As attorney Mark Cabaniss wrote on this news site in Sept. 2012:

“Even if politicians’ pensions are contracts protected by the Constitution, they are still breakable.  In pretending otherwise, the politicians are lying.  In other words, merely noting that pensions are contracts protected by the Constitution is not the end of analysis, but only the beginning, for all contracts are breakable, and all constitutional rights are subject to limits.”

Now the Los Angeles Times reports:

As millions of private employees lost their pension benefits in recent years, government workers rested easy, believing that their promised retirements couldn’t be touched.

Now the safety of a government pension in California may be fading fast.

It cited Stockton’s bankruptcy:

In his written opinion, U.S. Bankruptcy Court Judge Christopher M. Klein blasted CalPERS as “a bully” for weighing in on the proceeding to insist — wrongly — that the city had no choice but to pay workers their promised pensions.

Karol Denniston, a public finance lawyer at Squire Patton Boggs, said Klein’s ruling was “critical for every municipality in California.”

“Next time we see a Chapter 9 bankruptcy filing,” she said, “pensions will be up for negotiation just like every other creditor.”

The skyrocketing bill for pensions is a problem for cities across the state. Californians now owe nearly $200 billion for pensions promised to state and local government workers, according to an analysis by Adam Tatum, research director at California Common Sense, a nonprofit think tank.

The key event will be the next recession, when more may go bankrupt and face: a) eliminating key services, such as police and fire, that are the reason governments exist in the first place; b) raising taxes to unsustainable levels that drive out business and personal taxpayers; c) cutting pensions, despite what the California Constitution supposedly says; or d) some combination of the above.

When there’s no money, there’s no money.

By Mark Cabaniss

Caught between rising pension costs and  declining tax receipts, several local governments in California have gone bankrupt, including the city of San Bernardino, which has stopped making its required contributions to the California Public Employees Retirement System.  CalPERS is threatening to sue.

Meanwhile, the county of San Bernardino is thinking of trying to help the local economy by injecting it with billions of dollars, which, unfortunately, it doesn’t have.  So the people who run the county are thinking of simply seizing the money by using eminent domain.  But an examination of the plan reveals a simple scheme in which the right hand of government robs the left hand of government, because the idea that has been floated is simply to confiscate the money from institutional investors — and many of these institutional investors are pension funds, including government pension funds like CalPERS.

The plan came from Mortgage Resolution Partners, or MRP, of San Francisco, and it goes like this:   local governments would try to help local homeowners out of the housing crash by using eminent domain to condemn underwater mortgages, then refinance the mortgages with lower principal amounts, which would then have lower monthly payments, so local homeowners wouldn’t have to take the losses from the bursting of the property bubble.

MRP would take a $4,500 fee for each refinanced home. As there are an estimated 20,000 to 30,000 homes in San Bernardino County that would be good candidates for the plan, that would make MRP’s cut $90 to $135 million in San Bernardino County alone.  And the plan might expand elsewhere in California, even other states.

A public purpose supposedly would be served because each refinanced homeowner would suddenly have hundreds of dollars of “free money” each month to pump into the local economy.  But so far, there has been no mention of who would lose all of this free money, other than some vague references to “Wall Street.”

Robbing Peter…

At first glance, this seems like a typical government plan to rob Peter to pay Paul; to give “free money” to local residents, which money has been taken from some guy, somewhere, “out there.”  However, the proposed mechanics of the plan make it doubtful that all of the negative effects from the confiscation could be foisted off onto some nebulous, nefarious rich Wall Street types in other states.

More likely, it’s going to be robbing Peter to pay Peter — one part of government robbing another part.

A good, and even mostly sympathetic, article explaining the plan was written by Ben Hallman for the Huffington Post. When banks make a home loan, they don’t keep all the mortgages.  Many of them are sold off to other investors, in pools, to mitigate the effect of individual defaults.

