Archive for the 'Retirement' Category

California Pension Plan: Betting the house

Kurt Brouwer July 25th, 2009

From the New York Times [registration may be required] we get this report on the California Public Employees Retirement System (CalPERS), which is the largest pension plan in the nation.  CalPERS has struggled of late due to investment losses and funding issues.  It also has a credibility problem after helping bring about the current crisis in California public pensions.

Now, the investment chief for CalPERS is doing something that is quite unusual in that he is calling for the system to essentially bet billions on risky assets in the hopes of making a big gain [emphasis added below]:

CalPers Hopes Riskier Bet Will Restore Its Health (New York Times, July 23, 2009, Leslie Wayne)

Big as California’s budget woes are today, so are the problems lurking in its biggest pension fund.

The fund, known as Calpers, lost nearly $60 billion in the financial markets last year. Though it has more than enough money to make its payments to retirees for many years, it has a serious long-term shortfall. Meanwhile, local governments in the state are pleading poverty and saying they cannot make the contributions that would be needed to shore it up.

California’s public pension funding problem is one of the thorniest financial issues facing the state. The state made an unwise and almost certainly unsustainable deal to substantially raise public pension payouts approximately 10 years ago.  CalPERS played an important role in that disastrous decision (see Budget Busting Pensions).

The New York Times continues:

Those problems now rest largely on the slim shoulders of Joseph A. Dear, the fund’s new head of investments. He is not an investment seer by training, but he thinks he has the cure for what ails Calpers, or the California Public Employees’ Retirement System, the largest in the nation with $180 billion in assets.

Mr. Dear wants to embrace some potentially high-risk investments in hopes of higher returns. He aims to pour billions more into beaten-down private equity and hedge funds. Junk bonds and California real estate also ride high on his list. And then there are timber, commodities and infrastructure.

That’s right, he wants to load up on many of the very assets that have been responsible for the fund’s recent plunge. Calpers’s real estate portfolio has tumbled 35 percent, and its private equity holdings are down 31 percent. What is more, under Mr. Dear’s predecessor, Calpers had to sell stocks in a falling market last year to fulfill calls for cash from its private equity and real estate partnerships. That led to bigger losses in its stock portfolio.

CalPERS has made very significant investments in illiquid real estate and private equity partnerships.  Selling stocks last Fall to help keep those partnerships going may or may not have been a huge mistake, but it is certainly unusual behavior.

From the Sacramento Bee, here is a report on a billion dollar bust in CalPERS’ real estate portfolio.  The details do not sound encouraging:

…CalPERS made aggressive investments in real estate at the worst possible time, when inflated property values had peaked and were already beginning to decline.

As The Sacramento Bee’s Dale Kasler detailed in a recent article, one CalPERS real estate misstep stands out in particular. In February 2007, CalPERS invested $922 million in a deal with LandSource Communities Development LLC that involved thousands of homes and lots in seven states including Florida, Arizona and California.

A month before the investment was finalized, Lennar Homes, a principal partner in the LandSource deal, announced it was writing off $500 million in real estate assets because of deteriorating market conditions. That should have served as a clear warning to CalPERS, but it did not.

Sixteen months later, LandSource filed for Chapter 11 bankruptcy. Depending on what assets the partnership sells to pay off creditors, CalPERS could lose its entire investment, nearly $1 billion...

In fairness, CalPERS made lots of money from its real estate investments over the years, so a billion dollar writeoff won’t break the bank.  However, the bankruptcy of a private real estate deal like this one should be a warning light that the partnership investments the plan already holds may have other unwelcome surprises.

Joseph Dear, CalPERS’ new investment head seems to be a smart guy and he is certainly well connected in a political sense.  He also seems to be a gutsy guy in that he is definitely making a bet — in effect, betting the retirement future of many Californians  — that the private partnerships he likes will outperform more traditional investments.

…He [Joseph A. Dear] was hired in large part for his management skills and political savvy - honed in Washington, where headed the Occupational Safety and Health Administration in the Clinton years. He does not have an M.B.A. or any other advanced degree in finance. Harvard, Yale or Wharton is not on his résumé. Instead, his lone degree, in political economy, is from Evergreen State College in Olympia, Wash.

