We want to stay as far away as possible from bonds that depend on the politicians and general funds of financially shaky states and smaller issuers unless the price is right. You ask California Treasurer Bill Lockyer, one of the greatest bond salesman ever, about the state’s pension situation and all you get back is a thousand-yard stare and a quick change of subject. That’s concerning.– John Cummings, Head of Municipal Debt, PIMCO, quoted in “The $2 Trillion Hole”, Barron’s, March 13
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a 24-48 hour delay from time to time. Here is this week’s.
By now, most of us are familiar with the massive deficits, debt and off balance sheet obligations of our federal government – including $100 trillion in unfunded Social Security and Medicare liabilities. Less attention, however, has been devoted to the similar predicament of our states. This weekend’s cover story in Barron’s, “The $2 Trillion Hole”, on unfunded state pension liabilities, compelled me to address this subject.
Take California. Over the last 12 months ending February 2010, the state of California has taken in $83.2 billion in tax revenues and spent $89.3 billion for a $6 billion deficit. If you look at the attached chart of California’s General Fund 12-month rolling deficit, that’s actually a big improvement from the depths of the recession in early 2009.
But it doesn’t encompass unfunded pension liabilities and $74 billion in outstanding General Obligation bonds. How do these future liabilities get met when current spending outpaces current revenues and therefore there are no savings?
According to the latest Pew Center on the States report cited by Barron’s, 87% of California’s pension liabilities are funded leaving only a $60 billion deficit. But that report used fiscal year 2008 numbers when CALPRS had $238 billion in assets. They lost $57 billion on their investments last fiscal year. A good chunk of that has been made back in the last eight months, but not all of it. A rough estimate of current unfunded pension liabilities is probably somewhere around $90 billion.
A big part of the problem is the stranglehold public employee unions have over state government which they have used to negotiate incredible pay, benefit and retirement packages. The average pay and benefits package for a firefighter in Orange County is $175,000/year (“Plundering California”, Steven Greenhut, The Wall Street Journal, December 8, 2009).
In 1999, California sharply increased benefits for retirees. A survey by the California Foundation for Fiscal Responsibility found that 15,000 retired California state employees have pensions over $100,000 a year.
State employees go to all kinds of lengths to spike their pensions. Earlier this year, Contra Costa Times reporter Daniel Borenstein wrote a shocking article explaining how retired County Administrator John Cullen had manipulated his final year earnings to spike his pension to $240,000/year (“Short Term Contract, Long Term Gain”, Daniel Borenstein, Contra Costa Times, January 10, 2010).
Politically, there is a lot of resistance on the part of those benefitting from the status quo to reform and fiscal discipline. The UC student protests on March 4, 2010 including confrontations with police in Oakland, Berkeley and Sacramento are one example.
For now, everything continues as usual. There was so much demand for new CA General Obligation bonds last week that the offering was raised to $2.5 billion. The improvement in the economy and the stock market has eased the stress on the general fund and CALPRS to some extent. But longer term, I would be seriously worried about the creditworthiness of the state of California.
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