These pooled mortgages that are sold off are of two types: agency debt and non-agency debt.  Agency debt refers to mortgage debt that is guaranteed by the federal government through one of its agencies, such as Fannie Mae and Freddie Mac.  These government-owned home loans comprise the largest pool of underwater mortgages across the country, estimated at 3.3 million, but these loans would not be included in the MRP plan.  Instead, the plan would confiscate, through condemnation, only privately-owned, non-agency debt. Hallman explained:

“Private investors, including pension funds like California Public Employees’ Retirement System and the giant bond fund Pacific Investment Management Co., own much of the rest of the outstanding mortgage debt, which adds up to about 10 percent of all loans.

“These mortgages, though small in number, are most likely to be deeply underwater, and thus are in the most danger of failing. Privately owned loans are three times as likely as Fannie Mae or Freddie Mac loans to be underwater, for example. [Chief Strategy Officer John] Vlahoplus of Mortgage Resolution Partners said the eminent domain proposal is designed to target exactly these privately held mortgages that are at the highest risk of foreclosure.”

So the plan is to specifically target and seize CalPERS and other pension funds’ assets and give them away to lucky underwater homeowners — minus MRP’s cut, of course.  At bottom, this is a scheme for government to rob government pension funds, among other funds, to get the money to bail out underwater housing.

Fighting back

Some Securities Industry and Financial Markets Association members, perhaps mindful of their fiduciary duty to investors to protect the investments that are supposed to secure their retirements, began discussing ways to fight back when the confiscation plan was first floated.

But California’s irony-free Lt. Gov. Gavin Newsom wrote a letter to Attorney General Eric Holder demanding criminal prosecution of the targeted victims, who had been talking to each other about possible responses, as having violated the antitrust laws.

Newsom hasn’t had to write a letter demanding the prosecution of anyone at CalPERS — yet.  And he hasn’t had to write a letter demanding the prosecution of anyone at the Retired Peace Officers Association of California, or the California Judges Association — yet.

But CalPERS had a dismal rate of return of only 1 percent in 2011, despite having an assumed rate of return of 7.75 percent at the time (since reduced slightly to 7.5 percent), which was used in all their calculations projecting that their fund is solvent.  And California taxpayers and California government retirees are increasingly at odds about who should pay how much for a system that is increasingly seen as wildly unsustainable.

So, a few questions: What if CalPERS does become insolvent?  And what if the taxpayers are simply too broke to bail out an insolvent CalPERS?  Against that looming backdrop, shouldn’t CalPERS’ leadership at least try to protect their fund assets from naked confiscation? Shouldn’t they say something?  A peep?

So far, CalPERS is like Sherlock Holmes’ dog that hasn’t barked, leading one to wonder whether being backstopped by the taxpayers for investment losses has anything to do with their silence, even while a looting party is forming to come after their retirees’ assets. It is probably just a question of time until the CalPERS retirees realize they are in the crosshairs of a plan to forcibly seize their retirement assets.

When that happens, and the politicians realize they have to face down retired cops and firefighters rather than faceless Wall Streeters, perhaps this ridiculous plan to use government to confiscate the private property of some people and give it to other people will be laughed off the public stage.

By Mark Cabaniss

Democracy, it has been said, is two wolves and a sheep voting on what to have for dinner.

Yes, the sheep gets to vote.  And yes, in theory he could appeal to one of the wolves to break rank and vote with him instead of the other wolf.  But in reality, the sheep loses.  Every time.

The only way that the sheep could win, in a closed system, or zero-sum game, would be for him to convince one of the wolves that the other wolf would make a tastier meal than would the sheep himself.  Alternatively, he could try to convince one or both of the wolves that they are not, in fact, in a zero-sum game.  Historically, the sheep has had a difficult time doing this.

