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Was it constitutional for Proposition 124 to replace PSPRS' permanent benefit increases with a capped 2% COLA?

In this blog I and multiple commenters have broached the subject of the suspect constitutionality of PSPRS' replacement of the old perma...

Tuesday, October 30, 2012

A lesson for PSPRS members from Illinois' teachers

The following are current interest rates from several popular online bankers:

              Discover Online Savings Account             0.80% (APY)
              ING Orange Savings Account                    0.75% (APY)
              Ally Online Savings Account                     0.95% (APY)
              CIT Bank Online Savings Account            0.90% (APY)

These rates are not being given to advertise online banks but for some perspective. The State of Illinois Teachers' Retirement System (TRS), the pension for many of the states' teachers, announced that its 2012 fiscal year (FY) return was 0.73% (TRS earned less than one percent on its investments last year).  This rate was earned on a fund that has an assumed rate of return of 8.25% and during a year in which the stock market had positive returns (per the article, the S&P 500 grew 7.39% in FY 2012).  It would be interesting to know how much TRS paid in fees to its investment advisors and fund managers to get a rate of return that underperformed risk-free savings accounts.   If those fees are not already included in the 0.73% rate, TRS almost certainly lost money in FY 2012 once those fees are figured in. 

Illinois probably has the worst funded pension systems in the United States.  Illinois governor Pat Quinn has even brought up the idea that the federal government could bail them out by guaranteeing state bonds sold to cover current pension deficits.  This audaciously selfish plan would be a hard sell in the best of times and will never happen while trillion dollar annual deficits are being run up by the federal government.  However, this is a perfect window into the standard method of problem-solving used by politicians.

Governor Quinn seems to believe that Illinois can fall back on the "solution" that politicians have always used in the past: deferral and diffusion of current costs.  In this case, he believes he can defer TRS' liabilities even further into the future by selling bonds and diffuse the costs over an even greater number of taxpayers by using the federal government as the bonds' ultimate guarantors.  While this has always worked in the past, he now wants to push the problem up to the next level of government.   The problem is that the cavalry he is counting on to ride to the rescue of his state can not and will not help him.

An underfunded pension system that promises too much, saves too little, and can not even competently invest its meager funds to achieve risk-free returns has only two options: finding greater sources of funding or bankruptcy.  Illinois already has the largest budget deficit in the country, despite raising personal and corporate income tax rates in 2011, so we can see which option is more likely.  The reckoning due TRS will be ugly, with the wailing and gnashing of teeth by teachers' unions and retirees, who will see that all their political influence is impotent against financial reality.  The situation in Greece is a powerful cautionary tale for all Americans, and the ultimate fate of TRS stands as a powerful one for PSPRS members.

Friday, October 26, 2012

Pension Doomsday Scenarios I and II

The issues dealt with most often in this blog are financial issues, which can be complicated enough, though with a little analysis can be understood by anyone who is conversant in basic arithmetic.  Legal issues are another matter since the necessary background knowledge is quite extensive, as well the specialization necessary to understand any particular field of practice.

Included among the possible "doomsday scenario" for PSPRS are a major municipal bankruptcy or another financial crisis, but the most likely scenario that I can think of is a successful referendum to repeal the 1998 Arizona Proposition 100 (Arizona Public Retirement System Rules).  This proposition passed handily 61.4% to 38.6% and added to the Arizona Constitution this key statement, "Membership in a public retirement system is a contractual relationship that is subject to Article II, Section 25, and public retirement system benefits shall not be diminished or impaired."  The main reasoning behind Proposition 100 was to protect the state pensions from lawmakers that might misuse pension funds as had been done in other states and the private sector.

If Proposition 100 was repealed, it could allow the state to decrease benefits for retirees and the promised benefits of those currently working.  The language introduced into the Arizona Constitution is the basis for a successful court challenge to the cost of living allowance reforms that were part of SB 1609.  If Arizona taxpayers became sufficiently concerned about the financial burdens and service cuts being caused by the state's public employee pensions, Proposition 100 could be repealed. It would be a tough fight and any implementation of benefit cuts would assuredly be taken to court, but it remains very possible that it could be repealed.

