Setting the Record Straight on CalPERS and SB 400

Senator John Moorlach
California State Senate, 37th District

As California continues to grapple with pension reform, it’s important to keep the record straight on how the state got into this mess. A major reason was the pension spiking of nearly 20 years ago, specifically Senate Bill 400 of 1999, by state Sen. Deborah Ortiz, D-Sacramento, which retroactively increased pensions 50 percent for California Highway Patrol officers.

That began a stampede of similar increases across California for other peace officers, firefighters and public employees in state and local governments. The argument often was made that the benefit had to be granted or local workers would shift to more generous neighboring governments that already had goosed their pensions.

In 1999, the dot-com boom seemed to assure higher investment returns than in the past, meaning the higher payouts to retirees would not impact government budgets. Yet things did not compute that way, with state and local pension funds increasingly devouring budgets, forcing cuts in funding for schools, roads, health care and other public projects.

Despite that, Wayne Harris in the Sacramento Bee recently wrote an op-ed blaming the shortfall of pension funds on “Wall Street…not cops and firefighters,” saying alternative explanations show “California needs to invest more in mathematics instruction. When The Sacramento Bee editorial board  and city officials wag their fingers of blame at firefighters, teachers, police officers and state pension systems that have yielded 7 percent returns in the long run, it’s clear there’s a fundamental misunderstanding of the numbers.”

Retroactivity is a disaster when doing math calculations, Mr. Harris.

The Bee’s sensible editorial had detailed, “Loudly sounding the alarm, the League of California Cities reported this month that most members expect pension costs to jump by at least 50 percent by 2024-25. Pension payments – now about 11 percent of general fund budgets on average – will eat up about 16 percent by then.” Twenty years ago, that number averaged just 3 percent.

Harris is systems administrator for Woodland Joint Unified School District and a member of Californians for Retirement Security, an advocacy group for public employees and retirees. He continued, “In 1999, when Senate Bill 400 was passed with strong bipartisan support, CalPERS was 137 percent funded and the state was in the midst of an economic boom.”

True enough. And it’s lamentable that no Senate Republicans – long before I became a member – opposed the bill. But in the Assembly, seven Republicans voted Nay.

Also, for the record, CalPERS’ performance the past 20 years was not 7 percent, but just 6.58 percent. As Ed Ring of the California Policy Center calculated, “It doesn’t seem like very much, but the difference between a 7.0 percent rate of return and a 6.58 percent rate of return is actually quite significant.” The 0.42 percentage-point reduction “increases the required annual contribution as a percent of payroll from 23.0 percent to 25.8 percent – and as a fully funded plan becomes unfunded … the ‘catch up’ contributions start to pile up.”

Missing years

In his op-ed, Harris then skips to the 2008-10 Great Recession. But hold on, something else happened first.

Here are CalPERS’ investment returns for those earlier years:

  • 1997: +20.10%;
  • 1998: +19.5%;
  • 1999: +12.5%;
  • 2000: +10.5%.

That looks great. Silicon Valley and other high-tech centers in California were roaring in the dot-com boom.

Then in 2000, the dot-com bust struck and, over the next two years, the NASDAQ lost 78 percent of its value. Hundreds of tech companies went bankrupt. Even Cisco Systems Inc., a company that survived and is worth more than $200 billion today, dropped 86 percent back then.

The bust tanked CalPERS investments:

  • 2001: -7.20%;
  • 2002: -6.10%;
  • 2003: +3.70%.

As early as August 2003, five years before the Great Recession struck, as the market started to recover from the dot-com bust, the Sacramento Bee reported on SB 400’s early returns in its first four years: “The measure approved that day [in 1999] will cost taxpayers at least $10 billion over 20 years, plus uncounted billions for similar increases granted later at the local level. The legislation began a wave of public employee pension increases at a time when private sector employees were seeing their own retirement benefits shrink or disappear entirely. And the bill relied on a fundamentally flawed assumption – that state employees, not the taxpayers, were entitled to the fruits of the long running boom in the stock market.”

It added that SB 400 was the “brainchild” of CalPERS itself. And, “The details were negotiated behind closed doors by representatives of Gov. Gray Davis and the state employee labor unions.” So much for open government and following the democratic wishes of Californians.

And – remember this is 2003 – “Now lawmakers and pension officials acknowledge that the benefits are costing taxpayers at least $500 million a year, part of $2.2 billion in new pension costs that have added to the state’s huge budget deficit. But that price tag will surely climb even further because of follow up legislation that has given other employees pension boosts to match those granted in 1999.”

Over the next few years the economy recovered, or seemed to, in the boom of the mid-2000s, when sub-prime mortgages were driving ridiculous increases in housing prices. Here are CalPERS’ returns:

  • 2004: +16.60%;
  • 2005: +12.30%;
  • 2006: +11.80%;
  • 2007: +19.10%.

