Market Crash Slams State Pension Funds
By JOHN SEILER
So much for record gains in California state and local pension funds. The stock market crash of the past week worsened the funds’ crisis, putting taxpayers further on the hook for funds guaranteed by law.
Less than two months ago, CalPERS boasted that its fund had gained 20.7 percent in the previous calendar year, July 2010 to June 2011. The California Public Employees Retirement System is the largest pension fund in the nation.
“This is a great one-year achievement that powerfully affirms our strategy and the skills of our investment team,” said Chief Investment Officer Joseph Dear, as reported by CalPERS. “While we can’t assume that we’ll sustain this high level of earnings, we have averaged a net return on investments of 8.4 percent for 20 years.”
“These strong returns are a testament to our commitment to our long-term investing principles,” said Anne Stausboll, CalPERS Chief Executive Officer. “Our members, employers and California taxpayers all benefit from our disciplined approach to investing.” On June 30, 2011, the fund’s balance stood at $237.5 billion.
Since then, the fund declined to $226 billion on August 5. Then it crashed again to about $220 billion on yesterday, August 6, based on preliminary estimates. Combined, that’s a loss of about $17.5 billion in just five weeks, or 7.4 percent.
So practically half the gain from last year was wiped away. And there’s no gain for the new fiscal year. Yet the fund has to make at least 7.75 percent a year, on average, to keep its funding levels high enough to avoid further forced taxpayer contributions.
“We’re a long-term investor and have a long-term investing horizon,” CalPERS spokesman Wayne Davis told me. “We’re able to ride the waves — when it goes up or when it goes down.” As to the crash in the market, he quoted Joseph Dear as saying, “There’s fear out there.”
Back on July 19, the Fresno Bee reported, “Steve Maviglio, spokesman for the union-backed Californians for Retirement Security, said the solid returns should stall the movement toward overhauling the pension system.
” ‘When you have these kinds of numbers with the economy struggling, it shows the funds will be healthy in the long term,” he said.”
Yesterday I asked Maviglio about his statement of three weeks ago. “The 30 year average return for CalPERS averages 7.5 percent,” he replied. “My point was that the pension-bashing crowd used the depths of the recession as the reference point to sound an alarm about pensions instead of the long term returns actuaries use. And given the last two days on the market [August 5 and 8], the alternative that reformers are pushing — 401(k)s — are looking even worse than before.”
CalPERS Is the Market
Worse for public employees expecting pensions at current levels, perhaps, but not for taxpayers. The problem with the 401(k) comparison is that “CalPERS is so big it basically tracks the market,” Dan Pellissier told me; he’s president of California Pension Reform, which is pushing to put a pension-reform initiative on the November 2012 ballot. “It’ just can’t beat the market. Fundamentally, they are the market.”
The smaller funds may be able to do better because they are more nimble. But as Wayne Lusvardi reported on CalWatchDog.com on July 19, “The public stock component of Cal-PERS’ investment portfolio had a 30 percent return, while the Standard & Poor’s 500 Index had about a 31 percent return over the same time interval. So in public stocks, at least, the CalPERS fund slightly under-performed a plain-vanilla index fund. Politicians couldn’t help make public union pensioners any windfall profits over investing in index funds invested in a 401(k).
“An index fund is a passively managed fund designed to match the performance of the whole market or mix of funds. So whatever commissions CalPERS paid all its external fund managers to invest in public stocks apparently could have been saved just by passively investing in the S&P 500 Index.”
Peter Pan Portfolio
John Moorlach told me that CalPERS’ fund is similar to the “Peter Pan Portfolio” that led to Orange County’s bankruptcy in 1994. The meaning: If you just believe, the fund will be all right. In Orange County’s case, Treasurer-Tax Collector Bob Citron kept saying low interest rates would make the portfolio perform. But then interest rates soared and the county went bankrupt.
Back then Moorlach was an accountant warning of the county’s severe fiscal problems. Reporter Andrew Bary of Barron’s called Moorlach and wrote a story with the title, “Peter Pan Portfolio: Orange County bet that interest rates would stay low forever.” Moorlach later was appointed to replace Citron as treasurer-tax collector. And in 2006, he was elected as an Orange County Supervisor.
This time, he said about CalPERS’ Peter Pan Portfolio that fund managers are saying, “We’ve got to hope and pray that the Dow goes up,” meaning the Dow Jones Industrial Average.
“To have the market determine the pensions is scary, because you can’t control the investment arena,” he warned. “The pension spokespeople say, ‘We don’t have to fear,’ sort of like that’s half the story” because pensions go up in many years. “But don’t patronize me. Some years it goes up 20 percent, but the next year it will go down. If you lose 50 percent, you have to make 100 percent the next year to break even.
“It’s pretty risky to put it on taxpayers,” who have to make up for any market shortfalls because of legal guarantees in union contracts, as well as in the California Constitution. “They’re doing badly on their portfolios, too. And they’re supposed to pay more in taxes.”
Pellissier concurred. “The real point here is taxpayers should not see 5 percent daily swings” in the pension funds guaranteed by their tax dollars, he said. “Taxpayers need for public employees’ retirement programs to get off the stock market roller-coaster. Stop making pension promises to employees based on the stock market.”
His initiative would get replace the current defined benefits plan, in which the taxpayers are on the hook, no matter what happens in the market, with a defined contribution plan. In the words of the current reform draft, “All government employees hired on or after January 1, 2013 will receive an employer match into their defined contribution plan of up to 6 percent of salary, 9 percent for new safety employees.”
Employees could contribute more on their own if they wished. “It is a very simple approach,” he concluded. “Cap the government employer cost for new pension benefits at the private sector level and then let employees decide how much more of their money they want to pay. Give folks who do not have Social Security an equivalent benefit. Require a majority of pension board members be independent and experts.”
One thing I’ve always warned is that, if reforms aren’t made soon, even the pensions of current employees could be reduced — despite laws, union contracts and the California Constitution.
I put that question to John Bury, an independent actuary and author of a popular blog on pensions. “Default to retirees is probable, first by decreasing or eliminating COLAs and, down the road, direct reductions, possibly through taxing pensions,” he told me. So, it might already be too late to fix the system. “The reason this pension crisis isn’t being effectively addressed is that nobody dares to cut benefits or pay for the benefits already promised so there will be more Central Falls solutions.”
Bury was referring to the city of Central Falls, Rhode Island, which is in bankruptcy. Unlike the Orange County bankruptcy of 1994 or the Vallejo bankruptcy of 2008, Central Falls is trying to cut its payments to those already retired. The Providence Journal has reported on the matter.
Bury was even more pessimistic on his pension blog, where he wrote, “What will this precipitous drop in asset values do to public pensions across this country?
“Most of these plans are using ridiculously high interest assumptions to justify keeping required contributions low.”
“This crash simply reaffirms the need for serious statewide pension reform in California,” Jack Dean told me. He is vice-president of California Pension Reform and publishes the Pension Tsunami Web site, which chronicles state and national pension problems. “The system was unsustainable seven years ago when I started tracking the problem. The financial meltdown in 2008 didn’t cause the underfunding, it merely exposed the enormity of it.”
Dean added that the market crash of recent weeks “increased taxpayers’ liabilities for overly-generous public-employee pensions even as their own pensions and 401(k) accounts lost even more value. Not only is this path unsustainable, it’s also unfair, and taxpayers are eager to do something about it.”
How the stock market performs in coming weeks and months will determine what further steps will be taken by fund managers, taxpayers and voters. Unless the market makes a remarkable recovery, cuts seem to be inevitable. A market decline, or even stagnation, will spark chaos.
May 24, 2013