The following piece by Nick Dranias (Taxpayer Backing? What Taxpayer Backing?) raises the possibility of another doomsday scenario.  The intriguing part of his piece is that it states that there exists no guarantee that state pensions like PSPRS will "perform as promised."  For a layperson like me this raises some intriguing questions.  As it stands right now, Arizona employers have always made good on the contributions demanded by PSPRS, even as they have grown enormously over the past decade to make up for PSPRS' underfunded status, but from this article it appears that employers' financial obligations are limited.

If PSPRS is a separate entity from employers, employers could argue that they are not responsible for the unfunded liabilities of PSPRS that were due either to poor investments or market downturns.  If an employer made matching contributions into an employee's 401(k) investment account and the account dropped because of bad investment choices, market volatility, or fraud, the employer would not be expected to make good on the losses in his investment account.  The employer fulfilled his obligation to the employee with the initial matching contribution and has no further liability.  The same could be said for an employer contributing to PSPRS.  An employer could legitimately argue that their obligation to PSPRS should not include any amounts related to investment losses that were solely the responsibility of PSPRS and its managers.  This would mean that an underfunded PSPRS would have to make up for its own losses and underfunded status.

This whole premise negates the protections of Proposition 100 because the only entity legally obligated to PSPRS members is PSPRS.  PSPRS can demand that employers pay more to make up for market declines or bad investment decisions, but employers seem to have the legal right to refuse to pay amounts related to investment losses.  They could argue that it is PSPRS' responsibility alone to manage and invest the funds it gets from employees and employers in such a way to ensure it has enough money to meet all its obligations .  The question is how do you split out the normal ongoing obligations from the investment losses lumped together in the employer contributions demanded by PSPRS.  Is it even possible to make this split, and has it ever been done before?  Could PSPRS successfully fight back by arguing that employers never provided adequate funding to begin with?

This doomsday scenario is scarier than the repeal of Proposition 100 since it would cut the generally assumed financial obligation employers have to PSPRS.  If a financially strapped or bankrupt employer successfully made this argument, so could all other employers.  PSPRS would then find it very difficult to recover from its underfunded status and would have to rely on the charity of employers to help it, and charity, like hope, is not a good plan for financial health.

Thursday, October 25, 2012

The incredible shrinking PSPRS

PSPRS' consolidated annual financial report for the fiscal year ending June 30, 2012 should be released in the next month or two.  PSPRS Administrator James Hacking has already hinted that this upcoming annual report will show that PSPRS' condition has worsened over the past fiscal year.  With an already inadequate funding ratio of 61.9% on June 30, 2011, PSPRS members should brace themselves for some bad news just in time for the holidays.

If we want to know how bad, we can look to this piece by Byron Schlomach of the Goldwater Institute (Government Pension Funds: In Worse Shape Than They Admit).  Mr Schlomach shows that PSPRS has a funding ratio of only 53.9%, a drop of 8% over the previous fiscal year.  He lists Arizona State Treasurer Doug Ducey as the source of this official funding ratio, though he does not say if this is the funding ratio that will be included in the upcoming annual report.

If a 53.9% funding ratio is not alarming enough, Mr. Schlomach shows that the funding ratio for PSPRS would only be 37.1% if PSPRS used a more conservative rate of return of 5%, instead of its current rate of 8.25%.  Remember that the Government Accounting Standards Board (GASB) will soon require public pensions to be more conservative about how they use rates of return to calculate pension liabilities (PSPRS members: A dozen more reasons to be concerned about your pension )

Rates of return necessarily rise with risks taken, so the trap PSPRS has fallen into is one where it is forced to seek a riskier 8.25% return in order to meet its financial obligations.   This sets up PSPRS for the same type of devastating losses it experienced following the dot.com bust and housing market collapse if there is another financial crisis (e.g. Eurozone problems, Middle East war, fiscal cliff, etc.).  The other alternative is to use a lower assumed rate of return on its investments and acknowledge that PSPRS is critically underfunded and not able to meet it future obligations without a major infusion of capital.  This could mean requiring PSPRS members and/or taxpayers to contribute more each year to PSPRS or cutting benefits to retirees.

PSPRS deserves credit for diversifying its holdings away from its stock-heavy portfolios of the past.  We can all hope that diversification combined with a sustained bull market and growing economy will lead PSPRS back to financial health.  However, it appears that hope is a losing strategy that PSPRS members should not rely on.