We can construct a simple model with only three voting blocs, each of which considers only its own economic interests when voting, each represented by one of the animals:

1. People who don’t pay taxes (Transfer Wolf);

2. Public employees (Public Wolf);

3. Private sector employees (Sheep).

At dinner time — oh, excuse me — voting time, there are two propositions on the ballot:

A. Shall we raise (or decrease) taxes and use the money to raise (or decrease) spending on Public Wolf?

B. Shall we raise (or decrease) taxes and use the money to raise (or decrease) spending on Transfer Wolf?

Voting

The voting goes like this:  On Proposition A, Public Wolf votes to raise taxes and raise his own pay.  Sheep votes to lower taxes and to lower Public Wolf’s pay.  Public Wolf and Sheep are at a stalemate.

Transfer Wolf sits this vote out.  Since he doesn’t pay taxes, he doesn’t care what tax rates are.  Nor does he care how much Public Wolf is paid, unless — unless he is paid to care.

On Proposition B, Transfer Wolf votes to raise his own benefits and to raise taxes to pay for them.  Both Public Wolf and Sheep vote against him.

Transfer Wolf has a problem. He has been outvoted.  But luckily for him, Public Wolf also has a problem: He is in a stalemate with Sheep.  The two wolves realize that they need each others’ votes, so they agree to work together, against Sheep.  Each will support the other’s position, and Sheep will be outvoted on both propositions.

In actual practice, the evidence suggests this is exactly what is happening — transfer payment recipients and government workers have formed a successful political coalition.  According to a recent article by demographer Nicholas Eberstadt, since 1960 total United States transfer payments have grown from $24 billion to just short of $2.2 trillion in 2010, nearly a 100-fold increase in the last half century.

Simultaneously, total government spending, federal and state and local, has gone from about 24 percent of GDP in 1960 to about 36 percent in 2010, growth of 50 percent.

Nash equilibrium

A Nash equilibrium, as popularized in the book and movie “A Beautiful Mind” about mathematician John Nash, posits a game stalemate dependent on two conditions: first, each player knows every other player’s strategy; second, despite knowing everything, each player is nonetheless unable to adjust his own strategy to make it more advantageous.

In politics, there are no secret strategies, since elections involve trying to gain adherents to your strategy over the other side’s.  But in our simple Fairy Tale, even though the first condition for Nash equilibrium is there — everyone knows everyone else’s position — there is nonetheless no equilibrium.

Public Wolf and Transfer Wolf will continue to vote in tandem, and thereby grow; Sheep will continue to be outvoted, and shrink.  If we graphed Sheep’s life expectancy, it would be a curve breaking straight down, inversely proportional to the growth of his two compatriots.

But when we consider the second condition necessary for a Nash Equilibrium, we see how Sheep can get out of his predicament: He simply has to change strategy and start competing with Public Wolf by directly bidding for Transfer Wolf’s vote.

Why hasn’t Sheep already thought of that?  He could, after all, promise to cut Public Wolf’s pay and then split the savings with Transfer Wolf, much as Public Wolf promises to raise taxes and split it with Transfer Wolf.

The reason for this is history, and the simple inability to think past it.

Sheep has always been opposed to raising taxes, whether it is to increase the size and pay of Public Wolf or whether it is to increase the size and pay of Transfer Wolf.

But, just because Sheep has always been opposed to these ideas in the past does not mean that he has to stay opposed to them in the future.  If Sheep could let go of his historical antipathy to Public Wolf and Transfer Wolf, he could seek to make a deal with one against the other.

Of course, there is yet one more way out for Sheep. He could potentially try to convince one or both of the wolves that their dinner choice is not a zero-sum game; that they could, in fact, join forces and go foraging in the woods together for something that all three animal friends could eat.

Historically, this approach has been a loser for Sheep.  At dinner time, both of the wolves are usually too hungry to listen to reasoned pleas about thinking outside the zero-sum model.

So the only bet for Sheep may be to undergo a paradigm shift, overcome his qualms, and make a deal with one of the wolves to dismember and eat the other.

