“The six-year bull market is admittedly long in the tooth.”
CalSTRS Chief Investment Officer Chris Ailman, Sacramento Bee, July 17, 2015

If what Mr. Ailman really means is equity investments may not be turning in double digit returns any more, that makes the recent performance of CalSTRS and CalPERS all the more troubling. Because according to their most recent financial statements, CalSTRS only earned 4.8% last year, and CalPERS only earned 2.4%. That leaves CalSTRS 68.5% funded, and CalPERS 77% funded.

Are we at the top of a bull market? Take a look at this chart:

S&P 500, Last Twenty Years Through June 21, 2015

20150721-UW-pensions1

The S&P index, which reflects U.S. equity trends reasonably well, enjoyed a five year bull market that crested in mid-2000, then another one that ran five years from September 2002 to October 2007, then this current bull market, which began 6.5 years ago. The bull market ending in September 2000 saw a 170% rise in the S&P, the one that peaked in October 2007 rose 90%, and this current one has yielded a 188% rise. So far.

Is today’s bull market “long in the tooth”? It sure looks that way.

There’s more to this, however, than the new reality of globalized, largely automated equity trading that condemns stock indexes to unprecedented volatility – or the graphically obvious fact that we’re at another peak.

There’s something stock traders call “fundamentals,” in this case creating economic headwinds that all the high-frequency trading and hedges in the world can’t avoid. About the same time that CalSTRS and CalPERS announced they missed their earnings targets, Reuters published this: “Calpers chief looks to cut volatility as fund enters negative cash-flow era.”

In plain English, this “negative cash-flow era” means that CalPERS has crossed a big line financially. They are now going to be selling more investments each year than they buy. They are going to be net sellers in the markets. While the superficial explanation for this is “baby boomer retirements,” that is incorrect. Government staffing is not directly driven by population demographics. In government, new hires replace retirees and headcounts trend upward. The real reason CalPERS is entering a negative cash flow era is because the retroactive pension benefit enhancements that started in 1999 and rolled through agency after agency for the next six years or so are now translating into large numbers of people retiring with these enhanced pensions, replacing earlier retirees who had modest pensions. Meanwhile, new hires are, increasingly, accepting more realistic reduced retirement promises, and paying proportionately less into the funds.

If CalPERS were the only pension fund becoming a net seller in the market, it wouldn’t really matter. But all the major pension funds, everywhere, are becoming net sellers. That’s nearly $4.0 trillion in assets under management in the U.S. that suddenly are shedding assets faster than they’re acquiring them. When supply rises, prices drop. This is a headwind.

There are other headwinds. If government staffing doesn’t directly reflect population demographics, the general population obviously does. Between 1980 and 2030 the percentage of Americans over 65 will rise from 11% to 22% of the total population. And ALL of these seniors will be net sellers of assets.

If that weren’t enough, there is the small matter of the United States – along with most of the rest of the world – arguably in the terminal phase of a long-term credit cycle. Total market debt as a percentage of GDP in the United States is over 300%, higher than it was in 1929. When interest rates fall to zero, playing the debt card to stimulate economic growth doesn’t work anymore. And when interest rates rise, asset values fall and debt service becomes untenable. We’ve painted ourselves into an economic corner.

In the face of this reality, unconcerned and all-powerful, the government union band plays on. Today the Los Angeles based City Watch published an early version of what will become an irresistible torrent of propaganda opposing the proposed Reed/DeMaio pension reform initiative. The title says it all “Measure of Deception: Initiative Would Gut Retirement Benefits for Millions of Californians.”

Take a look at the average full career CalPERS pension per former employer. Bear in mind the average public sector retirement age is 61, and that the average Social Security benefit is around $15,000 per year. Is there no middle ground between “gutting” and restoring financial sustainability?

Restoring pension systems to financial sustainability in the face of economic headwinds will require two major changes in policy. First, pension benefit plans would need to change in the following ways: (1) Increase employee contributions, (2) Lower benefit formulas, (3) Increase the age of eligibility, (4) Calculate the benefit based on lifetime average earnings instead of the final few years, and (5) Structure progressive formulas so the more participants make, the lower their actual return on investment is in the form of a pension benefit. Finally, enroll all active public employees in Social Security, which would not only improve the financial health of the Social Security System, but would begin to align public and private workers to share the same sets of incentives. Taking these steps will repair the damage caused by SB 400 in 1999, which set the precedent for retroactive pension benefit increases.