Most recently, Mr. Dear headed the Washington State public pension fund, which gained a reputation as a daring investor under his oversight. It risked more of its portfolio - 25 percent - on private equity than any other public fund. The bet pushed the Washington State Investment Board, which now has $67 billion in assets, into the top 1 percent of its peer group in performance during the boom years, according to Wilshire Associates. But in the fiscal year that ended last month, the fund lost 27 percent of its value, or $18 billion.

Calpers has a lot riding on Mr. Dear’s effort to achieve above-market performance. The fund just posted a loss of 23 percent, the worst in its history. That leaves it 66 percent funded, the lowest level in two decades, meaning it has only $66 on hand for every $100 in benefits promised to 1.6 million California public employees and their families.

… “Calpers is significantly underfunded, and they have decided that they will roll the dice,” said Edward A. H. Siedle, president of Benchmark Financial Services, which audits pension plans. “Is that appropriate if you have just lost 25 percent of your portfolio? These are high-risk, illiquid, unregistered products where there is tremendous valuation uncertainty. I would bet you any amount that five years from now, this plan will not have outperformed the market.”…

On one hand, I applaud CalPERS and its new head of investments for taking a bold and contrarian stand.  It may work and, if so, I will be very happy.  On the other hand, I question the motivation behind this move.  Is it the desire to follow a sound investment principle of adding to solid holdings when they have fallen in value? Or, is it a move like that of a gambler who suddenly decides to double down in order to erase a series of losing hands?

Via: Calculated Risk

See also:

Budget Busting Pensions

10 Rules for Investing

Oakland ‘Mulls’ Bankruptcy

Budget Busting Pensions

Kurt Brouwer June 23rd, 2009

On a daily basis, we are seeing alarming news about the pension crisis in towns and cities across the state of California and the nation.  What the heck is going on?  In a nutshell, while you were out living your life, your local and state politicians were making pension promises that extend many years into the future.  And, in many cases, the required funding simply is not in place.  To make things worse, these promises were made to our firefighters, police and other employees of the government.  These are the people who make everything in a given town work.

42 Years Driving for Dolly Madison Cakes

Columns such as these two below have been attacked by unions as an attack on municipal workers.  I view it differently.  I come from a union family.  My father drove a Dolly Madison Cakes delivery truck for 42 years and he was a member of the Teamsters Union.  My mother still receives a very modest monthly check from the Teamsters.

My view of this issue is that if a city or county makes a promise to its employees, it should keep it.  But, if the city goes bankrupt, then of what value is the promise?  Both sides — taxpayers and employees — should be on guard to make sure that promised benefits are reasonable and sustainable because if they are not, then everyone loses.

This is no longer a boring and arcane topic of interest only to local politicians, municipal employees, union officials and pension plan actuaries.  We posted on this several months ago when pension obligations threatened the city of Vallejo, CA (see California City On Verge Of Bankruptcy).

Now, of course, the potential bankruptcy has become reality.  And, almost certainly, severe budget cutbacks or higher taxes or both lie ahead for the city.

The $3 Billion Pension Deal 

The Sacramento Bee makes an important — and politically explosive — point in the following piece.  About 10 years ago, the State of California got taken to the cleaners on employee pensions [emphasis added]:

Pension hike of a decade ago backfires (Sacramento Bee, June 22, 2009, Dan Walters)

A milestone on California’s meandering journey toward fiscal insolvency occurred exactly a decade ago when the Legislature enacted a massive increase in state employee pensions on the expedient assumption that it would cost taxpayers nothing.

Although the new pensions would generate almost countless billions of dollars in extra income for retirees in the years ahead, the CalPERS board, dominated by union representatives, told legislators that taxpayers wouldn’t have to bear the load because investment income, which was flowing into the pension trust fund from high-tech stocks, would continue indefinitely.

As it has done in so many ways, California took the good times for granted and assumed lavish investment returns would buoy public pension plans forever.  Unfortunately, reality has hit home, not once, but twice.  First, the tech bubble blew and now the real estate bubble and tumbling stocks have done the same.

“They (CalPERS) anticipate that the state’s contribution to CalPERS will remain below the 1998-99 fiscal year for at least the next decade,” said a final Senate analysis of the 1999 legislation that expanded state pensions, allowing Highway Patrol officers, prison guards and other “safety” workers in some cases to get more than 100 percent of their salaries.

…Within a few years, dot-com bubble had burst, CalPERS had suffered major losses and the state’s burden for pensions had pushed into the multibillion-dollar range, not counting the heavy impact on local governments that had cavalierly followed the state’s lead on boosting pension benefits (see Oakland ‘Mulls’ Bankruptcy).  

