One of the biggest unreported, blockbuster stories in modern America is the alliance between public sector unions and the speculative banking industry. It is a story saturated in greed, drowning in delusion, smothered and marginalized by an avalanche of propaganda – paid for by taxpayers who fund both the public sector union machine and the public employee pension funds.
If it weren’t for this corruption, delusion and greed that currently condemns them to inevitable doom, defined benefits would be a far preferable alternative than individual 401K accounts. Defined benefits offer retirees a stable annuity that lasts as long as they do, unlike individual 401K accounts, that can be decimated if a retiree happens to get old during a bear market, or is unfortunate enough to have a longer than average lifespan. The defining characteristic for a 401K account is risk, and the defining attitude of most 401K account holders is anxiety. And along with anxiety, guilt, since we must all aspire to becoming infallible investment experts if we are to ever realize the libertarian wet dream of individuals taking personal responsibility for all things – especially caring for themselves and their investments when they’re old and infirm. Try explaining declining balance annuities to the average 87 year old. This is the world that union leaders, quite understandably, want to spare their members. But to save defined benefits, they’ll have to face reality.
The problem with public sector defined benefit pensions can be boiled down to two cold factors: They are too generous, and they rely on rate-of-return assumptions that are too optimistic. The first is the result of greed, the second of delusion. To indulge these vices requires corruption, and it is a rot that joins public sector unions with the most questionable elements of that Wall Street machine they so readily demonize.
If you honestly review the numbers, greed is readily apparent. The average pension for a public servant who has worked 30 years or more in public service is more than four times what the average social security benefit is for someone who has worked 40 years or more in the private sector. To cite examples – the average CalPERS retiree who retired in the last five years, after 30 years service, collects a pension of $67,980, for CalSTRS, the average for recent retirees with 30+ years of service is $66,828 per year. Most of California’s independent city and county pension funds are even more generous; Orange County’s employee retirement system, for example, pays the average recent retiree with 30+ years of service a pension of $81,000.
These numbers are ridiculously out of step with reality. If every Californian over the age of 55 got a pension that averaged $65,000 per year, it would cost over $650 billion per year, one-third of California’s entire GDP. But the average public employee who works from age 26 through age 55 will easily collect that much. This is impossible to justify, and impossible to sustain. The average Social Security benefit for a 68 year old new retiree: $15,000 per year.
Greed is compounded with corruption and delusion, when in response for calls to bring public sector pensions into line with what is affordable and fair, unions and pension bankers claim 7.5% annual rates of return can be sustained forever. Their first mistake is suggesting that 7.5% rates of return is all they need. Current levels of underfunding mean either annual contributions go way up, or returns have to greatly exceed 7.5%. For example, CalSTRS is 67% funded, and to avoid becoming more underfunded, they must either earn 11.2% per year, or they must make a supplemental “unfunded contribution” of $4.1 billion per year – last year their unfunded contribution was only $1.1 billion. We are at the top of another bull market and in the terminal phases of a long-term credit cycle – anyone want to bet that CalSTRS is going to earn 11.2% a year for the next 30 years?
In an attempt to earn in excess of 7.5% per year, pension funds are increasingly turning to hedge funds, whose charter, essentially, is to earn over-market returns. To do this, they do all the things that public sector unions are supposedly opposed to and wishing to protect us from – opaque private equity deals, currency speculation, high-frequency trading – all those manipulative tools used by the super-wealthy, super empowered Wall Street players to siphon billions out of the economy. Except now they’re using tax dollars, channeled to them via government payroll departments, and cutting the government workers in on the skim. And if it goes south? Taxpayers pay for the bailout. And even if these funds can keep the lights on for a few more years before the whole scam collapses, isn’t it inherently exploitative for a government-ran pension fund, operated for the benefit of government employees, to aspire to over-market returns? To the extent the market is manipulated and over-market returns are extracted for an elite few, value investors with their individual 401Ks are penalized. That fact is irrefutable, simple algebra.
Which brings us to sheer abuse of power. Hypocrisy aside – and how much more hypocritical can it be for union leaders to hurl the word “profit” the way most of us might utter obscenities, yet ignore the fact that only “profits” can impel pension funds to appreciate at rates of 7.5% per year or more – it is raw power, sheer financial and legal might, that enables pension funds, with unions cheering them on every step of the way, to sue city after bankrupt city to ensure their “contracts” are inviolable, that the pension money keeps pouring in, even if it means raising taxes via court order, then selling the parks, selling the libraries, closing government offices and “furloughing” public servants, and giving raw deals to newly hired employees. But as courts will eventually sustain, perhaps out of financial necessity, the moral worth or worthlessness of a contract supersedes its technical validity. Power is a ship. Financial reality is a lighthouse.
To find a model for a sustainable defined benefit, look no further than Social Security. It has minimum and maximum benefit payments, it stays out of the market, much less hedge funds, and it is adjustable upwards or downwards as needed to maintain solvency. It is NOT a Ponzi scheme because there is no implied return of principle. It does NOT penalize young people, because just as their payments support retirees, when they eventually retire, young workers will make payments to support them. It is NOT a Pyramid scheme, because today the U.S. population is distributed equally between young and old, which means new participants no longer outnumber veteran participants. Public sector retirement benefits – like all taxpayer funded entitlements – should provide an austere safety net, like Social Security. Pensions should not enable a retirement lifestyle of luxury and ongoing leverage, exempting government workers from the challenges to save and prepare that face every other American citizen. Nor, in the process, should they impoverish taxpayers, enrich banks, and flush the social contract into oblivion.
The reason pension reform doesn’t happen isn’t merely due to the greed and exceptionalism of public sector unions. Despite their overwhelming power, unions probably couldn’t stop reforms all by themselves. Public sector unions receive formidable political, legal and financial support, along with intellectual cover in the form of delusional financial projections, from their partners in the financial sector, corrupt, crony capitalists who indeed give capitalism a bad name.
Ed Ring is the executive director of the California Public Policy Center.