Idea for ex­tra CalPERS pay­ment makes sense

Los Angeles Times - - BUSINESS - MICHAEL HILTZIK

It seems that scarcely a day passes when our politi­cians aren’t ex­horted to run govern­ment like a busi­ness, or like a cou­ple pon­der­ing house­hold fi­nances over the kitchen ta­ble.

Usu­ally this ad­vice is mis­guided, since govern­ment has vastly dif­fer­ent con­cerns and re­spon­si­bil­i­ties from busi­ness or the typ­i­cal house­hold. But Cal­i­for­nia Gov. Jerry Brown and Trea­surer John Chi­ang have cooked up an idea that ac­tu­ally meets those stan­dards, and makes sense.

Their idea is to bor­row $6 bil­lion from the state’s Pooled Money In­vest­ment Ac­count and spend it on an ex­tra pay­ment to the Cal­i­for­nia Pub­lic Em­ploy­ees’ Re­tire­ment Sys­tem — that is, make an ad­vance pay­ment to CalPERS for pen­sions. The idea was aired by Brown in his May bud­get pro­posal, which must be ap­proved by the Leg­is­la­ture by June 15.

The money would be re­paid over eight to 12 years from the rainy day fund es­tab­lished by Propo­si­tion 2 of 2014. Chi­ang and Brown fig­ure that the one-time pay­ment will save the state and its lo­cal­i­ties $11 bil­lion dur­ing the next 30 years via re­duced CalPERS con­tri­bu­tions. They say the idea isn’t much dif­fer­ent from bor­row­ing in the debt mar­kets to make the pay­ment, ex­cept in this case the state is ef­fec­tively bor­row­ing from and pay­ing in­ter­est to it­self.

The Pooled Money ac­count’s in­vest­ments cur­rently yield about 0.88% a year. The bor­rowed funds would be paid back with in­ter­est pegged to the twoyear U.S. Trea­sury rate, which has been run­ning mod­estly higher than that (cur­rently about 1.3%). So the Pooled Money ac­count would do a lit­tle bet­ter and the state, by pay­ing down a rapidly ex­pand­ing obli­ga­tion, would do a lot bet­ter.

Thus far, the plan has elicited a fair amount of ques­tions and doubts. The doubts are nat­u­ral, since any plan based on as­sump­tions about in­ter­est rates and in­vest­ment re­turns in the fu­ture is bound to be packed with im­pon­der­ables. For the most part, how­ever, the state would be do­ing what cou­ples do when they judge whether to make an ex­tra mort­gage pay­ment on a home loan cost­ing 4.5% a year, or let the money sit in a bank ac­count, which pays a frac­tion of a per­cent­age point in in­ter­est, but at least is there if the money is needed right away.

In­deed, one of the is­sues re­cently raised by the state Leg­isla­tive An­a­lyst’s Of­fice is whether it would leave the Pooled Money ac­count too

dry if the money was needed in the near term. On the whole, how­ever, the LAO gave the pro­posal its con­di­tional bless­ing, find­ing “bud­get sav­ings likely, but hard to pre­dict.” The LAO rec­om­mended that the Leg­is­la­ture take its time ap­prais­ing the idea: Though the bud­get dead­line is June 15, “there is no rea­son why this pro­posal needs to be ap­proved by that time.”

The plan re­sem­bles a step be­ing taken by the city of New­port Beach, which is boost­ing its con­tri­bu­tion to CalPERS by $9 mil­lion in the com­ing year, rais­ing it to about $43 mil­lion, in or­der to save an es­ti­mated $15 mil­lion over the fol­low­ing two decades, a pe­riod in which its pen­sion obli­ga­tions are ex­pected to rise about 7% a year.

“It’s like we have a 7% debt out there that we want to pay down as much as we can,” City Man­ager Dave Kiff told me. He rec­og­nizes that New­port Beach has fi­nan­cial ad­van­tages not shared by many other mu­nic­i­pal­i­ties, in­clud­ing sales tax in­come from the up­scale re­tail­ers at Fashion Is­land and New­port Cen­ter, and the Fletcher Jones Mercedes deal­er­ship. “Most of my col­leagues are just strug­gling along,” Kiff says of other ci­ties. Still, sales growth at New­port Beach’s big re­tail centers shows signs of flat­ten­ing out, so the city may have thought it should make the ex­tra pay­ment while it still has the money.

The state has con­sid­er­ably more fis­cal flex­i­bil­ity than any city. So let’s take a closer look at how this ma­neu­ver would work.

First, the hard re­al­i­ties. The state’s un­funded pen­sion li­a­bil­i­ties are cur­rently es­ti­mated at nearly $60 bil­lion. Its an­nual con­tri­bu­tions to the pen­sion fund un­der cur­rent as­sump­tions are ex­pected to nearly dou­ble from about $5.8 bil­lion now to $11.2 bil­lion in 2031-32.