The situation was ripe for a backlash, such as an initiative measure that would rein in public pensions, but union-controlled CalPERS lowered the political heat by offering employers a “smoothing” policy that would protect them against immediate jolts, spreading out the increases over a number of years.

By and by, the economy improved, albeit through an unsustainable explosion in real estate development, and the pension issue dropped from the political radar screen. But now we’re mired in the worst recession since the Great Depression, CalPERS’ investments have dropped by nearly a third and the state is paying more than $3 billion a year into the pension fund, nearly 10 times what it paid a decade ago when CalPERS made its bogus assertion to lawmakers…

I would say that’s a bit of a miss.  California is being forced to pay $3 billion a year (10 times what it paid a decade ago and far more than estimated) and we are now hearing that another billion or so is needed.  Eventually, a billion here and a billion adds up to real money.

Some other states are starting to wake up and take notice of the mess we have in California [emphasis added]:

Pension Costs Can Ruin Cities and States (Grand Forks Herald, June 18, 2009)

…As a result, California is “less than 50 days away from a meltdown of state government,” the state controller said last week.

It’s hard to know whether to stare in horror or avert your eyes.

Our advice: Stare. Because in California’s example, there are lessons for Minnesotans and North Dakotans to learn.

One such lesson has to do with public-employee pensions and a state’s fiscal health. California faces unfunded public employee retirement benefits of somewhere between $300 billion and $1 trillion, a panel discussion at the Milken Institute’s State of the State Conference concluded in May.

Joel Kotkin, presidential fellow at Chapman University in Orange County, Calif., and a popular writer on public policy, agrees. “The item that is most killing the state budget is the huge pensions for public employees,” he said in a recent CNBC interview.

“We have to figure out what we’re spending, how we’re spending, and to begin to make the public employees live by something close to the rules that the rest of society does.”

Basically, California governments let many workers retire early and collect generous pension and benefits for life. In Vallejo, Calif., for example, “base pay for firefighters is more than $80,000 per year, and employees can retire at age 50 with a pension equal to 90 percent of their salary,” Governing magazine reported last year.

Vallejo declared bankruptcy in 2008, citing pension benefits it no longer could afford.

The Milken Institute estimates that California has an unfunded pension liability of between $300 billion and $1 trillion.  Unless changes are made, that monstrous shortfall is going to haunt our workers, bankrupt our state and cause even more difficulties than we currently have.

And, just to put a human face to this, consider these stories.  The Grand Forks Herald continues:

“According to the data compiled to date, the highest paid public employee retiree in the state is Bruce Malkenhorst, the former city administrator, clerk, finance director and treasurer of the city of Vernon, Calif.,” the Sacramento Bee noted in an editorial.

“Vernon is a tiny industrial enclave near Los Angeles. He earns $499,674.84 a year or $41,639 a month in pensions.

“The local governmental agency with the most retirees earning $100,000 or more is the Sacramento Metropolitan Fire District. Fifty former employees of the Sacramento Fire Department receive pensions of more than $100,000.”

A pension of almost $500,000 per year for a small town treasurer?  Hopefully, there is some mistake here.  Assuming he lives 30 years past retirement, that would be $15,000,000 and probably much more with cost-of-living increases (see the SacBee’s State Worker Blog for more).

Just to put the last point in perspective, according to this statistic, the City of Sacramento is paying out $5 million per year to just 50 retired firefighters.  Now, I admire firemen and I have friends and relatives who do that work, which is dangerous and hard.  I don’t begrudge them a thing, but does anyone think this is sustainable.  $5 million per year for just 50 retirees from one modest-sized city?

Other newspapers also have weighed in. As the Modesto (Calif.) Bee editorialized, “the generous — and unsustainable — level of public employee pensions in California is finally getting some long-overdue attention.”

In the matter of overly generous pensions, among other financial matters, Minnesota and North Dakota should learn from California what not to do.

Federal, state and local pension plans (not too mention Social Security and Medicare) are woefully underfunded and they represent a ticking time bomb, not just in California, but nationwide.

Either governments rein in the soaring costs of public pensions or they face an increasing likelihood of bankruptcy.  Stopgap measures will not work for very long and the longer we wait to address this, the worse it will get.  Even raising taxes won’t help for very long because California’s tax rates are among the highest in the nation.

