Breaking public-employee pensions: The political path

Second in a series on public pensions. The first is here.

Sept. 27, 2012

By Mark Cabaniss

In taking on the California pension problem, the first step is dispelling some large, tenacious and commonly held illusions.

The first illusion is that pensions are contracts protected by the U.S. Constitution and the California Constitution, and therefore are legally unbreakable, “written in stone.”  But, as noted in my prior article, assuming that public pensions are contracts, there are nonetheless legally valid ways to get out of all contracts, including current pensions.  The most important of the contract law doctrines that could be used to get out from under current pensions is the doctrine of mistake. According to that doctrine, the current pensions were granted while relying on mistaken assumptions, specifically, unrealistic projected future pension fund investment returns which have turned out to be too high.

The second contract law doctrine which might be used to get out of onerous pensions is that the money simply isn’t there to pay excessive pensions (the current highest in California is, ha-ha, $302,492 per year). The legal arguments, as well as the political arguments, are the strongest for reforming the very highest pensions, those in excess of $100,000 per year.

But the only way to find out the extent to which these arguments would be successful is to try them in court. Which means that someone in government will have to try to alter the terms of current pensions, for example, by stopping pension payments in excess of $100,000 per year.  I myself have no doubt that the arguments would succeed at least to some extent, because no court is going to hold that every school, every prison, every hospital has to be shut down rather than a few retired people continue to receive in excess of $200,000 per year, and not a penny less.

Second illusion

These legal doctrines of mistake and impossibility of performance lead us to a consideration of the factual mistakes that really were made, and to the second great illusion created by those mistakes — that we are fighting over money.  Actually, we aren’t.  We are fighting over the illusion of money, or the hope of money.  In truth, the money doesn’t exist, and it never did exist. 

Two financial calamities, masquerading as booms, came in quick succession, and created an illusion of great wealth that simply was not there.  The first of these was the stock market dot-com boom of the late 1990s, during which companies with no earnings whatsoever nonetheless had, for a short while, stock market capitalizations of billions of dollars.  The bubble burst in 2000, many of the companies going bankrupt and their share prices going to zero.

Nonetheless, the dot-com boom lives on in the projected future returns of CalPERS, which currently has an assumed rate of return of 7.50 percent.  Last fiscal year, in 2011, they earned 1 percent.

The second great calamity which created an illusion of wealth was the housing bubble of the 2000s.  The latest California city teetering at the edge of bankruptcy, Atwater, since 2007 has seen its median home price drop about 40 percent to $139,000 and its property tax revenue drop by 27 percent.  Obviously, the property tax revenue has farther yet to fall, and Atwater’s woes are duplicated state wide.

Cherished illusions

But people cherish their illusions, particularly illusions about money, about how rich they are, or soon will be.  That is why the single most difficult part of reforming pensions may be simply moving the discussion to the plane of fiscal reality.  For example, CalPERS itself, on its “CalPERS Responds” website, recognizes that the stock market returns of the 1990s were highly aberrational, noting:

“The $400 million [that the state had to contribute to the CalPERS retirement fund] paid in 1999 was the lowest the State had paid in generations and it was due to the fact that the investment returns in the mid-1990s were so high, little was needed from the State to cover the plans. Some years, the State paid zero contributions for schools. This was due to higher than normal investment returns. Using a starting point of $400 million is misleading, because the late 90s was an atypical period for investment returns. In addition, payroll growth (bigger government) investment losses and people living longer and retiring earlier are the primary drivers of increased pension cost.”

Unfortunately, the aberrational returns of the 1990s are used by CalPERS only as the explanation for why subsequent state contributions had to be higher, and not as a reason to reassess growth assumptions.  And yet, to state the unpleasant and obvious, if the returns of the 1990s were “higher than normal,” then perhaps it is not a good idea to project them into the future with an assumed 7.50 percent rate of return.

Moreover, the money which did not exist in the past cannot be made to exist in the future by magical thinking.  The political “leadership” in Sacramento is doing virtually nothing to address the budget crisis, except for hoping for a tax increase which will do very little even if passed.

The real, although so far unexpressed, hope seems to be that something will save us, perhaps all the high-paying but dirty manufacturing jobs that government is working so hard to create in California; or perhaps a federal bailout, in which all the senators from the fiscally solvent states would for some magical reason agree to fork over wads of their citizens’ cash to all the bankrupt states.

No. Being realistic, there is no reason to think anything is going to save us, not a sudden turnaround in the California economy, and not a Deus ex machina in the form of a federal bailout.  So the fact is, we are fighting over far less money than is commonly realized; sadly, we don’t really have the money to pay anyone a $302,492 a year pension; sadly, we are fighting over how to divvy up the lunch money, rather than the lotto payout.

Third illusion

Once we get over these dreams of pie in the sky and start talking about money that actually is here, now, we can move on to the third great illusion, which is that pension reform is somehow bad for unions.

In fact, as we have seen time and again throughout the state, such as when the city of Costa Mesa laid off nearly half its workforce, the only way to pay for the current highest, unsustainable pensions is to fire busloads of currently working union members. The bosses keep their $200,000 pensions, and the rank-and-file get laid off.  Returning once again to CalPERS’ own website, we find:

“About 2 percent of the nearly half million CalPERS retirees receive annual pensions of $100,000 or more. Many are retired non-unionized or specialized skilled employees or other high wage earners who worked 30 years or more. Many served in high-level management positions.” 

According to CalPERS itself, then, it is the non-unionized management bosses who receive the greater-than-$100,000 pensions.  So, to ask another obvious question: Just how is it anti-union to cut the non-union bosses’ pensions to save union jobs?

Fourth illusion

This brings up great illusion number four:  It is political suicide to even attempt to touch current pensions.  But CalPERS’ own numbers suggest precisely the opposite.

If only 2 percent of retirees receive pensions of more than $100,000, then that would leave, by my reckoning, 98 percent who do not.  Obviously, if you were a politician making a naked political calculation regarding the political benefit that you could garner from championing pension reform, you would rather be on the side of the 98 percent, than on the side of the 2 percent.

And that question — Why don’t politicians make that naked 98 percent vs. 2 percent political calculation? — brings us to the very heart of the political problem. The politicians don’t want to touch pension reform, not because it is not a political winner, but because they themselves are, by and large, in the 2 percent group, not the 98 percent. 

Obviously, intuition tells us that this tends to be true of union leaders too.  Anyone negotiating contracts is going to be someone with a lot of experience and seniority, a high-wage person with the expectation of a high pension coming.  So there is a huge systemic built-in bias against pension reform. All the union leaders and political leaders are automatically and strongly against it because they themselves stand to garner huge pensions, as long as there is no reform.

So that leads to the conclusion, which is perhaps the only way out.  We should begin asking a simple litmus test question of all political candidates:  Do you support a $100,000 cap on pensions, including current pensions and including your own?  If politicians running for office had to answer that question, in every race, up and down the state, the people, through their electoral processes, could begin to address the problem of the very very highest, unsustainable, current pensions.

Mark Cabaniss is an attorney from Kelseyville.