When county supervisors were asked about this prideful stance, they’ve long pointed to the city of San Diego’s financial struggles — triggered by disastrous decisions by the City Council to intentionally underfund the local pension system in 1996 and 2002 — as a sign of their superiority.

But this narrative of “county smart, city dumb” has been badly undercut by the county’s own pension travails since 2009. The problems haven’t been financial; the San Diego County Employees Retirement Association has had one very good year during that span but overall average to somewhat above average returns. Instead, the negative headlines have been generated by an unusual — even unprecedented — level of deference that the SDCERA board gave its lead investment strategist before formally cutting ties with him this month.

The strategist — a charismatic, personable Texan named Lee Partridge — was hired by SDCERA in 2009 after an unremarkable stint advising the Texas teachers pension system. Yet the terms of his appointment suggested the SDCERA board thought it was getting the Warren Buffett of investment gurus.

Examples of Partridge’s special treatment by the board:

• He was paid more than four times the $210,000 salary of the investment adviser he replaced in his first year, and his compensation grew far bigger in subsequent years. The pension board only got around county legal limits on his salary by reclassifying him as a consultant. Many key details related to his compensation weren’t initially revealed.
• He was allowed to work out of Houston.
• He and his firm were allowed to have other clients.
• His plan to outsource investment research to employees of a company he controlled was given the go-ahead by the board. It was only derailed after attorneys warned that it wasn’t just a huge conflict of interest for Partridge to benefit financially from a plan he crafted; it was plainly illegal under state law.

National honor — followed by national incredulity

But Partridge remained in the good graces of the pension board after his aggressive investment strategy yielded strong returns in fiscal 2010-11 and won him the Small Public Fund Manager of the year honor from Institutional Investor.

But when returns lagged, Partridge kept getting more aggressive. In 2013 and 2014, Union-Tribune business columnist Dan McSwain — a businessman-turned-journalist and a savvy student of investment practices — laid out how unusual and risky the Partridge approach was for a government pension fund. His Aug. 9, 2014, column, headlined “County bets all-in at pension casino,” led to front-page coverage in The Wall Street Journal, which led to broad national attention.

Here’s part of it:

Don’t bet more than you can afford to lose. …

 

This basic life lesson, to risk only within your means, has somehow escaped the people who oversee San Diego County’s public pension system.

 

In April, pension board members unanimously approved a new investment strategy that dramatically increases use of “leverage,” a form of borrowing.

 

There’s nothing inherently wrong with leverage, which allows you to buy a lot of asset with a little equity. But it also magnifies losses when markets turn against you, as millions of homeowners learned in the recent real estate crash.

Hoping to beat odds — day after day after day

McSwain noted that the SDCERA board had been denied access to experts who questioned Partridge’s approach and that such a list of experts would start with Warren Buffett. Yet as of July 1, 2014, Partridge was …

… authorized to use the county’s $10 billion fund to put at least $20 billion at risk, mostly with options, derivatives and other arcane financial instruments.

 

Under the previous policy, Partridge was limited to 35 percent leverage in the county’s portfolio. Now he gets to place bets amounting to 100 percent.

 

And while the previous policy approved leverage to bet on the direction of relatively stable U.S. Treasuries, the new policy moves much of the county’s nest egg to volatile areas of speculative investing. Foreign junk bonds, emerging-market stocks, options on the future value of zinc … almost anything is fair game. …

 

Partridge is a very smart guy. However, his success depends on being smarter, every day, than the very smart people on the other side of his trades.

Pensioners turn on pension board

The national media coverage of the SDCERA strategy was as incredulous as McSwain’s column. This led county pensioners to begin attending pension board meetings and ask board members variations of the question, “Are you nuts?”

By November, only one board member opposed a resolution to end the county pension agency’s relationship with Salient, the Houston-based firm Partridge established that earned tens of millions in county fees the past six years.