As it has often done, California is leading the nation.  And, unfortunately, many other states have followed California’s lead on this issue:

New York City

New Jersey

Hidden Pension Fiasco

A Lighter View on Health and Longevity

Kurt Brouwer June 15th, 2009


‘Life should  NOT  be a journey to the grave with the intention
of  arriving  safely in an attractive and well preserved  body,
but rather  to skid in sideways -
Chardonnay in one  hand - chocolate in  the other -
body thoroughly used up,  totally worn out and
screaming ‘WOO  HOO, What a  Ride’ 

 

I’m not sure who actually wrote this, but it does contain a very different perspective on planning your life, doesn’t it?

 

My only quibble has to do with the wine selection.  I always thought chocolate went best with a nice, full-bodied red.

 

By the way, I found this quotation here.

Oakland ‘Mulls’ Bankruptcy

Kurt Brouwer June 10th, 2009

The state of municipal finance in California has been abysmal for some time now (see California City On Verge Of Bankruptcy).  Public borrowing, various gimmicks and a strong economy kept things going — until now.  This piece from SF Gate (San Francisco Chronicle) spells out the issues being faced by Oakland [emphasis added]:

Budget Woes Have Oakland Mulling Bankruptcy (SF Gate, June 9, 2009, Chip Johnson)

Even though city officials would prefer to avoid a public conversation, behind closed doors the Oakland City Council has discussed filing for bankruptcy protection in the midst of a $100 million budget deficit.

“We have asked the (bankruptcy) question because we wanted to know the impact,” said District 5 council member Ignacio De La Fuente. “In closed session, the question has been asked, and an answer was given.” He would not elaborate.

“It’s a possibility,” he acknowledged. “Things are that bad.”

…Consider the city’s cash position: Out of next year’s general fund of approximately $415 million, police costs are estimated at $212 million, fire protection service $103 million and $41 million in debt service payments. That leaves about $60 million to pay for everything else, from library services to recreation centers to public works.

And that calculation doesn’t include $50 million more in deferred debt service in a budget proposal presented to the council last month by Mayor Ron Dellums.

…For the City Council, which is expected to present more budget options next week, it is the end of the line.

It is faced with three choices: drastic pay reductions across the board, including police and fire services; massive layoffs; or bankruptcy.

It has been a great run for municipal employees in Oakland and across the state, who have been the beneficiaries of one of the most generous civil service systems in the nation.

...Add to the economic mix the union labor contracts in Oakland, which have provided city employees with high wages, good benefits and generous pension plans, and the problem is clear.

Barring a substantial cash transfusion in federal aid, the Oakland Police Department will lose close to 200 officers next fall unless Dellums, who’s in Washington, D.C., this week, succeeds in securing more than $60 million over the next three years.

A federal grant in any amount would help maintain the minimum requirement of 739 sworn officers.

Any Oakland resident will gladly tell you that the possible loss of 200 police officers on the streets of this city is a bone-chilling thought.

…Adding further woes to the budget, the police officers have negotiated a 4 percent pay raise scheduled to kick in July 1.

Given the city’s economic limits, De La Fuente said the city can’t honor the pay raise and maintain the force at its current size.

“We’re required to give them the (salary) increase, but it will require us to do other things within the budget to achieve the savings we need,” he said. 

For years, politicians have granted pay, benefit and pension increases to municipal workers without regard to the long-term consequences (see The Pension Time Bomb).

Also, deficits in prior years were papered over with bond measures that now must be paid back, with interest (see Local Governments Downgraded by Moody’s).

And, the state of California has its own severe budgetary problems, with a double-digit billion dollar deficit.  So, the city can’t count on help from that source (see California Tax Revolt 2.0).

And, as you saw in the article, the only solution the Oakland mayor could come up with is to go hat in hand to the Federal government.  Given the massive deficits we see on the Federal level, if I were an Oakland official, I would not count on Washington for much in the way of long-term support.

Eventually, all the stopgap measures and wishful thinking will end and the city will have to learn to live within its means.  Unfortunately, getting to that point will be painful.

Is a tax revolt brewing in California?

Kurt Brouwer June 8th, 2009

I don’t think it is a stretch to suggest that many, if not most, Californians are unhappy with the current financial mess the state is in.  Nor do I think it is an exaggeration to state that the gulf between ordinary Californians and the political elite is wide and it is getting wider.  Now, it is probably a stretch to suggest that Californians are ready for another tax revolt, but the mood among many voters is definitely changing.

