Glass Houses

David Crane
Lecturer and Research Scholar at Stanford University and President of Govern for California

Recently the Wall Street Journal reported that CalPERS, the country’s largest public pension fund, is recruiting executives for seats on poorly performing corporate boards.

Apparently, CalPERS places blame for much of the financial crisis on lax cultures inside corporate boards and a failure to hold directors accountable. As a CalPERS spokesperson put it: "If boards live in a world of no consequences and can let a company go to wrack and ruin, what are we to do?"

CalPERS is right to pursue better governance. Boards sometimes do allow practices that can lead to failure of enterprises and disaster for our economy. As starkly illustrated in the financial crisis, one glaring example took the form of misleading financial reporting.

At a minimum, directors should ensure that enterprises, especially financial enterprises, present fair and honest pictures of their financial condition. But directors of some financial companies authorized the issuance of misleading financial statements, thereby inducing others to engage in a web of transactions with them. When the truth could no longer be hidden, those companies failed and, because of that web, our financial system almost went down with them. 

It boggles the mind that, in 2007 (i.e., before the crash), directors of AIG, Lehman Bros, Fannie Mae and Freddie Mac approved statements showing shareholders’ equity of nearly $200 billion but just one year later, that equity wasn’t there, US taxpayers had to step up for more than $300 billion, and the final bill for just Freddie Mac and Fannie Mae is now projected at $1 trillion.

But what about CalPERS’s own board? 

Like Fannie Mae and Freddie Mac, CalPERS is a huge government-sponsored financial enterprise with enormous consequences for others, especially for state funding of healthcare, education, parks, environmental protection and more.  When CalPERS under-performs, those programs and taxpayers take the hit, not pension beneficiaries.  And like Lehman and AIG, CalPERS issues financial statements and forecasts that induce others to take risks.

For example, this year CalPERS will require almost $4 billion from the state, 500% more than the amount CalPERS forecast in 1999 when it induced the state legislature to grant large retroactive pension increases to hundreds of thousands of state employees. Back then, CalPERS implicitly forecasted that a doubling stock market every nine years would cover the costs of that increase. But eleven years later, the stock market is nearly 1,500 points lower than it was in 1999, the state has already paid out $20 billion more than CalPERS forecasted, and another $270 billion is projected to be paid over the next 30 years (under a revised assumption that the stock market will now double every ten years — if it doesn’t, the cost will be higher). Even then, pensions will be only 75% funded.  

What’s more, recent studies by Stanford, the University of Chicago and Northwestern claim that CalPERS understates liabilities, currently to the tune of $200 billion. And that’s not all. CalPERS allows board members to receive contributions from people and entities that could benefit from its actions and decisions and has continually resisted calls to change that policy.

For example, some board members who advocated for that retroactive pension increase were recipients of campaign contributions from beneficiaries of that increase. CalPERS board members have also on occasion failed to disclose potential benefits from actions they support or oppose. Yet, despite all this, no CalPERS director has even been singled-out much less criticized or fired.

As large as public pension costs have already been, the tsunami has yet to hit shore. A new study out of Northwestern predicts that, absent policy changes, many state pension plans will run out of money in 10-20 years and that with $3 trillion of unfunded pension liabilities, a bailout would far exceed the bailout costs for Fannie Mae and Freddie Mac. In light of such consequences, all citizens should care deeply about the competence, character and values of public pension fund directors.

As CalPERS turns its attention to directors of under-performing enterprises, it should start with a self-review.

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