Commentary

Oct. 31, 2012

By Mark Cabaniss

If you have the stomach, listen to Jesuit seminary dropout (1957)  Gov. Jerry Brown out on the campaign trail recently, selling his newest tax hike, Proposition 30:  “I like to quote from St. Luke: ‘From those who have been given, much will be asked.’”

To Brown and others of his ilk, it is always “the other” who has been given and from whom much should be asked.  People like him don’t own mirrors, or at least, don’t know how to use them.

He was talking to a teachers union. But since California teachers are the highest paid teachers in the nation, shouldn’t anything be asked back of them? Like maybe making it easier to fire teachers who have been accused of acts of perversion against schoolchildren? This past summer, the Democrats killed a bill in the legislature that would have done just that.

Maybe the governor should sit down with his Bible and find some scripture where it says we are supposed to protect the little children from those who would abuse them; I seem to remember something like that.  Then you could quote that same scripture at a press conference announcing your effort to get rid of child molesters in the schools.

How about California prison guards, among the highest paid in the nation. Should they be asked to give up anything, such as the “right” to commit crimes like smuggling in and selling drugs and cell phones to prisoners?  His Democratic pals in the Legislature gutted a bill that would have made such smuggling felonious, keeping such crimes mere misdemeanors instead, arguing that it would be “wrong” to be too hard on the li’l fellers just because they had made a mistake like commit a crime or something.  Er, the guards, not the prisoners.

Pension hogs

Or how about some of these pension hogs we read about, people like Randy Adams, former police chief of the city of Bell.  Remember him?  At a hearing for all the other former Bell officials who had been charged, the judge herself asked the befuddled prosecutor why Adams wasn’t one of the defendants.  Randy Adams is on the notorious CalPERS top ten list of highest paid pensioners in the state, currently receiving a pension of $265,437.48 per year.

Most people would say that he has been given a lot. Do you think he should give anything back, like some of the loot?  No?  Can’t reform pensions?  No matter what?  Never?

Here’s the governor in a non-scripture-quoting mood, talking about his own significance, or lack thereof: “At this stage [of his life], as I see many of my friends dying — I went to the funeral of my best friend a couple of weeks ago — I want to get s*** done.”

Like what?  Building a giant 19th century choo-choo to nowhere, the cost projections for which actually assumed that gasoline would be $40.00 a gallon?  If gasoline doesn’t get to $40.00 a gallon, the choo-choo won’t be cost effective, and shouldn’t be built.  Even worse, it may be built anyway, becoming a huge and ongoing cost for the state, literally taking food from the mouths of babes.

Is that the kind of “stuff” the governor wants to get done?  Snatching food from the mouths of the 99 percent to stuff it into the faces of the 1 percent, his overfed, gluttonous supporters?

No reforms

What a joke.  As long as Brown and his pals insist that child-molesting teachers shouldn’t be fired without the sort of endless due process rights that make it literally impossible to fire them; as long as he and his pals insist that cleaning up the worst abuses of the prison guards should emphatically not be part of cleaning up our ridiculous, absurdly expensive prison system; as long as there are more than 15,000 retired state and local government workers receiving “pensions” of more than $100,000.00 per year, for life, no one should be paying higher taxes, no matter what the fig leaf “purpose” dreamed up by the taxers.

For myself, I think it is wise to be mindfully reticent about trying to co-opt the words of the Bible to use as ammo in partisan political battles.  However, I recognize that some people, people who like to put on a Jesuitical affectation, disagree with me, and indeed, find it necessary to quote from the Bible to put on that very same Jesuitical affectation.

To them, a word of caution:  Before you go quoting the Bible, read it.  Deeply ponder the idea that it might apply to you as well as those you are lecturing.

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.

By John Seiler

Martha Montelongo’s great Gadfly Radio today featured two special gusts. Chris Reed, our special contributor, spoke on his recent article, “The nut graph you never see in a state government story.”

And Mark Cabaniss talked about his two articles on breaking state government employee pensions.