Friday, October 19, 2012

A little honesty goes a long way: another reason to vote NO on Proposition 121

As an addendum to this previous post (California Dreaming: Why Arizonans should vote NO of Proposition 121), another important reason Arizona voters should want to retain partisan primaries is that they are often the only arena where voters get a true sense of a candidates political views.

When candidates must compete with others in their own party, they are forced to distinguish themselves over various issues.  They can not simply agree with one another and say that they would all treat important issues the same.  This is especially important for general election voters since candidates will normally attempt to moderate their positions to attract those in the other major party as well as independents.

If Proposition 121 is approved, voters will lose this important forum.  Candidates will simply run as generic conservatives or liberals or will attempt to appear as moderates to appeal to independents.  Voters will never get a deeper insight into candidates' positions  Their choices may be limited to enigmas who feel the need to conceal their views to win over as many general election voters as possible.

Voters should expect candidates to be honest about issues, and unfortunately, partisan primaries are sometimes the only place where voters of all political persuasions may get to see behind a candidate's mask.  This is another strong reason to vote NO on Proposition 121 and keep partisan primaries as part of Arizona's elections.

Thursday, October 18, 2012

PSPRS members: Live long and prosper

One of the more compelling justifications for the generous benefits of public safety personnel pensions is that public safety personnel, particularly firefighters, have shorter life expectancy than those in other professions.  Point number three in this article by the Marin County Professional Firefighters (The Truth About Firefighter Retirement Benefits) is an example of the rationale for more generous pension benefits for firefighters. The article even states that including  longer-lived law enforcement personnel in the public safety pool skews the numbers to make firefighters look as if they live longer than they do.  They give no proof of this, and it seems a bit selfish and morbid for Marin County firefighters to criticize their law enforcement brothers and sisters for throwing off the average off by living normal lifespans.  Alas, these must be desperate times in Marin County.

PSPRS does not have a full breakdown of law enforcement and firefighters in either contributing members or retirees.  The closest they have is this data.  According to PSPRS's 2011 annual report, these are the top ten participating employers:

                                                     Employees         Percentage
    1. Phoenix Police         2,870                   15.40%
    2. Phoenix Fire             1,380                   7.40%
    3. DPS                           961                     5.16%
    4. Tucson Police           780                      4.18%
    5. Mesa Police              698                      3.75%
    6. Maricopa Sheriff      642                      3.44%
    7. Tucson Fire              500                       2.68%
    8. Pima Sheriff             494                       2.65%
    9. Glendale Police        397                       2.13%
    10. Scottsdale Police      387                       2.08%
                    Total Top Ten           9,109                   48.87%
                    All Others                9,529                    51.13%

As can be seen, two fire departments make up just a little over 20% of the top ten PSPRS contributing members.  I can only guess at the other 51%, but the top ten shows a ratio of 1 firefighter to every four law enforcement.  We can utilize this ratio for those like the Marin County firefighters who believe that law enforcement skew the longevity numbers, and the ratio shows that for every year longer that an average law enforcement officer lives would mean an average firefighter would have to live four years less to maintain the same average life expectancy for total public safety personnel.  If we use the current 78 year life expectancy of the average American male, the average law enforcement life expectancy would need to be 79 for the average firefighter life expectancy to be only 74 to maintain the total public safety average life expectancy at 78.

There is no evidence provided by the Marin County firefighters to support their contention that law enforcement skews the numbers.  Furthermore, the studies they cite about shorter life span do not address the issue of longevity.  They link to a Bureau of Labor Statistics study, but this study deals with on-the-job deaths, not longevity.  I have attempted to find data about life spans for professional firefighters and law enforcement through the Bureau of Labor Statistics and Census Bureau, but I do not find any.  It does not appear to be a statistical category that the government monitors.  As for the other link in the Marin County firefighters' article, it deals with the higher incidence of cancer among firefighters but does not quantify the risks.  This implies a shorter lifespan but gives no information about life expectancy.