Second, completely change the investment strategy of public pension systems to return to lower risk investments. Along with choosing, say, high-grade corporate bonds over global hedge funds, these lower risk investments could include investment in revenue producing civil infrastructure. A thoughtful article recently published in Governing, “How Public Pensions Are Getting Smart About Infrastructure,” explores this possibility. Not only would massive investment by pension funds in revenue producing infrastructure create millions of jobs, repair neglected public assets, and constitute a low risk investment, over their life-cycle many of these projects actually produce excellent returns. Moving to lower risk investments will repair the damage caused by Prop. 21, narrowly passed in 1984, that “deleted constitutional restrictions and limitations on the purchase of corporate stock by public retirement systems.”

Given the financial headwinds they face, it is going to take courage and creativity to save defined benefits for public sector workers. But depending on what direction these reforms take, they have the potential to greatly benefit the overall economy.

*   *   *

Ed Ring is the executive director of the California Policy Center.

CALIFORNIA POLICY CENTER PENSION STUDIES

California City Pension Burdens, February 2015

Estimating America’s Total Unfunded State and Local Government Pension Liability, September 2014

Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties, May 2014

Evaluating Public Safety Pensions in California, April 25, 2014

How Much Do CalSTRS Retirees Really Make?, March 2014

Comparing CalSTRS Pensions to Social Security Retirement Benefits, February 27, 2014

How Much Do CalPERS Retirees Really Make?, February 2014

Sonoma County’s Pension Crisis – Analysis and Recommendations, January 2014

Are Annual Contributions Into CalSTRS Adequate?, November 2013

Are Annual Contributions Into Orange County’s Employee Pension Plan Adequate?, August 2013

A Method to Estimate the Pension Contribution and Pension Liability for Your City or County, July 2013

Moody’s Final Adopted Adjustments of Government Pension Data, June 2013

How Lower Earnings Will Impact California’s Total Unfunded Pension Liability, February 2013

The Impact of Moody’s Proposed Changes in Analyzing Government Pension Data, January 2013

A Pension Analysis Tool for Everyone, April 2012

17 Responses to Why Pension Reform is Inevitable, and How Reforms Can Benefit the Economy

  1. S Moderation Douglas says:

    Concerning the “average full career CalPERS pension per former employer” linked near the middle of this article:

    Following a discussion (copied below) with Robert Fellner, I have been unsuccessfully trying to find the median full career CalPERS pensions. I’m not adept enough with a spreadsheet to calculate it myself. Is that figure available somewhere?

    Thank you

    Robert Fellner says:
    July 4, 2015 at 10:14 AM
    Doug cited a statistic that is false; I am stunned.

    You’d think, given Ed links to the median combined household income of $90k, you’d at least give some pause to how the average wage could be higher than the combined household income.

    The BLS reports the median earnings for a full-time, year-round worker in Santa Clara was $68,586 in 2013. That link is also in Ed’s article.

    These are the relevant, comparable numbers.

    The data you cite is not.

    It simply adds up the total wages paid and divides them by total employees. That is not a good predictor of what the average worker receives.

    The BLS reporting the median earnings is a good predictor of what the average worker receives. This data comes from individual employees’ actual earnings. Not gross receipts that sum total wages paid in the county divided by total number of employees.

    Here’s an example of why.

    There is a 10 person firm. The CEO makes $1M and the 9 employees make $75k.

    The median earnings in this firm is $75k. That’s what most people make.

    The averages wages paid, however, would be $167,500. That’s not what most people make, and 90% of the firm would take objection to you acting like since they “already make, on average $167,500″ are in no need of a raise.

    • Tough Love says:

      The “median” of all CalPERS pension is just slightly less LACKING-IN-VALUE than the mathematical average because BOTH include the pensions of:

      (1) those who retire long ago on much lower salary scales and lower pension formulas
      (2) those with short careers
      (3) those this part time service
      (4) the 50% beneficiaries of deceased pensioners

      All of the above disguise (and to an unknown extent) what a full-time, full 30+ year career worker would get if retiring today. It is THAT amount that should (in step 1 … see below) be compared to the COMPARABLE Private Sector worker’s pension.