Yours truly commented, along with Ben Boychuk of City Journal-California.

Click here to go to the show recording.

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. 

First on a series on public pensions.

Sept. 20, 2012

By Mark Cabaniss

The politicians in charge of “doing something” about the ongoing California pension debacle like to play a little game. It goes like this:  They decry the high costs of pensions that have already been granted, pretend to want to do something to rein in future pension obligations, and then turn their hands up and shrug that there is really nothing they can do about current pensions (including, cough cough, their own) — since, after all, pensions are contracts, and therefore they are protected by the Constitution.

But there is a problem with this self-serving assertion:  Even if politicians’ pensions are contracts protected by the Constitution, they are still breakable.  In pretending otherwise, the politicians are lying.  In other words, merely noting that pensions are contracts protected by the Constitution is not the end of analysis, but only the beginning, for all contracts are breakable, and all constitutional rights are subject to limits.

When, not if, state and local governments begin dishonoring the highest public pensions, there will be, obviously, a huge blizzard of litigation.  And when those cases are heard, some of the following basic concepts of contract law may be applicable.  (Note: My purpose here is not to write a treatise on contract law, nor to predict the course and outcome of future litigation.  My purpose is simply to show the lay person that there are several possible theories under contract law under which governments might be able to reduce the highest existing pensions rather than go bankrupt.).

All contracts are breakable, if you have a legally valid reason for breaking them.  For example, if a used-car salesman sells a car to a 10-year-old, the contract can be broken on the basis that the 10-year-old didn’t have the legal capacity (age) to sign a binding contract in the first place.  And all constitutionally protected rights, including contract rights, are nonetheless limited by finite resources. For example, your right to a fair trial does not mean that the government has to hire the entire Harvard Law School faculty to defend you in your shoplifting case. Society can’t afford it.

Regarding public pensions, the best and most obvious legal ground under contract law to get out of onerous pension obligation may be mistake of fact.  The legal rule goes like this: If you make a contract while holding a belief that isn’t true, you can get out of the contract.  For example, you make a deal to buy a Picasso for a million dollars, but it turns out that the painting is not a Picasso.  You can get out of the deal.  (Under the mistake doctrine, both sides have to be making the same mistake.  If only one side is mistaken and the other side knows the truth, you may still be able to get out of the contract under a different theory, such as fraud; more below.)

Pension spiking

Regarding high public pensions, the mistake that was made was simple, fundamental, and huge:  the supersize pensions that began to appear in the 1990s were justified on the grounds that pension funds “would” generate average annual returns of 7.5 to 8 percent or more into the future, forever.  This has turned out to be, ahem, not true.

The infamous SB 400, that then-Gov. Gray Davis signed into law in 1999, and which gave retroactive pension raises to state employees, including already-retired state employees, was sold by the California Public Employee Retirement System to the Legislature with lie after lie after lie — or “mistake” after “mistake” after “mistake,” if you prefer.  The CalPERS “analysis” that was “presented to” (perpetrated on?) the Legislature implicitly assumed that the Dow Jones Industrial Average would be at 25,000 by 2009, and 28,000,000 by 2099.  On the morning of Sept. 20, it is at 13,556.

Proving the existence of and reliance on the mistake(s) ought to be a lark. After all, a great deal of time, money, and work went into creating the rosy projections that were used to bamboozle government into granting the unsustainable pensions.  Were the mistakes made regarding future stock market returns mutual?  Well, the government certainly made a mistake on behalf of the taxpayers.  How about the public employees?  Who knows?  However, as a practical matter it is very hard to see how they would go in to court and say, “We were not mistaken as to future stock market returns.  We knew full well that the projections were a joke and that CalPERS was lying.”

Performance

The second big legal ground to get out of pensions is impossibility of performance.  If events make it impossible for you to perform the contract, then you can get out of it.  For example, you contract to sell your car, but before you deliver, it is destroyed by lightning.  Regarding pensions, the argument would be simply that the state and local governments have gone bankrupt since the pensions were granted.  In that event, the pensions could be modified to match the ability of government to pay them.