For a verifiable source of data, we can go to the PSPRS annual report's actuarial section.  The actuarial assumptions are more grounded since they are used to determine PSPRS' liabilities.  The 2011 report lists the following life expectancies for the most likely age range of male retirees:

Age             Future Life Expectancy
50                          30.07 years
55                          25.86 years
60                          21.64 years

So for those who retire between 50 and 60, the expectation is that they will live to be between 80 and 81 years old.  This is 2-3 years longer than the average American male's life expectancy of 78 years.  If we apply the law enforcement-skewing hypothesis, this would mean that the average Arizona firefighter who retires in 2011 will only live to be between 66 and 70 years old.  If we use PSPRS' 1998 annual report, the average PSPRS male retiree could expect to live to between 77 and 79 years old; the average lifespan of an American male in 1998 was 74 years.  Under the law-enforcement skewing hypothesis, the average Arizona firefighter who retired in 1998 could only expect to live to be between 54 and 65 years.  When we extrapolate out some actual life expectancy numbers for firefighters, the notion that law enforcement are living longer and raising the average life span of public safety personnel that was put forward by the Marin County firefighters is shown to be self-serving nonsense.

The origin of the data used in the PSPRS reports is not referenced, but it is possibly propietary data gathered by insurance companies. Life expectancy may be different for different regions and cities, and FDNY personnel involved in rescue efforts after 9/11 would be an example of a notable exception of public safety workers who could be expected to have shorter life expectancy due to their exposure to hazardous conditions at Ground Zero.  However, the California Public Employees Retirement System (CalPERS) uses similar life expectancy numbers (CalPERS Debunks Myth of Shorter Life Expectancy for Safety Employees), so the numbers used by PSPRS do not appear to be out of line, at least for the southwest.

No one can deny that public safety is more dangerous than most other fields, but the average public safety worker reaching retirement can expect to live to the same age or longer than the average American.  Shorter life expectancy may have been the case for public safety personnel in the past, and this may explain the persistence of this notion.  However, without better data and analysis, the only conclusion that can be reached is that public safety personnel do not have a shorter life expectancy versus other professions.  Perpetuating this false claim not only misinforms the taxpayers but will negatively affect the financial sustainability of PSPRS and other public safety pensions.

Tuesday, October 16, 2012

A COLA comparison: PSPRS vs. Social Security

The Social Security Administration (SSA) announced that Social Security (SS) recipients will be receiving a 1.8% cost of living allowance (COLA) starting January 1, 2013.  SSA awards a COLA each year to keep recipient benefits even with inflation.  SSA calculates this COLA based on the Consumer Price Index for Urban Wage Earners and Clerical Workers, which the Bureau of Labor Statistics bases on the prices of a representative group of goods and services.

As has been detailed before here (Have a COLA and a smile), PSPRS has used a different method to calculate COLA's for its beneficiaries.  PSPRS places a portion of earnings in excess of its annual expected rate of return into a Reserve for Future Benefit Increases.  As long as funds remain in this reserve, an annual COLA is paid.  The recent pension reform legislation will eliminate this method, and once the Reserve for Future Benefit Increases is exhausted a new formula will be used to calculate COLA's in the future.

The following chart gives a comparison of how much a PSPRS member and a SS recipient would get with their respective COLA's.  The $1,433.00 monthly benefit used is based on the maximum Social Security monthly benefit in 2000.  PSPRS members are awarded a fixed COLA, regardless of their monthly benefit, while SS applies a COLA as a percentage of the recipients monthly benefit. The COLA amounts are what would be included in the next fiscal year's checks, so for PSPRS members, they would have begun receiving their 1986 COLA starting July 1, 1985, while SS recipients would have begun receiving their 1986 COLA starting January 1, 1986.

Year      PSPRS Member     COLA     SS Recipient    Rate/COLA
2000     $1.433.00                  $93.24     $1,433.00          3.5%/$50.16
2001     $1,526.24                  $98.17     $1,483.16          2.6%/$38.56
2002     $1,624.41                  $102.53   $1,521.72          1.4%/$21.30
2003     $1,726.94                  $111.90   $1,543.02           2.1%/$32.40
2004     $1,838.84                  $116.82   $1,575.42           2.7%/$42.54
2005     $1,955.66                  $121.76   $1,617.96           4.1%/$66.34
2006     $2,077.42                  $127.06   $1,684.30           3.3%/$55.58
2007     $2,204.48                  $134.34   $1,739.88           2.3%/$40.02
2008     $2,338.82                  $138.66   $1,779.90           5.8%/$103.23
2009     $2,477.48                  $146.74   $1,883.13           0.0%/$0.00
2010     $2,624.22                  $152.84   $1,883.13           0.0%/$0.00
2011     $2,777.06                  $153.58   $1,883.13           3.6%/$67.79
2012     $2,930.64                  $120.00* $1,950.92           1.7%/$33.17
2013     $3,050.64                      **        $1,984.09                    ?