This month, the final links to Partridge were severed. His replacement, as many expected, couldn’t have a more conventional background. Stephen Sexauer previously …

… worked at Allianz Global Investors as Chief Investment Officer of Allianz Global Investors Solutions, managing over $7 billion in multi-asset institutional portfolios and retirement income solutions. Mr. Sexauer is also the co-author of papers on retirement portfolios published in the Financial Analysts Journal, The Institutional Investor Journal of Retirement, and The Retirement Management Journal. He graduated with an MBA in Economics and Statistics from the University of Chicago, IL.

Salient, meanwhile, has established itself as one of Houston’s largest money-management firms, and now has a San Francisco branch. But it seems unlikely to attract many government clients after Partridge’s unusual stint in San Diego.

For most Americans, it’s tempting to live in denial or outright fantasyland when it comes to paying for retirement.

That’s because doing the math evokes less-pleasant emotions like fear, anger or hopelessness.

Social Security, which replaces just 40 percent of the average earner’s paycheck upon retirement, is running out of money. The median household savings rate is zero. And half of workers have no pension or 401(k) account.

There’s just no way around the math. As a group, Americans have three choices: Spend less, work longer, or accept being poorer in retirement.

He’s not talking, yet, of government pensions, but what the rest of us will have to put up with. Years of slow or no economic growth, combined with the retirement of the massive Baby Boom generation — which didn’t have enough kids to replace itself — make all the actuarial tables look bad.

Combine that with the Federal Reserve Board keeping interest rates at zero percent (so federal debt is cheap; and money is forced into stocks), meaning it’s pointless to save in a bank passbook account as most people used to — and you have the makings of retirement disaster.

Public pensions

Then there are the government-worker pensions:

Yet this dire tableau is worse than it looks, because most public pensions are in the same shape as the average worker — under-saved and overcommitted.

The difference is that pensions are guaranteed by taxpayers under California’s constitution (and those of 11 other states).

Thus a poverty spiral looms: As workers fail to stash enough cash for their own retirements, they face growing claims on income from local governments.

To see how this works, consider the plight of a San Diego household.

Officially, the pension system for city workers and retirees was underfunded by $1.54 billion as of June 30, while the county’s unfunded liability was $2.32 billion.

When you carve out city residents’ share of the county total, this combined shortfall equates to $5,400 per household.

Paycheck deductions from public workers will help, but the bulk of this responsibility falls on taxpayers.

Right. As outgoing San Jose Mayor Chuck Reed has quipped, eventually the pension payments will loom so large that all current city employees will be cut in his city but one: a person who sends out the pension checks.

BK

I think, eventually, this situation will reach a boiling point. The services will be cut so much, and taxes raised so high, people just won’t take it.

So far bankrupt cities have worked out pension deals with CalPERS to keep the contributions going — with the cuts coming to city services. But that can’t last forever. Indeed, Vallejo, which went BK in 2008, already is at risk again for another BK because of its “pricey pensions.”

Whether the state constitution says the pensions must be paid, or not, eventually there will be no money to pay them in full.

But six weeks later, Moody’s has put out another release that examines how much strain the law meant to stabilize funding for California teachers’ pensions is likely to put on the state budget and warns about the effect on some school districts:

The rate increases that CalSTRS is instituting are modest and manageable for school districts over the  next three years. For 2015, school district contributions will increase by only 0.63% of payroll to total 8.88%, which is below the 9.5% that the governor included in the May revised budget. Fiscal 2015 school district budgets would likely have included the higher 9.5%, so the lower adopted rate is budget positive.

Over the next three years, school districts will receive higher LCFF funding from the state which will more than compensate school districts for their higher pension expenses. School districts’ pension contributions will amount to only 25% of the projected increase in LCFF funding over the next three years. Employers, consisting mostly of school districts, will contribute $1.29 billion more toward the CalSTRS pension plan, but LCFF funding will increase by $5.26 billion through fiscal 2017. …

Managing rising pension costs will prove challenging over time because CalSTRS rate increases are back-loaded. School districts face future budgetary stress not only from rising pension costs but from salary and benefit expenditures and programmatic priorities. Further, school districts have minimal revenue flexibility. … Rising pension costs will pressure financial operations and may cause a deterioration in credit quality for some school districts.

