MOORLACH UPDATE — Cal Watchdog — August 9, 2011

The old adage, “may you live in interesting times,” may be a bit overused of late.  If you ever wanted to live long enough to watch a government meltdown, you’re getting a small taste of it as we speak.  Yesterday’s Dow Jones Industrial average took a beating.  If you go back ten years to July 2001, the Dow was at the same level.  We’ve been flatlining for a decade.  It is slowly dawning on the American people that our leader at the Federal level is bringing unwanted change to our nation.

The ramifications of mismanaging the country’s economy trickles down to your pocketbook in more ways than one.  In the last ten years, public employees have negotiated defined benefit plan improvements that have included severe overreaches.  Taxpayers will be asked to pay higher taxes and have access to fewer services that are being offered now.  It is irresponsible to improve benefits in the middle of the game with defined benefit pension plans and it’s criminal to grant those benefits retroactively to the date of hire.  The priorities of late have shifted from serving and protecting the taxpayers, to funding the retirement benefits of state and local government employeesAnd, those who negotiated the pension enhancements could not have done so at a more inopportune time.  Cal Watchdog has a piece on the topic.  Enjoy the meltdown.  The LOOK BACK below will remind you that you were warned.

One note of elaboration:  I still believe that granting retroactive pension benefits is not allowed under the California Constitution, which does not permit any debt to be assumed without voter approval.

INVITATION:

Experience Bolsa Chica on Saturday, August 13, 2011, from 9 a.m.-11 a.m.

Meet at the Bolsa Chica Interpretive Center, located at 3842 Warner Avenue, Huntington Beach.  Be prepared to:

       Discover wildlife in urban Huntington Beach

       Take a guided tour of the Bolsa Chica Wetlands

       Learn about the history, wildlife, and restoration of the wetlands

       View exciting and interactive exhibits at the Bolsa Chica Interpretive Center

Please bring closed-toe shoes, drinking water, sunscreen/hat, and camera/binoculars.

RSVP:714.834.3220 or by email: District2@ocgov.com

P.S.  Happy 31st anniversary, Trina!

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Market Crash Slams State Pension Funds

By JOHN SEILER

So much for record gains in California state and local pension funds. The stock market crash of the past week worsened the funds’ crisis, putting taxpayers further on the hook for funds guaranteed by law.

Less than two months ago, CalPERS boasted that its fund had gained 20.7 percent in the previous calendar year, July 2010 to June 2011. The California Public Employees Retirement System is the largest pension fund in the nation.

“This is a great one-year achievement that powerfully affirms our strategy and the skills of our investment team,” said Chief Investment Officer Joseph Dear, as reported by CalPERS. “While we can’t assume that we’ll sustain this high level of earnings, we have averaged a net return on investments of 8.4 percent for 20 years.”

“These strong returns are a testament to our commitment to our long-term investing principles,” said Anne Stausboll, CalPERS Chief Executive Officer. “Our members, employers and California taxpayers all benefit from our disciplined approach to investing.” On June 30, 2011, the fund’s balance stood at $237.5 billion.

Since then, the fund declined to $226 billion on August 5. Then it crashed again to about $220 billion on yesterday, August 6, based on preliminary estimates. Combined, that’s a loss of about $17.5 billion in just five weeks, or 7.4 percent.

So practically half the gain from last year was wiped away. And there’s no gain for the new fiscal year. Yet the fund has to make at least 7.75 percent a year, on average, to keep its funding levels high enough to avoid further forced taxpayer contributions.

“We’re a long-term investor and have a long-term investing horizon,” CalPERS spokesman Wayne Davis told me. “We’re able to ride the waves — when it goes up or when it goes down.” As to the crash in the market, he quoted Joseph Dear as saying, “There’s fear out there.”

Back on July 19, the Fresno Bee reported, “Steve Maviglio, spokesman for the union-backed Californians for Retirement Security, said the solid returns should stall the movement toward overhauling the pension system.

” ‘When you have these kinds of numbers with the economy struggling, it shows the funds will be healthy in the long term,” he said.”

Yesterday I asked Maviglio about his statement of three weeks ago. “The 30 year average return for CalPERS averages 7.5 percent,” he replied. “My point was that the pension-bashing crowd used the depths of the recession as the reference point to sound an alarm about pensions instead of the long term returns actuaries use. And given the last two days on the market [August 5 and 8], the alternative that reformers are pushing — 401(k)s — are looking even worse than before.”

CalPERS Is the Market

Worse for public employees expecting pensions at current levels, perhaps, but not for taxpayers. The problem with the 401(k) comparison is that “CalPERS is so big it basically tracks the market,” Dan Pellissier told me; he’s president of California Pension Reform, which is pushing to put a pension-reform initiative on the November 2012 ballot. “It’ just can’t beat the market. Fundamentally, they are the market.”

