In California, the return of hot, dry winds signals the arrival of a familiar crisis. With summers spent under relentless sunlight, the dry sage and chaparral adorning the coastal hills and inland forests have become a tinderbox, primed for disaster.
The consequences are as predictable as day following night. A single spark—be it from a downed power line or a malfunctioning truck—can ignite a fierce wildfire. Once again, California finds itself engulfed in flames, the sky painted an eerie orange as ash settles on its streets.
This scenario plays out annually, yet each season is labeled as the worst ever. Fires continue to blaze until cooler winter temperatures arrive, after which many seem to forget the devastation… until the inevitable mudslides occur.
Indeed, California is a land of contradictions. The Governor, seen as an eccentric figure, aspires to be a leading candidate for the 2024 presidential election. The state and local governments often lean towards socialistic policies, while the public desires high-quality infrastructure at minimal costs. Alarmingly, nearly half of the nation’s homeless population resides here.
Yet, the core issue in California isn’t solely about wildfires; it is far more complex and grim. The narrative revolves around the state’s finances and its public pension systems—a situation unfolding in various regions across the country. The true conflagration lies not in flames but in the financial instability stemming from extravagant government promises.
This story follows an army of public employees and the unsustainable promise of lavish retirements. Far more pressing than the flames devouring landscapes is the fire consuming California’s enormous pension fund, leading to inevitable broken promises and a necessary reckoning.
Where do we start?
Doing Time
Over a decade ago, while consulting for a county sanitation district, we encountered an irritable employee whose focus was not on work but on his imminent retirement. With only six months left, he eagerly anticipated a significant milestone.
This disgruntled employee was approaching two crucial markers: turning 55 and completing 36 years in the district. As he explained, reaching 55 years of age would shift his retirement formula from 2% to 2.5% for each year served.
With a steady paycheck for nearly four decades, he was on the brink of a significant benefit: by multiplying 2.5% by 36, he’d qualify for 90% of his final year’s salary for life. Clearly, spending an additional four years for a mere 10% increase was not appealing to him.
A similar scenario played out for my son in fifth grade. His teacher, someone with a condition closely linked to overeating, frequently shared news of her career’s end, reminding the class that she had just seven more years until her comfortable retirement.
Both Mr. Grumpy and Ms. Rotund are recipients of the California Public Employees’ Retirement System (CalPERS), the nation’s largest public pension fund, which currently requires 2,875 full-time staff to manage its operations.
As of the last count, there were over 2 million members in the CalPERS system. Some may have contributed positively before retirement, while others likely did not meet the same standards. Yet, all entered their tenure with commitment.
However, what they receive upon retirement may not accurately reflect their contributions…
California’s Real Wildfire
The true calamity in California is the financial wildfire raging within CalPERS. This inferno, fueled by mathematics and mismanagement, threatens to engulf the entire state.
Officially, CalPERS claims to hold about two-thirds of the necessary funds to fulfill promised benefits. However, this is predicated on an optimistic investment return assumption of 7% annually—an expectation that has historically fallen short.
For example, in the fiscal year ending June 30, CalPERS recorded a 4.7% return. Over the last two decades, the average annual return has only reached 5.5%. As such, the real gap between CalPERS’ assets and its obligations is significantly larger. If we adjust the expected return down to its historical average, unfunded liabilities could spike from $160 billion to over $200 billion.
Closure of this gap could come from increased contributions from government entities and employees or reductions in future benefits. However, California’s Supreme Court has ruled against the latter.
As for the former, state and local governments struggle to meet their CalPERS commitments, forcing them to divert funds from essential services, raise taxes, and borrow money to sustain an unsustainable system.
Some municipalities are resorting to financial maneuvers that only delay the problem. They employ tactics like issuing lease revenue bonds (LRBs), using city streets as collateral for borrowing. As highlighted by Forbes journalist Elizabeth Bauer and reported by Zero Hedge:
“Two cities in California are issuing bonds backed by their own city streets to address unfunded pension liabilities. West Covina and Torrance have accumulated a combined $550 million in funds for various projects or to pay down debts to CalPERS.
“These lease-revenue bonds (LRBs) offer a major advantage to local officials: unlike standard general-obligation bonds, they can be approved without a vote and can be executed rapidly, showing government action amid low rates. Some proceeds are even directed towards past pension underfunding.”
Those investing in these LRBs should consider the reliability of a revenue stream from leased streets. Yet, within the maze of modern finance, it’s conceivable that these LRBs could end up in CalPERS’ investment portfolio.
Nevertheless, the real wildfire in California truly burns at CalPERS, and the eventual fallout promises to be extraordinary.
Sincerely,
MN Gordon
for Economic Prism
