Gov Employee Pensions Bankrupting New York

MARY WILLIAMS WALSH and AMY SCHOENFELD discuss public sector pensions in the NYT. See HERE for more:

In fact, the cost of public pensions has been systemically underestimated nationwide for more than two decades, say some analysts. By these estimates, state and local officials have promised $5 trillion worth of benefits while thinking they were committing taxpayers to roughly half that amount.

As they say, a trillion here, a trillion there, and pretty soon, we're talking about real money. Sigh.

Bonus: "Christmas is a time when kids tell Santa what they want and adults pay for it. Deficits are when adults tell the government what they want and their kids pay for it." -- Richard Lamm

Taxpayers on the Hook for Public Pensions

From WSJ (July 6, 2009, Andrew Biggs):

http://online.wsj.com/article/SB124683573382697889.html

[E]conomists Robert Novy-Marx and Joshua Rauh calculate that, even prior to the market collapse, public pensions were actually short by nearly $2 trillion. That's nearly $87,000 per plan participant. With employee benefits guaranteed by law and sometimes even by state constitutions, it's likely these gargantuan shortfalls will have to be borne by unsuspecting taxpayers.

Lord, what fools these mortals be.

Stuff We Can't Afford: Credit Card and Public Pension Debt

Nice graphic re: credit card debt:

http://www.mint.com/blog/finance-core/the-descent-into-credit-card-debt

Now I need to go figure out if any of my credit cards have an "inactivity fee."

Also, here's an excellent article (8/20/2007.) on public sector pensions and how to fix them:

http://reason.org/news/show/1006943.html

The argument of generations past, that government must offer greater benefits than the private sector to offset smaller salaries, clearly no longer applies. Today, government employees receive significantly higher benefits and salaries than their private-sector counterparts. According to a 2005 study by the Employee Benefit Research Institute, public-sector employees earn 40 percent higher salaries and 60 percent greater benefits than private-sector employees.

Thanks to Adam Summers for catching this issue back in 2007. Too bad almost no one listened.

Finally! Public Pensions Exposed

Thank you, Craig Karmin, for your June 24, 2009 WSJ article, "Group Shines Light on Hefty Government Pensions."

http://online.wsj.com/article/SB124580096328044597.html

Pension funds provide guaranteed payouts, so even though public funds lost a collective $1 trillion last year, their retirees' monthly checks are unchanged. And the funds' solvency is ultimately backed by taxpayers.

By the way, apparently, the California School Employees Association, a union, represents 230,000 public employees. And that's just one union. No wonder public sector unions have so much power in Sacramento.

Public Pensions Bills to Surge, Taxpayers on the Hook

The WSJ's Craig Karmin has an interesting article on pensions ("Pension Bills to Surge"):

http://online.wsj.com/article/SB123716064273635495.html

Everyone acknowledges we have to hire good teachers, police officers, and firefighters; however, to prevent the public sector unions from taking more taxpayer funds than necessary, taxpayers need to be ever-vigilant. After all, that's our money and our children's money they're investing and taking.

Public pensions are an especially difficult issue to resolve, because they represent a long-term taxpayer liability. Thus, taxes and services do not need to be immediately raised or cut even if a pension's actuarial projections are incorrect. This absence of a short-term trigger makes it harder to alert taxpayers to the slowly ticking time bomb of pension liabilities.

California's problems are acute because even if pension assets decline substantially, payouts do not change. For example: if a California public pension loses 20% of its assets in one year, retirees still get paid the same amount, even though the pension has to dip into its assets to make the payouts. Why is this a problem? Dipping into a pension's assets usually means the pension is underfunded and will need higher-than-normal returns or more taxes to keep paying retirees. So either taxpayers are on the hook for ever-expanding retiree benefits, GM-style, or pension funds have to take risky investing strategies to bridge the gap between payouts and assets. No incentive exists for prudence. It doesn't have to be this way.

Wisconsin has a prudent policy "of adjusting the amount of benefits paid based on the pension fund's performance." Although this policy causes to retirees receive a benefit reduction, it also creates incentives for conservative investments and fewer tax hikes. If a pension doesn't do well, at least retirees will complain and hopefully cause some changes to be made to sustain the pension without a call for higher taxes (yes, this is partly wishful thinking, but at least someone becomes accountable more immediately). The WSJ also points out that some state employees could be switched to 401k plans, which is something I've advocated in the past. (See here.)

No matter what the solution is to the pension liability problem, action needs to be taken. More of the same isn't acceptable.