The third possibly applicable doctrine is known in contract law as consideration:  for a contract to be legally binding, there has to be something of value promised, on both sides.  For example, if I promise to give you a million dollars, and you promise to take three breaths between the hours of 1:00 p.m. and 2:00 p.m. next Tuesday, there is no mutuality of consideration, since I am giving something up and you are not.  The contract is voidable.

In the public pension realm, one obvious place where the consideration doctrine would come into play would be SB 400, the 1999 retroactive pension increase.  Since some of the workers who received retroactive pension increases were already retired, they obviously could not promise or give anything at all in exchange for the money, and indeed they did not.  Therefore, at least in regard to these already retired workers, there was a complete absence of consideration.  (A similar argument can be made not on contract law, but on Article 16 Section 6 of the California Constitution, prohibiting the giving away of public funds.)

A fourth possible ground for breaking managements’ pensions is fraud: If CalPERS or any of the other groups pushing big pensions knew that the pensions would not be self-funding and would require massive infusions of taxpayer cash, and they did not divulge that information, then any such pensions obtained on the basis of such fraudulent disinformation would be voidable.  Moreover, widespread and undisclosed self-dealing might qualify as fraud. For example, CalPERS officials, as public employees, themselves benefitted from the huge pension increases granted in 1999, and they did not disclose to the legislature that they would benefit.

Unconscionability

Another contract doctrine which might be used to break onerous pensions is “unconscionability,” which means simply that a contract is so one-sided that it is just unfair to enforce it against the disadvantaged party.  While normally this doctrine is applied to consumer contracts, some of the factors courts look to in weighing claims of unconscionability — such as whether the parties had equal bargaining power, whether the contract makes a one-sided allocation of risk (for example, where the taxpayers have to pick up the tab, all the tab, in the event that the Dow does not hit 25,000 by 2009, ha-ha) — are applicable to public employee pensions, as well.

Finally, one more area of contract law might be used to break the pensions: lack of capacity to contract.  If you are drunk or insane, for example, you cannot sign a contract to buy a house.  In the public pension context, the lack of capacity would be a little more subtle (maybe; hopefully).  For example, if you are under duress, being threatened to get you to sign a contract, that could qualify as a lack of capacity, since you lack free will.

Steven Greenhut and others have written recently about bullying tactics, including the attempt to frame a city councilman for DUI, being used in Costa Mesa to get local officials to see things the public employees’ way.  Testimony about such incidents could nullify the contracts obtained thereby.

Similarly, if you were being bribed to sign a contract, that too would qualify as a lack of capacity, since you would not be acting in your capacity as a fiduciary to the public, but rather in your private capacity as a criminal.  Another way to look at it is that if you are a manager sitting at a table “negotiating” a pension increase that will benefit not just the parties across the table but yourself as well, you may not be acting within the scope of your employment as a public official, but instead acting on your own behalf.  Therefore, you do not have the legal capacity to act to bind the public to pay for your self-dealing little scheme, since you are not at that moment acting as a public official.   Needless to say, were the courts to start taking bribery and self-dealing seriously, they could nullify a lot of contracts.

To sum up: There are a great many helpful doctrines under contract law that could be used to break onerous public pensions.  These legal arguments are strongest against the very top pensions, because they are the most unconscionable, they are the least possible to continue to pay, and they are the most likely to have been the result of self-dealing or bribery.

Therefore, the legal grounds for attacking the biggest pensions, managements’ pensions, coincide nicely with the public policy grounds of wanting to go after only the largest, most abusive pensions, and not the pensions of the retired school teacher or janitor.

Next article in this series: Breaking public employee pensions: The political path.

Mark Cabaniss is an attorney from Kelseyville. He has worked as a prosecutor and public defender.