An ‘inflection point’ for the bond market?

To get a handle on the implications of this, I turned to someone who speaks bond. Dan McSwain is a successful businessman turned journalist who is now an unusually insightful business columnist for the U-T San Diego. (Enjoy his amazing look at the latest Socal pension follies here.) Dan thinks that Moody’s is sending a clear warning signal to investors — and to the state of California.

… ratings agencies telegraph future adjustments far in advance, when they can. And this is definitely a shot across the bow of the school bond issuers themselves. So while CalSTRS might keep its rating, I wouldn’t be surprised to see a series of downgrades in a few years for districts that issued all those stupid long-term iPad bonds over the last few years. They’ve gotten a decent bump in cash flow this year and last, but this retirement contribution squeeze could get tight very fast when the next recession comes and the state pulls back again.

Also, downgrades can cause a vicious cycle, triggering selling by mutual funds and pension funds that are required to keep only top-rated munis in their portfolios. This doesn’t hurt issuers directly; only bond holders who want to sell before their bonds reach full term. Yet when the buy side disappears, it kills the ability of schools and governments to sell new bonds. These guys depend on the ability to sell new bonds whenever they want to refi or build something, because they don’t build construction reserves in California.

Maybe I’m looking too far down the road, but this Moody’s advisory seems like an inflection point of some kind.

I defer to Dan on how to interpret Moody’s actions. But I think the Cal Watchdog piece I wrote in May about the dog-eat-dog budget politics that are sure to result from the CalSTRS fix looks more likely to come true than ever. The state of California can’t just casually come up with $4.5 billion a year — because it can’t print money.

Covering the cost of the CalSTRS bailout going forward is going to be the Sacramento version of the federal budget sequester for non-education budget categories. Spending on just about everything but  K-12 is going to be curtailed.

Or was the nuclear plant closed primarily because of excessive regulation — the latest victim of a California bureaucratic culture that prefers reflexive edicts to thoughtful decisions driven by cost-benefit analysis?

U-T San Diego business columnist Dan McSwain — one of the few newspaper business columnists I’ve ever read who actually used to be a successful businessman — makes the case quite persuasively that it was for the latter reason:

“Without question, San Onofre’s steam generators have serious technical problems. But the decision to abandon the plant was a regulatory and political calculation. It wasn’t a technical decision, not by a long shot. …

“Mitsubishi … is a global conglomerate that has installed 116 generators similar to San Onofre’s. ….

“Edison bought its steam generators as part of a 2009 retrofit. The old ones were supposed to last until 2022, but corrosion ruined too many of the generators’ thousands of narrow metal tubes.

“The tubes convert superheated water from the nuclear reactors into steam, which drives power-producing turbines.

“Mitsubishi’s retrofit plan had been used in dozens of similar plants. The plan used a more corrosion-resistant alloy, but added hundreds of tubes because the new alloy was less efficient in transferring heat.”

Fixes made around the world — but not in California

The point McSwain makes about similar equipment functioning just fine at numerous nuclear plants around the world can’t be made  enough. There were some unique problems at San Onofre, but Mitsubishi depicted them as manageable.

“After much discussion, and the addition of supports to reduce vibration in the long, narrow tubes, Edison signed off on the plan as the lead designer.

“But last year radioactive steam leaked from San Onofre’s Unit 3. The tubes were vibrating in a direction that had never been seen before, causing them to hit each other and wear catastrophically.

“At this point Edison decided to also keep Unit 2 offline until officials figured out what to do. In June, 16 months later, Edison CEO Ted Craver announced that San Onofre’s shutdown was permanent.