Bonus: Shelby Steele writes a very interesting article on Republicans and race:

http://online.wsj.com/article/SB123716282469235861.html

Berkshire Hathaway's 2008 Annual Letter

Every year, Warren Buffett issues a fun, easy-to-read letter to his shareholders. Here are this year's highlights:

Cash is King: As the year progressed, a series of life-threatening problems within many of the world’s great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: “In God we trust; all others pay cash.”

Government will get bigger without a firm hand: Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.

The government's interference in credit markets is causing some disruptions: Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.

On bond insurers: By yearend 2007, the half dozen or so companies that had been the major players in this business had all fallen into big trouble. The cause of their problems was captured long ago by Mae West: “I was Snow White, but I drifted.” [Mae West, of course, was the rebel Hollywood sex symbol known for her wit.]

Public pensions are still a major concern: Local governments are going to face far tougher fiscal problems in the future than they have to date. The pension liabilities I talked about in last year’s report will be a huge contributor to these woes. Many cities and states were surely horrified when they inspected the status of their funding at yearend 2008. The gap between assets and a realistic actuarial valuation of present liabilities is simply staggering.

For more on this important topic, see my previous posts, here, here, here, here, and here.

On buying ConocoPhillips (COP) and the future of oil prices: I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. [Looks like investors who want to get a better deal than Mr. Buffett may want to consider buying COP.]

Just darn good writing and advice: Beware the investment activity that produces applause; the great moves are usually greeted by yawns.

On derivative contracts: Receivables and payables by the billions become concentrated in the hands of a few large dealers who are apt to be highly-leveraged in other ways as well. Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with.

Questions at this year's annual meeting will be handled differently--various journalists will sort through the questions and pick which ones to ask: The journalists and their e-mail addresses are: Carol Loomis, of Fortune, who may be emailed at cloomis@fortunemail.com; Becky Quick, of CNBC, at BerkshireQuestions@cnbc.com, and Andrew Ross Sorkin, of The New York Times, at arsorkin@nytimes.com. From the questions submitted, each journalist will choose the dozen or so he or she decides are the most interesting and important. (In your e-mail, let the journalist know if you would like your name mentioned if your question is selected.)

Disclosure: I am bullish on ConocoPhillips (COP).

Public Pensions: Rotting from Within

With all the talk about earnings per share and future profits, it's easy to forget that a country's stock market won't experience a bull market if the country spends more than it collects. This is the basic law of business, and it doesn't change just because government is involved. One area that needs a closer look is public pensions.

Pension Tsunami is a website about public pensions, and it's definitely worth a look. Here is one recent article on San Jose public pensions, focusing on police officers and firefighters. (The San Jose Mercury article contains the chart posted above.)

Most people respect police officers and other public safety workers, but there is no reason for any public worker to receive more benefits and a higher salary than the average private sector worker. When government employees receive higher salaries and benefits than private sector employees, private citizens end up protecting and serving the government--an odd reversal. This is because private sector taxes and IOUs (bonds) are used to finance government expenditures, and those monies come from the private sector. If there is an imbalance, government will have to run up deficits to keep paying itself, creating an imbalance that will devalue the currency (due to the need to print more money to pay for the higher-than-normal benefits) or cause inflation. Thus, whenever the people work to serve the government instead of the other way around, fiscal responsibility will not exist.

There's also the small matter that America was created so private citizens would not have to kowtow to kings or an insulated, domineering government. In short, American government was designed to serve non-government citizens. America's founders would probably disapprove of a political system where people work primarily to serve and pay their government.

Even though the evidence favors treating government workers no better than private workers, it will take a massive paradigm shift to educate the public about the danger of excessive government spending/benefits.

First, television glorifies police officers, D.A.s, and other government workers, while accountants and small businesses don't get any airtime. I still remember my CHiPs costume when I was a kid--but I don't remember seeing any bank teller or taxi driver costumes on Halloween. When the average American watches hours of television, public sector workers have an advantage because they are portrayed as more important than private sector workers--even though it's the private sector workers who are footing the bill.

Second, most of the people teaching our children are government workers. As a result, most students spend eighteen years in a system that has no incentive to educate them about the true costs of excessive government spending and exclusive government benefits. This systemic education failure not only aggrandizes teachers' unions, who have no incentive to reform themselves, but also creates a class divide. Rich people tend to send their children to private schools rather than public schools. In addition, many top government workers, including President-Elect Obama, send their children to private schools. When the children of the middle class and poor spend eighteen years in a different system than the children of the rich, class conflict is virtually guaranteed.