The smaller funds may be able to do better because they are more nimble. But as Wayne Lusvardi reported on CalWatchDog.com on July 19, “The public stock component of Cal-PERS’ investment portfolio had a 30 percent return, while the Standard & Poor’s 500 Index had about a 31 percent return over the same time interval.  So in public stocks, at least, the CalPERS fund slightly under-performed a plain-vanilla index fund.  Politicians couldn’t help make public union pensioners any windfall profits over investing in index funds invested in a 401(k).

“An index fund is a passively managed fund designed to match the performance of the whole market or mix of funds.  So whatever commissions CalPERS paid all its external fund managers to invest in public stocks apparently could have been saved just by passively investing in the S&P 500 Index.”

Peter Pan Portfolio

John Moorlach told me that CalPERS’ fund is similar to the “Peter Pan Portfolio” that led to Orange County’s bankruptcy in 1994. The meaning: If you just believe, the fund will be all right. In Orange County’s case, Treasurer-Tax Collector Bob Citron kept saying low interest rates would make the portfolio perform. But then interest rates soared and the county went bankrupt.

Back then Moorlach was an accountant warning of the county’s severe fiscal problems. Reporter Andrew Bary of Barron’s called Moorlach and wrote a story with the title, “Peter Pan Portfolio:  Orange County bet that interest rates would stay low forever.” Moorlach later was appointed to replace Citron as treasurer-tax collector. And in 2006, he was elected as an Orange County Supervisor.

This time, he said about CalPERS’ Peter Pan Portfolio that fund managers are saying, “We’ve got to hope and pray that the Dow goes up,” meaning the Dow Jones Industrial Average.

“To have the market determine the pensions is scary, because you can’t control the investment arena,” he warned. “The pension spokespeople say, ‘We don’t have to fear,’ sort of like that’s half the story” because pensions go up in many years. “But don’t patronize me. Some years it goes up 20 percent, but the next year it will go down. If you lose 50 percent, you have to make 100 percent the next year to break even.

“It’s pretty risky to put it on taxpayers,” who have to make up for any market shortfalls because of legal guarantees in union contracts, as well as in the California Constitution. “They’re doing badly on their portfolios, too. And they’re supposed to pay more in taxes.”

Reform Initiative

Pellissier concurred. “The real point here is taxpayers should not see 5 percent daily swings” in the pension funds guaranteed by their tax dollars, he said. “Taxpayers need for public employees’ retirement programs to get off the stock market roller-coaster. Stop making pension promises to employees based on the stock market.”

His initiative would get replace the current defined benefits plan, in which the taxpayers are on the hook, no matter what happens in the market, with a defined contribution plan. In the words of the current reform draft, “All government employees hired on or after January 1, 2013 will receive an employer match into their defined contribution plan of up to 6 percent of salary, 9 percent for new safety employees.”

Employees could contribute more on their own if they wished. “It is a very simple approach,” he concluded. “Cap the government employer cost for new pension benefits at the private sector level and then let employees decide how much more of their money they want to pay.  Give folks who do not have Social Security an equivalent benefit.  Require a majority of pension board members be independent and experts.”

Default Next?

One thing I’ve always warned is that, if reforms aren’t made soon, even the pensions of current employees could be reduced — despite laws, union contracts and the California Constitution.

I put that question to John Bury, an independent actuary and author of a popular blog on pensions. “Default to retirees is probable, first by decreasing or eliminating COLAs and, down the road, direct reductions, possibly through taxing pensions,” he told me. So, it might already be too late to fix the system. “The reason this pension crisis isn’t being effectively addressed is that nobody dares to cut benefits or pay for the benefits already promised so there will be more Central Falls solutions.”

Bury was referring to the city of Central Falls, Rhode Island, which is in bankruptcy. Unlike the Orange County bankruptcy of 1994 or the Vallejo bankruptcy of 2008, Central Falls is trying to cut its payments to those already retired. The Providence Journal has reported on the matter.

Bury was even more pessimistic on his pension blog, where he wrote, “What will this precipitous drop in asset values do to public pensions across this country?

“Doom them.

“Most of these plans are using ridiculously high interest assumptions to justify keeping required contributions low.”

What’s Next?

“This crash simply reaffirms the need for serious statewide pension reform in California,” Jack Dean told me. He is vice-president of California Pension Reform and publishes the Pension Tsunami Web site, which chronicles state and national pension problems. “The system was unsustainable seven years ago when I started tracking the problem. The financial meltdown in 2008 didn’t cause the underfunding, it merely exposed the enormity of it.”