Wall Street and CalPERS

Getting back to Harris, he continued in his piece, “Then, due to the fraud and abuse by Wall Street bankers, the worst recession since the Great Depression hit and investors across the globe watched as trillions of dollars in asset values were wiped out. CalPERS lost $69 billion in the first year; over the next two years, its funded status dropped by 40 percent.

“If it weren’t for the Great Recession, SB 400 benefits would have been funded for 138 years. That’s why it is unfair to criticize hard-working public employees and their pensions, while union critics give Wall Street a free pass.”

I’ll include CalPERS’ performance for those years:

  • 2008: -5.10%;
  • 2009: -24.00%.

That last, of course, was the killer.

But, it didn’t have to be so. If the CalPERS Chief Investment Officer would have reduced the holdings in equities before the dot-com bust, and repositioned into 8 percent paying bonds, then Harris may have a point. And if the CIO didn’t buy highly leveraged real estate, prior to the subprime meltdown, then maybe those losses would have been lower.

As Pensions & Investments reported on Dec. 28, 2009, “Behind CalPERS’ staggering real estate losses lies a strategy that took on too much risk and lacked adequate oversight. Once the fund’s star asset class, the real estate portfolio of the $201.1 billion California Public Employees’ Retirement System lost nearly half its value during the one-year period ended Sept. 30…. At the heart of the problem is a freewheeling approach that took on massive leverage, gave enormous discretion to staff and experienced poor timing with its investments.”

But, it’s easier to blame Wall Street when one is asleep at the investment wheel.

I immediately need to point out that other pension reformers and I are not blaming the employees, nor giving Wall Street a pass. I’m only pointing out that the history of what happened is essential to finding solutions now – and avoiding future disaster.

I’ve been a CPA and certified financial planner for more than three decades. And I’ve been a public official emphasizing prudent use of the public purse since I became Orange County’s treasurer-tax collector in 1995, after the county’s 1994 bankruptcy, which I had warned might happen.

Although recessions, including the Great Recession, are not predictable precisely, what is predictable is that eventually the business cycle goes down as well as up. There will be rough patches that need to be guarded against as much as possible through prudent financial management, especially when the public’s tax dollars are at stake.

As Harris noted, in 1999 CalPERS was 137 percent funded. But that was the very height of the market, something that should not have been expected to continue – and before the pension spiking. Indeed, as the market was zooming upward, none other than Federal Reserve Board Chairman Alan Greenspan on Dec. 5, 1996 warned of “irrational exuberance” which has “unduly escalated asset values.”

Harris solely blamed “the fraud and abuse by Wall Street bankers” as the reason for the Great Recession. Certainly, there was chicanery there. Although President Obama never prosecuted any of the bankers, even though he was elected in part because the president at the time of the crash was Republican George W. Bush.

But a large recession commonly doesn’t have just one cause. And economists spend a great deal of time debating the causes, including in this case. Other reasons for the 2008-10 debacle have included:

  • Government interferencein the market;
  • The 1999 repealof the Glass-Steagall banking regulation;
  • Fannie Mae and Freddie Mac providingtoo many cheap loans;
  • The Federal Reserve Board printingtoo much money;
  • The Fed not printingenough money;
  • The Iraq and Afghanistan wars costing as much as $7 trillion;
  • President Bush and the Republican Congresses of 2003-06 increasing domestic spendingfaster than any time since Lyndon Johnson’s Great Society in the 1960s;
  • Turning the balanced budgets of 1998-01 into record deficits, including those $413 billion in 2004 and $459 billion in 2008.

But, let’s get back to math lessons. If you increase the benefits of a fully-funded, defined-benefit pension plan 50 percent, retroactively, then the plan becomes two-thirds funded. And for that, we have public-employee unions to thank for an immediate and massive UAAL – unfunded actuarial accrued liabilities!

More pension reform needed

Some people have learned the lesson. Take Gray Davis. According to FollowtheMoney.org, he received $5 million in campaign donations from public-employee unions for his 1998 election. But in 2016, he conceded in an interview in the Los Angeles Times, “If you’re asking me, with everything I’ve learned in the last 17 years, would I have signed SB 400…. no, I would not have signed it.”

And none other than Gov. Jerry Brown, a longtime ally of public-employee unions, has called for more pension reform. He even is challenging the so-called California Rule, under which public-employee pensions supposedly never can be cut after being made in a collective bargaining agreement.

Brown argued last November in a lawsuit brief defending his limited 2012 pension reform, “For years, self-interested parties, overly generous promises whose true costs were often shrouded by flawed actuarial analyses, and failures of public leadership had caused unsustainable public pension liabilities.”

So even the governor blames the problem, not on one of the periodic recessions that hit us, but on mistakes by pension experts and public officials.

That means it’s up to today’s public officials to fix these problems. Now that we have the appropriate components of the equation, all the parties should take the remedial mathematics instruction one self-interested beneficiary of the pension recommends. And if pensions are not fixed, the public employees themselves will be most hurt from the mistakes of the late 1990s.

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