Third in a series on public pensions. The first is here and the second here.

Oct. 5, 2012

By Mark Cabaniss

On Wednesday, the city of Atwater declared a fiscal emergency, putting it on the path to become the fourth California city to declare bankruptcy this year, joining San Bernardino, Mammoth Lakes and Stockton.  Unfortunately, these four cities seem to be just the tip of the iceberg.  Many other California cities are rumored to be heading for bankruptcy as well, including, at least according to former mayor Richard Riordan, Los Angeles.

The common thread to these bankruptcies is  current retiree pension obligations, which were granted during the go-go years of the stock market and property bubbles, but which have proven dramatically, unbelievably unsustainable during periods of economic contraction, such as the one we are caught in now. For example, Gov. Gray Davis’ infamous SB 400, which in 1999 retroactively boosted state worker pensions, implicitly assumed that the Dow Jones Industrial Average would be at 25,000 by 2009.  (As of 9 am Friday, it is at 13,637.)

One reason that cities have chosen bankruptcy as a means of restructuring pensions, rather than choosing the more direct route of simply attempting to alter current pensions, is the widespread assumption that current public employee pensions are legally untouchable.  However, even though widespread and oft-repeated, this assumption may be wrong.  The only way to find out is to test it in court.  Such a court battle would, I believe, make plain the reality of the situation, which is that what seems to be a “complex legal issue” is in reality a political issue — nothing more, and, unfortunately, nothing less.

The naked political issue can be stated different ways.  In the “social justice” formulation, pension proponents state their argument as, “Is it right for government to just tear up its debts to retirees that have worked their whole careers for that money?”

“Social justice”

In their own version of the “social justice” formulation, pension opponents frame their argument as, “How much money must one group of people give to another group of people, when times are unexpectedly tough, as now?” Or, “Is it right for some politician to sell my children into slavery just to get himself elected?”

Since the “social justice” formulations are so fraught with emotion, simple numerical tautology may be the best and most honest way to frame the argument:  “If the government does not have the money to pay all pension obligations, must the government still pay all pension obligations?”

Obviously, this is a very contentious political issue. But if we frame it as a political issue, the solution presents itself, because it can then definitionally only be solved by doing what is politically possible in the first place, which means that any solution will have to get a majority of people to back it.  Therefore, one possible way to approach the pension crisis is to cut only the very highest pensions, those more than $100,000 per year which, according to CalPERS, only 2 percent of current retirees receive.

Currently, Social Security benefits, to which you have no contractual rights, are capped at a maximum of $30,156 per year. Implementing a pension cap of $100,000 per year would put the 2 percent in the position of arguing that they just can’t live on over three times as much money as everyone else, an argument to which the voters, the 98 percent, might not be sympathetic.

Pension abusers

To their credit, CalPERS has been taking the politically admirable step of going after some of the very worst pension abusers, such as former Bell City Administrator Robert Rizzo (former pension $650,000 per year; new pension $50,000 per year); former City Manager of Vernon Bruce Malkenhorst (former pension $540,000 per year; new pension $115,848 per year) and Scott Plotkin, former Executive Director of the California School Boards Association (former pension $205,000 per year; new pension $72,288 per year).

Nonetheless, such symbolic sacrifices will not be enough to make a dent in the problem. To have an effect, governments will have to make an across-the-board cut in current pension payments, by, for example, simply stopping the payment of benefits in excess of $100,000 per year. If they do that, they will soon find themselves in court, where the legality of the proposition “pensions are contracts and contracts are sacred” will be put to the test.

In evaluating this claim, courts will look to prior cases, in which governments have altered or torn up other contracts. They won’t have to look far; recent governmental actions in California show the government’s ongoing belief that it absolutely has the power to alter or amend or tear up contracts as it sees fit, to promote the governmental objective of ensuring the health, safety, and well being of the citizens.

Ironically, one of the warriors currently working hard to establish the legal precedent that, yes indeed, governments can tear up contracts, is none other than Lt. Gov. Gavin Newsom. He Newsome recently wrote a strongly worded letter supporting the idea of local governments using eminent domain to seize underwater mortgages at below-contract prices, and then resell them to the homeowners at the lower prices.  The idea is that government has an interest in stabilizing the housing market, and thereby stabilizing tax revenues.

Who would lose under the plan to use eminent domain to seize mortgages?  Obviously, the current owners of the mortgages, such as banks and funds owning mortgage-backed securities, would lose. But aren’t these mortgages contracts, and aren’t contracts sacred?  Yes, but some contracts are more sacred than others.

So how do you tell which contracts are sacred?  If the highest pensions were to be cut, how would the defenders of the 2 percent top pensioners explain the contradictory proposition that government can tear up some contracts when it feels like it and yet is absolutely forbidden to tear up other contracts, such as current pension benefits?

