facing Pension Crisis Even With Good Stock Market Returns

Unions try to use good years to deflect attention from a growing problem.


California's fiscal watchdogs are bracing for the forthcoming press statements from the nation's largest state-run pension fund, and from the public-sector unions that depend on the system to pay their members' generous retirement packages.

Expect something to this effect: "The California Public Employees' Retirement System's investment earnings for the fiscal year ending June 30 were above 9 percent, reconfirming the health of the state's pension system—and debunking the naysayers who claim that unfunded pension liabilities will obliterate municipal and state budgets."

There's no question that many investors will see returns approaching or even exceeding double-digit levels for the recently completed fiscal year, as the stock market has done exceedingly well in recent months. A pension crisis? As police officers often say at the scene of an accident, "Keep moving, folks. Nothing to see here."

Californians need to temper the glowing statements and shrug off the efforts to keep us from looking too closely at the wreckage. Of course, impressive stock-market returns are a good thing that reduce the amount of taxpayer-backed pension obligations. But one good year doesn't fix a problem that has been two decades in the making. For perspective, CalPERS' returns for the previous two fiscal years were 0.6 percent and 2.4 percent respectively.

It could take decades to make up not only for past years of poor stock-market performance, but for the massive and relentless retroactive pension increases that state and municipal governments have been granting their workers since 1999.

"CalPERS' funded ratio 20 years ago was 111 percent," explained Stanford lecturer David Crane, who was Republican Gov. Arnold Schwarzenegger's pension adviser. He notes that "despite a wonderful 6.7 percent annual return for 20 years, CalPERS' funded ratio fell 48 percentage points… because pension liabilities compound at high rates."

Crane was responding to a Sacramento Bee op-ed by a union president, who recently compared investment returns to the state's drought: "The funded ratio of pension funds has risen and fallen like the levels at Lake Shasta." The union official, Yvonne Walker of the Service Employees International Union Local 1000, has gotten an early start on the kind of argumentation we should expect. She blasts pension reformers' "doomsday predictions." Just like the drought, low returns won't go on forever.

Indeed, private 401(k) retirement plans and public "defined benefit" plans both are dependent on investment returns, but in significantly different ways. In a 401(k) plan, the employee contributes a set amount of money to the account, to which some employers offer full or partial matches. If the market soars, the employee's nest egg grows. If it falls, so does the account balance. There is no unfunded liability because the employee isn't promised any specified amount of retirement income.

In the public sector, employees are guaranteed an annual benefit based on a formula. California police and fire officials, for instance, typically receive 90 percent or more of their final years' pay until they and their spouse pass away. Nothing short of a municipal bankruptcy can legally reduce what they receive. The pension funds invest the dollars contributed by the agency and employees in the stock market. Even if the stock-market does poorly and the liabilities rise, the retirement pay stays the same.

That's why CalPERS and other union-controlled pension funds have a vested interest in celebrating up years and downplaying bad years. Good years let them hide the amount of taxpayer-backed debt that's accumulated. These pension funds also predict unrealistically high rates of return far into the future, which masks the size of the problem and reduces efforts to lower pension benefits.

But there is a steep cost to this approach. When public agencies spend more on pensions, they must cut services or raise taxes. Most are savvy enough to pitch the tax hikes as being for "public safety" or "transportation," rather admit they are needed to pay for pensions. "Deceptively-hidden pension liabilities are already ravaging education and other public services and already causing tax, tuition and fee hikes," Crane explained.

This is a national problem, although it hits California hardest because of the state's overly generous pension system. A recent national study by the well-respected Hoover Institution at Stanford University found that "pension promises are consuming state and local budgets."

The study says pension funds hide their costs through their investment assumptions: "What is in fact going on is that the governments are borrowing from workers and promising to repay that debt when they retire, but the accounting standards allow the bulk of this debt to go unreported through the assumption of high rates of return."

There are a few good reasons for doom saying.

Even a year of good returns will do little to correct the vast level of pension underfunding. After this year's returns, "the nation's largest public pension system will still be seriously underfunded," Ed Mendel reported in a recent Calpensions article. CalPERS is now only 65 percent funded and "is worried about a downturn that might drop funding below 50 percent, a red line actuaries think makes recovery very difficult."

Pension spending continues to consume local and state budgets and is leading to cutbacks. In a recent City Watch LA article, the California Policy Center's David Schwartzman detailed governmental cutbacks in California cities tied to growing pension costs. For instance, Santa Barbara County laid off 70 employees and remains unable to fund $546 million in infrastructure improvements. In a July 8 article, Crane detailed the woes of California's public school systems, which are struggling even during "an economic recovery and after a large tax increase." He pins the blame on "exploding spending on pension and retiree health-care obligations."

It's unrealistic to bank on this year's stock-market surge to be followed by additional surges. During his budget announcements each year, Gov. Jerry Brown (D) always features a chart showing that, since the turn of the millennium, the years with budget deficits outnumber those with surpluses. Brown's points deal with general-fund budgets rather than pensions, but the point is similar. It's more realistic to expect downturns than unending boom years.

Indeed, the Pensions & Investments article about the latest returns is aptly headlined, "Strong returns nice, but aren't expected to last." Ed Ring's May 2016 California Policy Center analysis concluded that public pension funds "will be hit much harder in a downturn than private pension funds" because they "are not subject to the same rules that private pension funds have to adhere to."

Because unions continue to control the state Capitol and many local governments, we will see a continued ratcheting of compensation levels. Here's one small example from the VoiceofOC, which reported this month that the Santa Ana City Council just hiked the pay for 477 police employees "amid staff projections of major funding shortfalls." Median police compensation there is now above $213,000, according to the news site. As we've seen many times before, good fiscal news typically leads unions to lobby for even higher pay and benefit levels.

By all means, let's toast the favorable stock-market returns. But a more reasonable press release would suggest that despite those returns, the pension crisis continues to be as pressing as ever. Let's not be misled by those with a vested interest in downplaying the problem.

This column was first published by the California Policy Center.