The sources of the short­fall are etched into history; they in­clude a pe­riod dur­ing the late 1990s when CalPERS felt so flush from mar­ket gains that it gave the state a con­tri­bu­tion “hol­i­day,” cut­ting re­quired an­nual con­tri­bu­tions more than 80% even as it en­dorsed in­creases in pen­sion ben­e­fits. When the mar­kets crashed in 2000 and again in 2008, a yawn­ing gap opened in the pen­sion fund. The op­tions for fill­ing it to­day are to raise taxes, cut ser­vices or deny work­ers promised ben­e­fits, none of which is palat­able.

That’s the li­a­bil­ity side of the ledger. On the as­set side, there’s the Pooled Money In­vest­ment Ac­count, which is cur­rently brim­ming with $50 bil­lion in state funds, in­vested in safe, short-term paper yield­ing a measly 0.88% a year. The ac­count typ­i­cally is used to help state and lo­cal agen­cies man­age their sea­sonal cash flows, since bills don’t al­ways sync up with tax rev­enues. But its bal­ance is un­usu­ally high just now, thanks in part to re­cent bud­get sur­pluses.

Chi­ang con­tends that the bal­ance helps make this the per­fect mo­ment to ex­ploit the ac­count to help close the pen­sion gap. “Rates are low and we have this in­cred­i­ble sur­plus,” he says. He doesn’t think the fur­ther study ad­vo­cated by the leg­isla­tive an­a­lyst is war­ranted: “I un­der­stand that they want more in­for­ma­tion. But this makes sense now.”

What could go wrong? The most out­spo­ken critic of the plan is David Crane, a for­mer in­vest­ment pro­fes­sional who has served as a Univer­sity of Cal­i­for­nia re­gent and (from 2004 to 2010) as a fi­nan­cial ad­vi­sor to Gov. Arnold Sch­warzeneg­ger.

Crane ar­gues that in­creas­ing pen­sion con­tri­bu­tions is good, but bor­row­ing to do so is bad, es­pe­cially now. “This is just a lever­aged bet on the mar­kets,” he ar­gues, when in­ter­est rates are near a his­toric low and the stock mar­ket is at a record high. Those con­di­tions in­crease the risk that the cost of the bor­row­ing will out­strip any gains from pay­ing down the debt, es­pe­cially since the state will be pay­ing a float­ing rate on the bor­row­ing. He says the process Brown and Chi­ang have in mind is akin to bor­row­ing from a child’s col­lege sav­ings to fund a par­ent’s bank ac­count.

Crane is speak­ing from ex­pe­ri­ence: He helped Sch­warzeneg­ger craft his “deficit re­duc­tion bonds” in 2004 to kick the state’s deficit down the road, but ac­knowl­edges now that that was a mis­take. “Those bor­row­ings ... just cov­ered up the prob­lem, with in­ter­est to boot,” he re­cently wrote on his blog. He ar­gues that the only proper way to fund the pen­sion red ink is by rais­ing taxes, cut­ting spend­ing and par­ing pen­sion ben­e­fits so em­ploy­ees share the costs.

It’s cer­tainly true that no one knows for sure what the fu­ture holds for in­ter­est rates and stock mar­kets. As the leg­isla­tive an­a­lyst ob­serves, over the last 30 years, the an­nual re­turn of the Stan­dard & Poor’s 500 stock mar­ket in­dex has ranged from neg­a­tive 37.22% (in 2008) to plus 32.43% (2013), though its av­er­age an­nual re­turn over that pe­riod has been an in­fla­tion-ad­justed 7.36%. In the same pe­riod, the two-year Trea­sury rate has ranged from above 14% to al­most as low as zero.

So it’s pos­si­ble that the cost-ben­e­fit cal­cu­la­tion could turn up­side down in the time that the loan from the pool is out­stand­ing; as Crane ob­serves, al­most no one ex­pected the prac­tice of re­fi­nanc­ing one’s home to take out cash while hous­ing val­ues were on a per­ma­nent curve up­ward to be a bad bet — un­til the hous­ing mar­ket crashed in 2007.

Chi­ang may be a bit too un­nerv­ingly san­guine about some­thing like that hap­pen­ing again — he says the re­turn from CalPERS in­vest­ments might fall be­low the two-year Trea­sury rate “if the U.S. col­lapsed, but then we’d have larger prob­lems.” So it would be wise to fol­low the leg­isla­tive an­a­lyst’s ad­vice and sub­ject this plan to fur­ther ac­tu­ar­ial scru­tiny. But in a world where noth­ing is cer­tain, its risk-re­ward ra­tio looks like a good bet.

John G Ma­ban­glo Euro­pean Pressphoto Agency

GOV. JERRY BROWN, left, and Trea­surer John Chi­ang fig­ure that the one-time pay­ment will save the state and its lo­cal­i­ties $11 bil­lion dur­ing the next 30 years via re­duced CalPERS con­tri­bu­tions.

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