California’s Bad Bet Makes JPMorgan’s Look Minor
Worrisome as that gamble was -- after all, the banking crisis was largely due to bad bets by banks -- it is unfortunate that Congress has never called hearings on a far bigger bet, one that has had more catastrophic consequences for millions of taxpayers.
The one I’m referring to was made by California legislators on Sept. 10, 1999. They decided that investment gains would cover 100 percent of the cost of retroactive pension increases they granted that day to hundreds of thousands of state workers.
The politicians made the wrong bet -- and the result has been a penalty to California’s budget that has averaged $2 billion a year ever since and that will cost the state billions more for decades to come.
Promising that “no increase over current employer contributions is needed for these benefit improvements,” and that the state pension fund would “remain fully funded,” the proposal, known as SB 400, claimed that enhanced pensions wouldn’t cost taxpayers “a dime” because of healthy investment returns. The proposal went on to assert that it “fully expects” the state’s pension costs to remain below $766 million a year for “at least the next decade.”
The Legislature included cost projections provided by the California Public Employees’ Retirement System -- or Calpers -- in the description of the bill and passed it with broad bipartisan support. Governor Gray Davis signed it.
Since then, the pension system has earned only 75 percent of what it had hoped. Because the state is unconditionally on the hook, the state budget has had to make up the difference. As a result, the state has spent $27 billion on pensions, $20 billion more than Calpers projected.
Because the boosted promises last for decades -- for employees’ lifetimes -- and because the pension fund amortizes the difference between what it expected to earn and what it really earned during such a long period, just a small portion of the increased costs has so far been recognized. Far larger increases are in store.
To finance the $20 billion of extra cost for pensions, the state has cut spending on services and raised taxes. As one example, spending on the University of California and California State University systems declined 18 percent from 2002 to 2012, while state spending on pensions rose 214 percent.
The pension deal was a stunning example of nondisclosure. The legislators didn’t inform the taxpayers that:
1. The state was on the hook for deficiencies if actual investment returns fall short of assumed investment returns.
3. Potential costs to the state were uncapped.
4. Members of the Calpers board had received campaign contributions from beneficiaries of the legislation.
Ten years later, a journalist uncovered that Calpers had produced internal projections showing the risks to the state if the bet didn’t work out. The internal projections forecast that if the system earned half of what it assumed, state costs for the pensions would rise to almost $4 billion a year by 2010, close to where those costs ended up.
This problem wasn’t caused by the public employees who receive the pensions but by the politicians who made the promises without setting aside sufficient funding. “Because the fuse on this time bomb is long,” Warren Buffett noted in 2007, “politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed.” Most of the politicians who made those promises in 1999 are long gone and keep their heads low whenever the issue is discussed.
In JPMorgan’s case, the losers of the bet were the bank’s shareholders and, according to Dimon’s testimony, some of the employees who made the bet. But in California, the losers are taxpayers and recipients of public services. None of the elected officials who made the bet will suffer any consequences. Perhaps we should require politicians to post personal bonds whenever they make bets with the public purse. After all, they are still making bets every day on new pension promises and counting on investments to cover the cost.
(David Crane, a former financial-services executive and a Democrat, is a lecturer at Stanford University and president of Govern for California, a nonpartisan government-reform group. He was an economic adviser to California Governor Arnold Schwarzenegger from 2004 to 2011. The opinions expressed are his own.)
Today’s highlights: the editors on why it’s time for an EU-U.S. free-trade pact, on amnesty for illegal immigrants and on plugging national-security leaks; William D. Cohan on the death of Dodd-Frank; Noah Feldman on the Supreme Court’s coming decisions; Albert R. Hunt on why Obama’s campaign needs help; Richard Vedder on why the government should get out of the student loan business.
To contact the writer of this article: David Crane in San Francisco at firstname.lastname@example.org.
To contact the editor responsible for this article: Katy Roberts at email@example.com.