      AND …. it is NOT just the DOLLAR AMOUNT of THAT full-time, full-career recent Public Sector retiree’s pension that should be compared to the DOLLAR AMOUNT of the comparable Private Sector retiree, because Public Sector retirees get a full/unreduced pension at a MUCH younger age, and while virtually all PUBLIC Sector pensions are annually COLA-increased, it is VERY VERY rare for a Private Sector Plan to include COLA increases. And EACH of those 2 differences increase the typical Public pension’s “value at retirement” by about 1/3. This makes the Public Sector pension 1 x 1.33 x 1.33 = 77% greater in “value at retirement” …. even with the identical monthly payout.

      • S Moderation Douglas says:

        “The “median” of all CalPERS pension is just slightly less LACKING-IN-VALUE”

        Understood, which is why I was asking for the …….”median *full career* CalPERS pensions”……

        Web searches pulled up a couple of (questionable) medians of *all* pensions. That doesn’t help me anymore than the average for *all* …..for the reasons you stated.

        Why would I want this? I have seen articles or bloggers comparing “average pensions” to “average private sector wages”, which Mr. Fellner indicated is problematic, or, worse, comparing “average pensions* to *median* private wages.

        Why median? Several years ago, when I first saw a figure for average state pay, it was about $66,000 annual. I was surprised, because I knew very few people who made that much. And the “average full career” pension now is about $68,000 (?) Again, I know very few at that level. There are thousands of us full career retirees with pensions well below $50,000. I just wondered how that affects the “median”

        • Tough Love says:

          The pensions of …. “median full career CalPERS pensions” …. is not good enough either.

          In NJ, there are loads of weasels (mostly political types, on Town Councils, on “Commissions”, etc.) who gain many pension-service-years in NJ’s pension system with very minimal part time service), and then (using their political contacts), land a high paying gov’t job for 3 years and retire with a gov’t pension equal to a full-career, full-time worker.

          The Public Sector workers to be compared should ONLY include full (30+ year) career, full-time, VERY recent year retirees.

  2. Jody Morales says:

    It is absurd to believe that this completely unsustainable system can be perpetuated without major changes, such as those proposed in this excellent article.
    Elected officials are to blame for kowtowing to union demands, knowing that doing so – while it may increase their campaign coffers – is leading to disaster. That disaster affects not only the taxpayers, who are getting nailed with higher taxes, rates and fees, plus seeing core, vital services cut, but will ultimately and very dramatically harm public employees. That old adage about paying through the nose to attract “the best and the brightest” will eventually require hiring whoever will take the job because the retired top brass retirees will be siphoning off the ‘available’ funds. Why not make enact sensible pension reform now? Citizens for Sustainable Pension Plans http://www.marincountypensions.com

    • Tough Love says:

      Quoting …. “Why not make enact sensible pension reform now?”

      Because those with the power to implement the needed changes (our self-interested Elected Officials) are BOUGHT-OFF with Public Sector Union campaign contributions and election support.

      Little will change until Private Sector taxpayers get sufficiently educated and pissed-off to go to the polls en-mass and vote these Taxpayer-betraying officials out of office.

  3. john m. moore says:

    I believe that pension and salary reform will come about, but only by the election of a majority of Reformers to state and local legislative bodies.

    Three Ca. cities have utilized Chap. 9 in bankruptcy. All of them made a concious decision to leave busted pensions untouched.

    In Sonoma county and Marin county, grand juries have produced unassailable evidence of massive pension embezzlement, yet their legislative bodies have purchased unconscionable legal opinions that ignored even the mention of Ca. supreme court precedent and concluded that all in all everything was maybe kosher. Based thereon, the legislative bodies have made a conscious decision to let the embezzlements stand and let the felons stay free to enjoy the swag.

    There are now ample weapons for any legislative body to use as leverage to bring about true reform of pensions and salaries. By meeting and confering until a final impasse, legislative bodies can and should bring the embezzlers to its knees by reducing salaries across the board by ten, twenty,thirty, fifty, even 60%; whatever it takes to get their respect. Many may leave, good. It could not get less honorable and corrupt as now exists.