Cumulative COLA's              $1,617.64                                $551.09

* This monthly benefit amount was approved for the July 2012 payment to PSPRS beneficiaries but may be changed after final investment results are calculated.
** No adjustment under the old method as the Reserve for Future Benefit Increases should be exhausted.  Any potential COLA will be based on funding ratio as well as the prior year's rate of return.  This change is being challenged in court.

After 13 years a PSPRS member will be earning over $1,000 per month more than someone receiving Social Security.  The starting $1,433 per month figure was used because it was the maximum monthly SS payment in 2000.  This meant that if you had worked from the age of 21 to 65, all while earning Social Security's taxable maximum, the most you could receive was $1,433 per month once you turned 65.  For a 55-year-old PSPRS member who retired with 20 years of service before fiscal year 2000, his high three-year average salary would have been only $34,392.  So for a PSPRS retiree, $1,433 per month amount  would seem to be an unusually low amount.

However, even if we used a more realistic $3,000 per month benefit, this member would still be making more than 50% more per month in FY 2013 than he did in FY 2000.  These annual increases in benefits certainly stretch the definition of cost of living allowances and could more accurately be termed raises.  COLA's are meant to prevent retirees from losing money as inflation raises prices.  Enriching retirees is not the purpose of COLA's.

We also need to keep in mind that between 2000 and 2011 there were two major market downturns, and PSPRS went from being well over 100% funded to being only 61.9% funded.  Forgone pay raises, decreased promotions, furloughs, and higher contribution rates all have been experienced by those still working and paying into PSPRS.  With PSPRS in such dire financial straits, it is a bizarre system where retirees get raises and workers earn less.

Monday, October 15, 2012

California Nightmare: Why Arizonans should vote NO on Proposition 204

"I have seen the future, and it works"
                    Lincoln Steffens, after his 1919 visit to the Soviet Union

In addition to Proposition 121, the Professional Fire Fighters of Arizona (PFFA) has also endorsed Arizona Proposition 204, the Arizona Sales Tax Renewal Amendment.  Proposition 204 would make permanent the temporary one cent state sales tax increase that Arizona voters approved as Proposition 100 in May 2010.  Proposition 100's intent was to close a large budget shortfall and prevent cuts to education.  The sales tax will end on May 31, 2013 if Proposition 204 is not approved in November.

Proposition 204 mandates how revenue would be spent with the bulk going to education and smaller amounts designated for social programs and infrastructure.  Proposition 204 also puts several restrictions on the state legislature.  These include setting a minimum spending level on education and restricting how vehicle license tax and highway user funds can be used.

As with Proposition 121, we again see the influence of California politics in another ballot measure, but a little more history is in order in the case of Proposition 204. In 1988 California voters approved Proposition 98, the Classroom Instructional Improvement and Accountability Act, which amended the California Constitution to require that 40% of general fund revenue go to K-12 education and community colleges.  The rallying cry at the time was similar to that of supporters of Arizona's Proposition 204: legislators can not be trusted to fund education and a designated revenue stream is needed to bring the state's schools up to where they need to be.

Proposition 98 has done such a fantastic job solving California's education funding problems that, flashing forward to the present, Governor Jerry Brown is now pushing a new referendum.  Proposition 30, the Sales and Income Tax Increase (2012), will raise the state sales tax by a quarter of a cent from 7.25% to 7.50%, as well as income tax on those earning over $250,000 a year.  These new revenues would again be used to fund K-12 education and community colleges.  The income tax increase is listed as temporary and is supposed to expire seven years after enactment.

Financially pressed California voters are currently being treated to veiled threats of blackmail.  College students are being threatened with tuition hikes, parents are being warned about the harm to their children, and all citizens are being warned about dire conditions if they do not vote for Proposition 30.

This should make Arizona taxpayers feel like Ebenezer Scrooge when the Ghost of Christmas Future showed him what lay ahead if he did not change his ways.  Arizonans are being sold the same nonsense that Californians were in 1988.  The revenue designated for education in 1988 was never about quality education but was meant to lock up funds for those special interests involved in education, mainly school and college employees and their union representatives.