This is why allowing parents to have the option of charter schools is so important. With charter schools, public schools have competition--which usually improves performance--and public schools no longer have a monopoly on education. In general, the public opposes monopolies, knowing they typically produce less innovation and high performance; however, when it comes to charter schools, much of the public is against them. This is surprising, because vouchers are the easiest way the middle-class and poor can escape the monopoly of public schools. When the public views teachers' unions as the Microsofts of education and charter schools as the Googles of education, change will happen.

There are simple ways to resolve the problem of entrenched government. One, require all government workers to have medical and retirement benefits only available to private workers. If a 401(k) is good enough for private sector doctors and lawyers, why do D.A.s and teacher get better retirement benefits in the form of guaranteed pensions? If the average private sector worker doesn't get lifetime medical benefits, why should government workers get such an expensive benefit? (By the way, if we actually equalized medical benefits, all Americans would probably get subsidized healthcare coverage.) When government workers have to use the same services as the public, they have more information about how the average person lives and more of an incentive to fix problems.

Two, institute term limits for all government workers. If we have term limits for the president and other representatives, why allow lifetime jobs for other government workers? A reasonable term limit would be 10 to 15 years. After this time period, a government worker could not go into any other government position and would have to earn his keep in the private sector. The knowledge that a government job is not a lifetime position would incentivize the government worker to improve his/her skills for the inevitable day when s/he applies for a non-taxpayer-subsidized position.

In addition, the turnover would be beneficial to the younger population, who could learn significant job skills through government work and then use those skills in the private sector. It would be like having a government-funded apprenticeship, where future leaders would be trained by experienced government workers to serve the public. Experienced government workers would begin training the new crop of workers from Year 13 to Year 15.

Doing it this way, government would be a non-fossilized place. This moderate turnover (as opposed to almost non-existent turnover) would allow new ideas to flourish in government. It is true we would lose skilled government workers to the private sector, but the key is to train newer workers to ensure a consistent stream of skilled government workers.

In the end, if America wants another bull market, it needs to return to budget surpluses. Demanding that our government not spend more than it collects is one way Americans can help get our country back on track.

More on public pensions here.

Warren Buffett's Letter to BRK Shareholders and Government Liabilities

Each year, Warren Buffett publishes a letter to Berkshire shareholders that is both informative and humorous. This year, Buffett discussed an issue that gets far too little press: pension plan liabilities and actual costs of future benefits, which are notoriously difficult to calculate:

"Whatever pension-cost surprises are in store for shareholders down the road, these jolts will be surpassed many times over by those experienced by taxpayers. Public pension promises are huge and, in many cases, funding is woefully inadequate. Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed. Promises involving very early retirement – sometimes to those in their low 40s – and generous cost-of-living adjustments are easy for these officials to make. In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep."

I am happy to say I sounded the horn on this issue before Mr. Buffett, at least in print. On or around December 2007, The Metro published a letter from me discussing the government's pension plan liabilities. In the letter, I sound quite Ron-Paul-ish, probably more than I actually am, but I have revised the letter and included it below:

America was founded to ensure that private citizens had freedom. To that end, the Constitution provided for a limited federal government, recognizing that large, non-transparent governments and freedom are incompatible. Indeed, any government salary (or new law, for that matter) saps resources from private citizens that could be spent on innovation and other, more productive activities, while also increasing a government official’s power to exert influence and control over private lives. High government salaries are particularly problematic, because they are a form of fraud on the public, i.e. the taking of more funds than necessary from dispersed private citizens to support unionized government members. Here, our local government wanted to hide how much its members were making, which prevents the discovery of corruption and fraud in the form of higher-than-normal salaries. Yet, almost any county position could be filled with qualified individuals even if the county reduced its salaries significantly, recognizing that a pension and the possibility of lifetime medical benefits are more than enough to attract qualified workers. In fact, almost no one in the private sector receives pensions or lifetime medical benefits, and all the private companies that used to offer such benefits, such as General Motors and Ford, are changing their policies. There is a lesson there for private citizens, who may eventually be forced to pay higher taxes to support the unusually generous benefits the government keeps giving itself.

As an attorney, I have litigated against several government agencies and have been shocked at how power individual citizens have granted to unqualified government members. In one case, the DFEH brought an action in a separate tribunal set up exclusively for employment claims, in front of an unelected judge who used to work for the DFEH. The DFEH’s client was awarded no money in the case, but my client had to pay thousands of dollars in attorneys’ fees for a case that almost no one in the private sector would have touched. Yet, we are all paying for a tribunal (the FEHC) with the power to award 150,000 dollars against any small business or individual.