In his polling, Scott Rasmussen tracks the opinions of ordinary citizens and compares them to the opinions of what he calls the political class.  Needless to say, the gulf between the citizens and the elite is far wider than the gulf between regular Democrats, Republicans or Independents.

This is an interesting poll. It certainly is in line with the roughly 66% we saw voting against tax increases in California a few weeks ago [emphasis added]:

77% See Politicians Unwillingness to Cut Government Spending as Bigger Problem… (Rasmussen Reports, May 22, 2009)

For nearly four-out-of-five U.S. voters, the problem is not their unwillingness to pay taxes. It’s their elected representatives’ refusal to cut the size of government.

Seventy-seven percent (77%) of voters say the bigger problem in the United States is the unwillingness of politicians to control government spending. Just 14% say the problem is that voters are unwilling to pay enough in taxes, according to a new Rasmussen Reports national telephone survey.

These findings parallel results in California just before voters there rejected several ballot initiatives aimed at raising taxes. After that vote on Tuesday, Governor Arnold Schwarzenegger suggested the state might need federal financial help, but voters nationwide oppose any bailouts for California and other economically troubled states.

Just 28% of all voters say, generally speaking, that increases in government spending help the economy, down seven points from February. Fifty-three percent (53%) now believe spending increases hurt the economy, and seven percent (7%) say they have no impact…

If these results are accurate, then our elected officials may want to start paying attention. I think voters are increasingly estranged from politicians and the sense of strong resentment is growing. This poll is evidence for that theory.

But, if voters are so upset, why are they so passive?  That’s a good question.  Turnout in the recent special election in California was very low for example.  However, the results were a foregone conclusion so that may be part of it.

Nonetheless, not all voters are passive and some are actually going out of their way to attend protests against unwise tax policy and poor government accountability.  Here is a photo of of a pretty cool guy and 500 friends at a tea party gathering in Nevada County (see below).

the-unioncom-tea-party-bilde.jpeg

Roy Gustafson shows his “Don’t Tread On Me” flag at a Tea Party gathering Saturday at the Nevada County fairgrounds.

Photo courtesy Robert Steuber and The Union.com

The photo above is from a piece about a ‘tea party’ gathering in Nevada County [emphasis added]:

About 500 protesters of runaway government spending turned out in force Saturday for the Nevada County Tea Party, according to organizer Stan Meckler.

“It was an amazing, patriotic event,” Meckler said. “We’re not against taxes — we believe they should be spent appropriately, and that’s the politicians’ job.

“We don’t talk about social issues,” Meckler said, noting that people at the Tea Party came from all walks of life and beliefs. “We want to influence politicians to watch the money more closely and not spend what we don’t have.

“Congressman Tom McClintock showed up and has been a supporter of getting government spending under control,” Meckler said.

…The event at the Nevada County Fairgrounds was an adjunct to other Tea Parties thrown around the country this spring and summer. Almost 100 county residents went to the California Tea Party demonstration at the state Capitol on April 15.

The national Tea Party effort got going before the last election, when California and other people across the country said it was time for government to curb spending and taxes…

Over the past few months, there have been other tea party gatherings in California, with a couple of dozen on April 15 alone.  The Tea Party movement is also active all over the country.

Via Instapundit.com, we hear of recent events in Michigan and other states.  The event in Kalamazoo, MI reflects similar themes to recent events in California and other states as this piece shows [emphasis added]:

When Tia Graz helped organize a “tea party” in Kalamazoo to protest government spending, bailouts and taxes, she figured it would be a one-time event.

But that rally, one of hundreds held across the country on April 15, has sparked a grass-roots movement leading to the formation of the Kalamazoo Tea Party, which has almost 200 members, a Web site, a mission statement and another rally planned for July 4.

Statewide, the first annual Michigan Tea Party Convention will be held Saturday at Capital Area Baptist Ministries in Holt.

“Our vision is not a third (political) party but to have a group of politically active citizens,” said Gene Clem, a 66-year-old retiree who co-founded the Kalamazoo Tea Party. “Our principles really come down to going back to a democratic republic founded on the U.S. Constitution.”…

I suspect our political leaders view these as quaint and harmless events and perhaps they are.  But, I certainly sense that many people feel we no longer have government of, by and for the people, but rather government for the special interests.

See also:

California Tax Revolt 2.0

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