The citizens of Arizona did a noble and unselfish thing in 2010 by approving a temporary one cent sales tax to close a historic budget gap.  Now supporters of Proposition 204 are trying to flog them with their own kindness.  Voters should realize that no amount of funding will ever be deemed enough by those advocating Proposition 204.  Voters may be frustrated by their legislators, but there still exists some influence over them through the ballot box.  If Proposition 204 passes, voters will further lose control of how Arizona is governed, empower special interests, and push Arizona closer to California's dysfunctional nightmare.

As general guidance, voters would be wise to reject any idea that comes from California.  Vote NO on Proposition 204.

Sunday, October 14, 2012

California Dreaming: Why Arizonans should vote NO on Proposition 121

Yesterday I received the Professional Fire Fighters of Arizona (PFFA) endorsement guide.  PFFA President Tim Hill's introductory letter explains PFFA's rationale for its endorsements and urges members to vote in November.  In addition to this standard verbiage, he also takes the opportunity to give a pitch for Proposition 121, the Open Elections/Open Government Initiative (aka "Top Two" Initiative).

Proposition 121seeks to eliminate partisan primaries and allow all voters, regardless of party, to vote in a single primary.  The two candidates receiving the most votes would advance to the general election, even if they belonged to the same party.  Californians passed a similar referendum, Proposition 14, in 2010.

Ostensibly this would appear to be a good idea, which allowed all voters, including independents, to pick the two candidates they like best.  Ideally, candidates would be forced to appeal to the greatest number of voters along the political spectrum in order to push themselves into the top two slots.  However, elections do not work under ideal conditions.

California's Proposition 14 is currently in effect and has already produced a situation in which a heavily Democratic district will have two Republicans candidates on the general ballot because four Democratic candidates split the vote to the point that none of them got enough to be in the top two.  This would not appear to be the wishes of the voters in this district.  However, this will most certainly be the last time something like this happens in this California district because future primaries will have no more than two Democratic candidates on the ballot.

Therein lies the problem with California Proposition 14 and Arizona Proposition 121.  These types of referenda will end up limiting voter choices by forcing parties to coalesce around a single candidate in an evenly split district or a pair of candidates in a district dominated by one party.  If a party runs too many candidates, they risk the possibility of having none of them on the general election ballot.  Someone will have to pick the one or two candidates on the primary ballot, and it will be party leaders, not voters.  This is redolent of the proverbial smoke-filled rooms of politics past where party bigwigs hand-picked candidates for office.  Instead of reducing the power of political parties, it will actually enhance it. (Note: according to this October 9, 2012 Arizona Republic article, Proposition 121 would create a 'top 2' primary in Arizona, the Arizona Republican party is officially opposed to Proposition 121, while the Arizona Democratic party has not officially taken a position, but has expressed reservations about it.)

Furthermore, the ability to disrupt primaries through the entry of bogus candidates to split an opposing party's votes will further turn primaries into a farce.  The other beneficiary of Proposition 121 will be special interests, who will exert more influence in the selection of primary ballot candidates and see a reduced slate of viable candidates.

Mr. Hill writes that Proposition 121 "will do more to moderate our state than anything we have ever seen," but moderation is neither the goal nor the purpose of elections in Arizona or anywhere else.  Elections express the will of the people, a noble goal in and of itself.  Proposition 121 will limit the choices of voters and put more power in the hands of political parties and special interests.

Vote NO on Proposition 121.

PSPRS: broke or broken promise

For PSPRS members, calculating one's pension is easy: take the average of your high three (or five) years of salary and multiply it by a percentage between 50-80% based on your years of service.  This amount is the annual retirement you will receive for the rest of your life.  However, the simplicity of this calculation belies the more complex system inside PSPRS where actuaries use mathematical models to project costs into the future and financial professionals have to make critical decision about where to invest funds in order to meet those cost projections.

The danger for PSPRS members is to simply think of the promise that is implied in their retirement calculation and not the mathematical and financial reality behind it.  The attempts to reform PSPRS are often portrayed as a breach of faith by government, despite the fact that Arizona's public employers have fulfilled their obligations to PSPRS and all other state pensions.  Unlike some public employers in other states, Arizona has not delayed or withheld funding to PSPRS or tried to hide its obligations in pension bonds, so the breach of faith explanation does not hold water.