Although many lawyers will construct various arguments differentiating the tearing up of private mortgages from the tearing up of public pensions, perhaps the argument is best collapsed down to its most basic: the distinction between public contracts and private contracts. Stated simply, the defenders of the 2 percent believe that it is okay for the government to tear up contracts if doing so negatively affects the rights of private citizens; but it is not okay for the government to tear up public contracts if doing so negatively affects the rights of public employees.

In other words, they believe in an explicitly two-tiered society: government employees have inalienable rights, non-government employees have alienable rights. To put it even more simply, what they really believe is this: contracts which protect my money are sacred; contracts which protect your money are toilet paper.

Will this argument be a winner?  For myself, I wouldn’t want to make it.

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. 

By Chriss Street

Atwater, Calif. just admitted it does not have the cash flow to make a $2 million municipal bond payment due in November. It may become the fourth local California government to file for Chapter 9 municipal bankruptcy this year.

The 28,000-resident farming community has been strangled by environmentalists less interested in family farms than in protecting the lifestyle of a three-inch fish called the Delta Smelt.  With the city burdened with crippling unionized public employee wage and pension costs, while private sector wages and property values drop, Atwater is the latest in a soon-to-be tidal wave of local government failures.

Beginning in 2007, Federal Judge Oliver Wanger imposed limits on the amount of water pumped from the San Joachin-Sacramento River delta to farms in California’s Central Valley in order to protect a two-inch endangered fish called the Delta Smelt.  As a result, hundreds of thousand of acres of farmland lie fallow, and tens of thousands of jobs were lost. (Wanger later partly reversed himself.)

More than 200,000 farmers, migrant workers and their family members were financially devastated.  Homeless shelters and bread lines were overwhelmed as crops withered and banks foreclosed on family farms.  Local public schools continue to report rising malnutrition, as many proud families are too embarrassed to take government welfare.

The U.S. House of Representatives Congress passed San Joaquin Valley Water Reliability Act, H.R. 1837,  to try to restore the water flow. But California’s two U.S. Senators, Barbara Boxer and Dianne Feinstein, fought off the legislation in July by convincing President Obama’s senior advisors to recommend a presidential veto.

A disgusted Speaker of the House John Boehner said on the House floor that using the Endangered Species Act to protect a fish at the expense of food production and economic growth is “a perfect example of the overreach of government”.

The median home price in Atwater has plunged from $336,000 in June 2007 to just $140,000 today and unemployment has surged to 21 percent.  The 2010 Atwater median household income was $42,226. That was 19 percent below the national average of $51,914.  Almost a fourth of the population is now considered below the poverty line, compared with 13.7 percent statewide, according to U.S. Census figures.

Falling revenue

Even with all this pain and suffering, Atwater’s city tax revenue fell by only 20 percent since its peak in 2007.  Atwater did reduce its bloated union payroll from 120 to 80 since 2008, but mostly through attrition and laying off low paid younger workers.

To keep the lights on, the city depleted its cash reserves, while union wages continued to rise and the city agreed to pay all general employees’ portions of mandatory pension contribution and all but 2 percent of the mandatory contribution for highly paid police and firefighters.  The city also continued to pick up most of the cost of health-care premiums that rose by 15 percent this year and are scheduled to rise 10 percent next year.

With the threat of bankruptcy, wages now may be slashed.  According to Atwater Mayor Joan Faul, “We just started negotiating with our unions and they are going to have to take a major cut. We hope that once we declare a fiscal emergency that they will realize that we are definitely in an emergency.  If they want to save all the jobs, everyone is going to have to take a cut.”

Standard & Poor’s seems to have been shocked to learn that city is broke and hacked Atwater’s Public Financing Authority’s wastewater revenue bonds solvency rating on September 24, from a strong credit-worthy A rating to a BBB- junk-bond rating.

Under a state law passed by California’s ultra-liberal legislature and signed by Gov. Jerry Brown last year, cities seeking bankruptcy protection are forced to first declare a fiscal emergency or hold talks for 90 days with creditors through a mediator or wait for 60 days if they run out of money.  With Atwater and many other local government cities and agencies about to bounce payroll checks, California bankruptcy courts are going to need to go on a hiring binge to handle the coming long lines of municipal failures.

Chriss Street co-hosts “The American Exceptionalism Radio Talk Show”

Streaming Live Monday through Thursday from 7-10 PM

Click Here to Listen: www.edtalkradio.com

Dinesh D’Sousa will be the guest at 7 pm on Oct. 4. He is the director and star of “2016: Obama’s America.”

PLEASE CALL IN AT: 530-742-5555