“Mitsubishi maintains that Unit 2 probably could have restarted and run successfully for years, because its design was slightly different and tube wear was close to normal ranges. And it says Unit 3 can be repaired in about four years.

“’We were developing a 100 percent fix,’ said Frank Gillespie, a top U.S. executive for Mitsubishi’s nuclear division.”

I don’t know about you, but I trust Mitsubishi far more than California regulators.

And if your power, or my power, goes out this year because San Onofre is no longer able to supply hundreds of thousands of homes in San Diego and Orange counties, I know who’s to blame.

California already has a man-made drought. In Socal, now we’ve got a man-made power shortage.

P.S.: Yes, movie buffs, the photo of San Onofre above is a screen grab from “The Naked Gun.”

By Chris Reed

This is saying a lot. But in my 23 years in California, no regulation has more clearly established the vapidity of how the state’s regulatory culture works than a new rule embraced by the San Diego Regional Water Quality Board.

My colleague at the U-T San Diego, business columnist and former editorial writer Dan McSwain, has done a superb job chronicling its insanity.

‘Faith-based policymaking’ yields idiotic policy

This is from McSwain’s Nov. 12 editorial:

“California’s latest experiment in faith-based policymaking is being unleashed today on the San Diego public, as regional water-quality officials begin hearings on new regulations that seem crafted to turn most owners of a car, house or dog into criminals within a decade or so. We wish we were exaggerating.

“Under the draft rules, ordinary homeowners may face six years in prison and fines of $100,000 a day if they are deemed serial offenders of such new crimes as allowing sprinklers to hit the pavement, washing a car in the driveway, or, conceivably, failing to pick up dog poop promptly from their own backyards, let alone the sidewalk.

“Cities throughout San Diego, south Orange and southwest Riverside counties must enforce the law, and set up 24-hour hot lines for people to report violations by their neighbors.

“The new regulations even apply to firefighters, who would be forced to somehow capture and scrub the water running down the street from fire hoses and burning buildings, although the bureaucrats promise wiggle room for ’emergency situations.’ We’re at a loss to imagine the fire that doesn’t present an emergency situation, but we’re sure California’s army of environmental lawyers will be glad to help cities figure that out in court.”

Pushing for a state cleaner than before it was colonized

This is from McSwain’s Sunday column:

“Last week, a state agency ordered dozens of local governments to spend whatever it takes to reduce the levels of bacteria, dirt and chemicals in the water that flows from storm drains into creeks and the ocean, when it rains and during dry weather.

“The ambition is noble, not to mention popular with Californians; everybody wants clean water. However, society has made such enormous gains in water quality over the last 40 years that further progress is becoming enormously expensive, with fewer prospects for helping the environment.

“As returns dwindle on our clean-water investments, the new rules imposed last week by the state’s San Diego Water Quality Board appear to be particularly unfortunate.

“Agency officials confirm that nobody knows the cost of their new stormwater rules. San Diego County estimates that just one of the standards, for animal bacteria in runoff, could cost $5.1 billion over 18 years.

“That’s the cost to local governments. It doesn’t begin to include the tab for businesses to scrub rainwater leaving parking lots with bird droppings. Or, eventually, fines to homeowners whose sprinklers hit the sidewalk, or who fail to promptly pick up after Fido, causing trace amounts of fecal bacteria to flow into gutters during a mild rainstorm.

“Meanwhile, scientists say they really don’t know whether the state’s new rules will substantially improve human health or the environment.

“At a hearing last week, an expert hired by the county showed that Mother Nature routinely violates the new standards in the Arroyo Sequit, a pristine watershed in the Santa Monica Mountains that represents San Diego before Juan Cabrillo sailed into the bay.”

Jerry Brown, live up to your rhetoric. Please.

This is beyond insane. Mother Nature isn’t clean enough for state regulators.

Jerry Brown, come on down. If you really loath stupid regulation as much as you say you do, here’s a hanging curve.