The financial problems of PSPRS and other public pension are often portrayed as a broken promise since this idea is easier to sell instead of the reality that PSPRS has to survive in the same world as IRA's, 457(b) accounts, Social Security, and every other investment account.  PSPRS does not exist separately in its own financial realm where the only problem is legislators reducing funding or benefits.  Amity Shlaes addresses this situation very starkly in her September 28, 2012 article (Election won't prevent pension crash).

If it was financial self-delusion to think that dot.com companies could enrich investors without earnings or that home prices could rise indefinitely, then it is equally dangerous for PSPRS members to think their pension is isolated from market forces, common sense, or arithmetic.  Anyone who tells members that PSPRS' financial problems are only about broken promises is setting them up for disaster.

Friday, October 12, 2012

The future is the past

The comparison between  defined benefit pensions and defined contribution pensions is often portrayed as a moral choice.  Defenders of defined benefit pensions believe that they are an obligation that caring employers owe to their employees, while the defined contribution pensions are viewed as a cold-hearted abandonment of employees to their own retirement fate.  This good vs. evil model sets up those who advocate for defined contribution pensions as the bad guys.

This simplistic model is complicated by financial reality.  The principal justification for the defined contribution pension is that it allows the employer a way to predict costs.  By paying a known cost based on wages and salaries, the employer knows that there will be no future surprises that could affect their ability to operate.  In the private sector, this also benefits employees of a company that later liquidates by keeping their retirement funds in the control of the employee.  The public sector has an decided advantage over the private sector because public sector entities, though they can and do go bankrupt, will never cease to exist or lose the ability to bring in revenue.

However, the public sector still has to budget and predict future costs, and the inability to do this is what caused the public sector pension crisis.  At the time most public sector pensions were established the honest belief was that defined benefit pensions could be managed and funded in perpetuity, but unfortunately, political and financial reality intruded.  Now public employees will go into the future with uncertainty about their retirement benefits hanging over their heads.

This leaves the good vs. evil model a tired argument, but it is still being sold to citizens and public employees.  The real test is if a defined contribution pension can allow governments to plan for costs (and avoid bankruptcy) and provide a fair and adequate retirement for their employees.  The following articles show that it can be done:
(How three Contra Costa cities avoided the doomsday of pension plans)
(Social Security by Choice: The Experience of Three Texas Counties)
It is amazing that the three California cities were able to resist the siren song of CalPERS and public employee unions when they were peddling financial snake oil.  The city officials who resisted these appeals had an unusual grasp of finance and a rare concern for their citizens and workers.  The Texas counties are similarly remarkable for rescuing their employees from the losing proposition of Social Security.  These long-retired officials in California and Texas are exemplars, not only for their ability to design retirement plans that were mutually beneficial to taxpayers and employees, but also for their sober and realistic attitude about future costs and benefits.  Regardless of what eventually happens to public sector employee pensions, this same attitude should be the standard mindset going forward.

Friday, October 5, 2012

The usual suspects, part 6

This series of posts on the usual suspects concludes on a rather depressing note.  The public sector pension crisis is an unfortunate manifestation of several groups all doing what is best for themselves.  Some might also include public pension actuaries in this stew, but while they may be guilty of overly rosy expectations, they are bound by the laws politicians enact and must invest in a volatile and unpredictable market.  Neither politicians, Wall Street, nor public sector employee unions intended to create the public sector pension crisis, and the reader can make a judgment as to who has the most responsibility.  However, blaming any or all of them is pointless.

The previous five posts were meant neither as a defense nor an indictment of politicians, Wall Street, or public sector employee unions.  Instead, it was to show how each group acts in the best way it knows to maximize benefits for itself.  The more suspicious readers may believe that this is part of a conspiracy in which politicians, public sector employee unions, and Wall Street all collaborate to fleece the taxpayer.  Politicians promise public employee unions generous pay and benefits without the revenue to pay for them.  These promises eventually become unsustainable, so underfunded pensions are forced to invest in riskier and riskier Wall Street products in a losing game to bring pensions back to full funding.  Wall Street reaps large fees that they can also channel back to politicians in a neverending cycle.  Each group then points the finger at the others to confuse the taxpayer about the shared culpability.

