Hostages to CA's Accounting Fraud

$593B and growing

Yesterday my SFMuni bus ride took me past a protest led by SFUSD teachers striking for better pay. You cannot blame the teachers. You also can’t blame the students whose schools are closed or the taxpayers who have been providing record revenues to schools. All are victims of a deception that started 27 years ago.

Enabled by a measure put on the California ballot by public sector union bosses in 1992, the deceit commenced in 1999 when the state’s most senior fiscal officials, then-State Treasurer Phil Angelides and then-State Controller Kathleen Connell, backed an assertion by the president of the state pension fund CalPERS that a huge retroactive pension increase for public employees “would not cost taxpayers a dime” because CalPERS would earn “excess returns.” This is a screenshot from a document that, according to Gemini, has “mostly been scrubbed from CalPERS' active servers” but of which I have a copy:

The deception was advanced the next decade when CalPERS and the state teachers’ pension fund CalSTRS rejected warnings from Warren Buffett and others that those pension funds not be able to achieve the excess returns and the State Senate removed me from CalSTRS’s board for pointing out the nonsense of the excess returns they were expecting and advocating for pension contributions based on non-excessive expected rates of return in order to avoid big pension deficits down the road.

CalPERS and CalSTRS and the politicians that protect them seek to base pension contributions on an expectation of excessive returns because that shifts more pension costs from employees to taxpayers and hides the true size of pension promises. While both employees and taxpayers contribute to the “Normal Cost” of pensions, which is the upfront contribution based on the expected rate of return, only taxpayers are on the hook for the financial consequences of failing to meet the expected return. The higher the expected return, the lower the Normal Cost, but when the expected return isn’t realized, an “unfunded liability” (UAL) is created that is only for the account of taxpayers. That’s exactly what has happened since 1999.

Since 1999, CalPERS and CalSTRS have earned enviable compound annual growth rates of 6.45% and 7.2% but because CalPERS and CalPERS based Normal Cost contributions on a higher (8.25%) expected return, the two pension funds incurred UALs that — so far — have cost school, state and other government budgets at least $593 billion.*

The victims are today’s school teachers, students, residents and taxpayers. The beneficiaries are public sector union bosses and the elected officials they finance.

For two decades I have offered solutions to the pension problem but elected officials have been too afraid of public sector union bosses to implement them. Now, because of accretion of the huge discount caused by the utilization of excessive expected return assumptions and issuance of more unfunded retirement obligations, I fear it’s too late to do anything other than to declare bankruptcy where possible and to reorganize debts, including deceptive pension obligation bonds marketed by Wall Street. Failure to stop the bleeding from UALs will mean constant tax increases even as services continue to decline. But maybe sharper minds have better ideas.

*In 1999, CalPERS and CalSTRS had surpluses totaling $45 billion but by 2026 they had UALs of $190 billion plus over the intervening 27 years the two pension funds extracted $715 billion from employers, at least 50% of went to pay off UAL.