Dean added that the market crash of recent weeks “increased taxpayers’ liabilities for overly-generous public-employee pensions even as their own pensions and 401(k) accounts lost even more value. Not only is this path unsustainable, it’s also unfair, and taxpayers are eager to do something about it.”

How the stock market performs in coming weeks and months will determine what further steps will be taken by fund managers, taxpayers and voters. Unless the market makes a remarkable recovery, cuts seem to be inevitable. A market decline, or even stagnation, will spark chaos.

FIVE-YEAR LOOK BACKS

August 9

2006

Slowly, but surely, the realization of the magnitude of the rising cost of pensions was settling in on journalists.  Christian Berthelsen of the LA Times brought the subject home for the county in “O.C. Faces Difficult Pension Choices – The Shortfall for that and retiree medical costs dwarf the debt from the county bankruptcy.”  Slowly, but surely, the County had to deal with its massive unfunded liabilities.  Addressing the retiree medical unfunded liability, which started with a request for a pay increase from the County’s largest public employee union, had begun.  Here is the article in full:

During two days of hearings in June, Orange County supervisors discussed all manner of spending for the coming year. They decided to shell out $10 million more for indigent healthcare and declined to kill a $187,000-per-year tourism promotion program.

But one of the biggest spending increases was barely mentioned. Buried in the appendix of the budget under the heading "Miscellaneous" was $65 million more for the county’s pension fund. The increase, which brought the county’s spending on pensions to $255 million this fiscal year, equaled more than half the county’s property tax windfall from recent lofty assessments.

The growing cost of paying for retired employees’ pensions and medical coverage is wreaking quiet havoc on Orange County’s finances, no small thing in a place still recovering from the largest municipal bankruptcy in history. The county owes its pension and retiree medical funds about $3.7 billion, an amount that dwarfs the $1.7 billion in debts it cited in the 1994 bankruptcy filing.

The spiraling burden is the result of soaring medical costs combined with a large population of retired workers who are expected to live longer. At the same time, investment returns that support the funds have fallen in recent years, dipping below 1.5% in 2003 and 2004.

The issue is a politically sensitive one for supervisors, because at least part of the pension fund’s increased cost is the result of sweetened labor contracts the board has approved. That has angered conservatives who complain that the cost is eating into the county’s ability to deliver services.

"Some things have to give," said county Treasurer and Supervisor-elect John M.W. Moorlach, who takes office in January. "Everything is on the table."

Supervisors and county officials are in the early stages of seeking a solution, but there are few palatable options.

The retiree medical fund faces $1.4 billion more in anticipated costs than it can pay for. Although investment returns once covered the county’s contribution, the county last year had to contribute $19.5 million to keep it afloat. This year, the county must pay $24 million.

If supervisors do not increase contributions or reduce costs, the fund will start spending more than it takes in by the end of this fiscal year. As a result, officials are contemplating ways to reduce the program’s costs.

One of them involves a complex plan to move the county’s obligation into a trust, moving the fund’s liability off the county’s books so it doesn’t harm its credit rating. Instead of reflecting $1.4 billion in debt, the county’s ledger would show only how much money it must pay to the trust each year. Still, this does not solve the problem of paying the debt.

Another option involves splitting the pool of medical beneficiaries into active and retired employees, which would require retirees to cover higher costs. Still others include freezing benefits and changing eligibility, such as increasing years-of-service and age requirements.

Those options have alarmed retirees, who believed continued medical care was provided under their union contracts and did not expect them to be taken away or made more costly.

"These are retirees, in spite of what the public may think of them, who worked very hard, gave up a lot and helped make this quality of life that we enjoy here in Orange County," said Fred Branca, a 31-year veteran county accounting manager who is president of the Orange County Retired Employees Assn. "It’s a little disheartening."

The county has taken the position that, unlike with pensions, it is not legally obligated to provide medical benefits for its retirees. Any changes to the program will have to be negotiated with the unions in the coming months, and officials say they must get it done before new accounting rules kick in at the start of a new fiscal year in July.

Still, county officials believe the issue could end up in court.

Though it is an even bigger obligation, the county has fewer options in dealing with the $2.3-billion shortfall in its pension plan.

Last year, an actuary determined the fund’s obligations were $1 billion more than previously projected, and despite changes in investment return assumptions and other accounting maneuvers, the county must pay more to cover the costs.

The county’s executive officer, Thomas G. Mauk, had asked department heads to find ways to cut their budgets — and reduce county services — in order to make the increased payments necessary to erase the shortfall.

The cuts were not made, however, because of better-than-expected property tax receipts. But the difficult choices still loom.

"This is not an easy thing," Board of Supervisors Chairman Bill Campbell said at a meeting last week. "I believe we are going to try to be fair. Everyone must share the pain in some way."

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