The truth is much simpler and sadder.  There was simply no one who would stand up to the absurd and dangerous groupthink that afflicted politicians, Wall Street, and public sector employee unions.  The politicians in Stockton already had adequate evidence of the harm done by passing unsustainable pension costs into the future, yet when Lehman Brothers told them they could again push costs further into the future, they went for it.  They did this despite their own skepticism and professed ignorance of the bond market.  This never addressed the fundamental problem that got them into the mess in the first place--promising more than they could ever pay for--and kept right on with their standard behavior.

As for public sector employee unions, it is possible to see the dangerous groupthink here in Arizona.  The reforms to PSPRS are slowly being chipped away.  The public employee unions never really accepted the changes made to PSPRS, and they are fighting them out of sight of the public in the courts and legislature.  The notion that a benefit could be taken away is anathema to unions, and the cost, sustainability or fairness of a benefit is not a consideration, even if its existence affects the long-term health of PSPRS.

There is not a lot to say about Wall Street.  Pensions must work with Wall Street to earn the returns they need to pay retired members what they were promised, but pensions are under no obligation to buy or utilize defective products.  Wall Street is just as prone to groupthink as the others and will follow any trend that makes them money.  They will have no qualms about selling a popular or profitable product, even if there is a potential for poor returns or default.  Pensions should not count on Wall Street to help them earn enough to make up for bad political and financial decisions .

If this is the way the system continues to work, the public employee pension crisis can only end with the bankruptcy of defined benefit pensions and their replacement with defined contribution pensions.  Simple arithmetic tells us that costs can not be deferred infinitely to the future and that benefits can not accumulate infinitely without a way to finance them.  The only salvation will be if politicians and public sector unions begin to accept reality and honestly deal with the crisis before courts and angry taxpayers do.

Monday, October 1, 2012

The usual suspects, part 5

According to the Bureau of Labor Statistics' 2011 data, the rate of union membership in the private sector is 7.2 million workers, representing 6.9% of the private sector workforce.  Union membership in the public sector is 7.6 million members, representing 37.0% of the public sector workforce.   This 37% of public sector union membership is greater than the 35% all-time high of private sector union membership achieved in the mid-1950's.

The high level of public sector unionization is in addition to civil service systems that provides many job protections to public sector workers not available in the private sector.  So what accounts for this seeming  incongruity of the data?  Do public sector workers do more dangerous work, work longer hours, or have a more contentious relationship with management than private sector workers do?  The answer, of course, is no, so another explanation is necessary.

As was detailed in the prior post, public sector unions inherited the DNA of private sector unions.  They understand the importance of politics and politicians because that is where their power ultimately derives.  They also embrace the concept that benefits approved are benefits earned, and these benefits should never be given up without a fight.  However, these values are complicated by the different labor-management relationship in the public sector.

The most militant union member in the private sector knows that there is a limit to his demands.  If a business is driven into bankruptcy or liquidation, all previous agreements become subject to a court's discretion, and the court can diminish or eliminate benefits previously awarded.  The public sector unions have no concerns about a government entity ceasing to exist and municipal bankruptcy courts have so far protected promised benefits.  Public sector unions also have the unique ability to influence the choice of their ultimate bosses, politicians, through elections.  In the private sector, unions can not replace owners, and boards of directors choose CEO's of corporations.  Finally, the notion of a fair share of revenue that private sector unions can legitimately negotiate with management over does not exist in the public sector as their wages are paid with taxes.

This combination of private sector union values in conflict with public sector attributes makes for an interesting  battleground.  The battles in Wisconsin over the past 18 months show how ingrained the values of private sector unions are in public sector unions.  The elected government of Wisconsin fulfilled the promises they made to voters and acted within their legal authority to change the law in Wisconsin.  This is how politicians, as representatives of taxpayers, are supposed to act.  Public sector unions responded with a series of recalls, legal challenges, and mass protests.  The rhetoric used by public sector unions attempted to frame this conflict as a regression to a mythical dark time in the history of  public sector labor, rather than the governor and legislators doing what they thought was best for taxpayers, workers, and public school students.

The situation in Wisconsin brought to the surface the private sector tendencies of public sector unions by a clear and open challenge to their power and benefits.  The usual modus operandi is to influence politics behind the scenes in order to increase benefits whenever possible and fight any changes in benefits.  This has been a very effective strategy over the years and explains why union membership is so high in the public sector.