This government excess is not limited to legal tribunals. San Jose’s independent police auditor is having to fight to get a small measure of authority to review taser deaths caused by San Jose police. To get an idea of what happens when government workers are strongly unionized and do not have to fear discipline, read the case of Grassilli v. Barr (2006).

California's own government is so large, I was shocked the first time I saw a list of just the state agencies. Take a look at this link–it does not include city or county governments and yet shows a massive, sprawling government:

http://www.ca.gov/About/Government/agencyindex.html

Someone must pay for all of these employees and their pensions, sabbaticals, and health care. Teachers’ unions usually ask for more money, but the California State Teachers Retirement System is already worth around $125 billion.* It has around 750,000 members and is the third largest public retirement fund in the country. Yet, after health care, education reform remains crucial, and the CTA continues to ask for more money.

As a result of government salaries and benefits spiraling out of control, California’s bond ratings have gone from AAA to single A and are approaching status that is slightly above junk (see http://www.treasurer.ca.gov/ratings/current.asp). The high salaries and unusual benefits of local government workers are just one small part of major fiscal problems that will not get better on their own. The lack of transparency in local government salaries has been remedied somewhat, but many other issues remain. I pray that this country’s citizens will read its history and think harder about current Constitutional issues; otherwise, we will be seeing a great power slowly but inexorably degenerate into a bloated, inefficient police state.

*My figure placed the value of the CTA pension plan at $125 billion. It is actually $131.2 billion, according to the Wall Street Journal's February 28, 2008 article, "Dear Crunch," C1. But what is problematic is that the CTA pension plan is underfunded by 19.6 billion dollars, all of which eventually has to be paid by California taxpayers. This means that the current debt calls for paying retired California teachers 19.6 billion dollars, and the pension plan doesn't have that money now and is hoping to get it in the future (stock market gains, more dues, higher taxes, etc.). To get an overall picture of the financial liabilities we face, the WSJ states that we--that includes you, if you pay taxes in the U.S.--owe our government $440 billion dollars, all of which will be put into the pockets of government workers. In a sign that the purse is already appearing shallow, the WSJ said that the city of Vallejo, CA is considering filing for bankruptcy. Its local government granted itself so much in benefits and salaries that the police and fire department's "salaries and benefits account for 80% of budget costs." Again, if you look at my letter to The Metro, the unstated premise is that without oversight, government will enrich itself at the expense of private citizens, especially in the areas of police power. The City of Vallejo, with almost all the taxpayer revenue going to police/fire union members, proves my point. Yet, even recent front page news stories about how the San Francisco mayor's office increased the salaries of close associates, or how various government departments are paying so much in overtime that correctional guards regularly exceed 100,000 dollars per year in compensation, is not causing any alarm bells to go off (This in a country that now has 1% of its adult population behind bars and will probably need more correctional officers in the future). When front-page news does not shock the public into demanding reform, we need to re-examine how we grant benefits and salaries to government members, perhaps even having referendums or some opt-in voting measure to establish reasonable salaries and benefits. Otherwise, every government employee will be functioning in a pyramid scheme where actual future costs of benefits, especially health care, remain undisclosed and incalculable. Such a situation is not good for taxpayers or our government members. Government, like private industry, benefits when new and highly performing members are attracted to jobs and bring with them fresh ideas. At this rate, government agencies will not be able to hire new employees, and private citizens will not benefit from a fiscally-healthy, secure government.

One of the links in my letter led to bond ratings for all the states. As of today, it shows that California's bond rating is the second worst in the nation, leading to higher borrowing costs and difficulty with improving our infrastructure. Who has the worst bond rating? Louisiana, which was battered by Hurricane Katrina and is still feeling its effects economically. It should be shocking that the sixth or seventh largest economy in the world has the second worst bond rating in the U.S., above only a hurricane-ravaged state, but so far, there are no protests in the streets, no condemnation of government expenditures by citizens, and no cries of unjust takings from our grandchildren. Our founders would be stunned at our utter complacency, but perhaps also proud of the prosperity we have achieved in such a short time. With that in mind, it would be a shame if future generations were unable to see America's promise of prosperity because government members and unions were enriching themselves at our expense or refusing to accept pay cuts, even as tax revenue decreases.

Original letter here: http://www.metroactive.com/metro/12.26.07/letters-0752.html

Update on January 13, 2009: here's a great website on public pensions:

http://www.pensiontsunami.com/