  4. KNOWN_TROUBLE_MAKER says:

    From your article above

    (1) Increase employee contributions – Employee contributions are being increased every year by an act signed into law by JB about two years ago

    (2) Lower benefit formulas – The richest (3%@50) formulas have been reduced to 2.5%@57 by JB over two years ago. In addition the administration (as I have been informed) is in the process of trying to shift 3% employees to 2.5% for future years.

    (3) Increase the age of eligibility – per #2 above, the age of eligibility was changed for POFF safety positions over two years ago.

    (4) Calculate the benefit based on lifetime average earnings instead of the final few years – Interesting idea.

    (5) Structure progressive formulas so the more participants make, the lower their actual return – What % penalty per 10k of annual salary would be ‘progressive’ enough?

    • Tough Love says:

      Quoting …. ” In addition the administration (as I have been informed) is in the process of trying to shift 3% employees to 2.5% for future years.”

      Don’t make me laugh !
      ———————————-

      In any event, your #s 1, 2, and 3 changes (most of which apply only to workers hired since the pension change of a few years ago) will STILL Leave Public Sector workers with pensions that upon retirement have a value 3+ times greater than those of their Private Sector counterparts.

      It should be no greater than EQUAL. They are NOT “special” and deserving of greater pensions and better benefits on the taxpayers’ dime.

      • S Moderation Douglas says:

        Quoting: ” …….pensions that upon retirement have a value 3+ times greater than those of their Private Sector counterparts.

        It should be no greater than EQUAL. They are NOT “special” and deserving of greater pensions and better benefits on the taxpayers’ dime.”

        Don’t make me laugh !
        ———————————-

        Will you never learn? The value of pensions at retirement should be no greater than equal?

        Absurd. You know that public workers earn less in wages in exchange for higher pensions. Then to claim the pensions “should be no greater than equal”?

        It’s a non starter.

        • Tough Love says:

          And YOU know that when wages, pensions, and benefits are ALL included in the PUBLIC/PRIVATE Sector compensation comparison, BOTH California and NJ (our home states) show (on average for all workers combined …. which is the financial result impacting the Taxpayers) a 23% “Total Compensation” ADVANTAGE over their Private Sector counterparts.

          yea … I see you’re keeping up with your distractions, distortions, misstatements, omissions of material facts, and lies.

          Sure, certain individual worker’s compensation should go up and others down to achieve better equity, but OVERALL the Taxpayers must DEMAND a net 23% of pay reduction in Public Sector “Total Compensation”

          • S Moderation Douglas says:

            1) “a 23% “Total Compensation” ADVANTAGE” is not the same thing as “They are NOT “special” and deserving of greater pensions and better benefits on the taxpayers’ dime.”

            2) “And YOU know ……….a 23% “Total Compensation” ADVANTAGE over their Private Sector counterparts.”

            What I “know” is that one of several major studies claims that public sector advantage. One.

            3) “Sure, certain individual worker’s compensation should go up and others down to achieve better equity,…..”

            That is not necessarily the case. It is simplistic thinking.

          • Tough Love says:

            You can call it whatever you like, but in NJ and CA ………. “EQUAL, but not better” …. means that the “Total Compensation” (wages + pensions + benefits) of ALL Public Sector workers taken together, needs to be reduced by 23%-of-pay.

            If invested over their full career, that likely averages to well over $1,000,000 per full-career Public Sector worker ….. wealth unnecessary stolen from the Private Sector in unnecessary, unjust and unfair taxes.

            And for most, 23% each and every years adds

        • KNOWN_TROUBLE_MAKER says:

          SMD –

          Why are you replying to him? Just ignore, and continue on with an intelligent conversation with other posters.

          • S Moderation Douglas says:

            No fun in that.

          • Tough Love says:

            You seem to be incredibly naive.

            Example… I noted your post with numbered change above and for ease of reading, re-posted #s (4) ans (5) below. I suggest you publicly propose (in say a Council meeting) that police pensions be changed per your #s (4) and (5) when there is a large police presence in the audience.

            Then, please report back to use with their response.
            ————————-

            (4) Calculate the benefit based on lifetime average earnings instead of the final few years – Interesting idea.

            (5) Structure progressive formulas so the more participants make, the lower their actual return – What % penalty per 10k of annual salary would be ‘progressive’ enough?

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