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California Pension Death Star Approaching

Contributed by Chriss Street. Specialist in corporate reorganizations and turnarounds, former Chairman of two NYSE listed companies. His latest book, The Third Way, describes how to achieve management excellence and financial reward by moving organizations from Conflict and Confrontation to Leadership and Cooperation. He lives in Newport Beach, CA.

When Moody’s Investors Services issued a “Request for Comment” last July about their plan to begin recalculating the effect of massive state and local unfunded pension liabilities on credit quality, I warned that this would eventually result in across-the-board slashing of municipal bond credit ratings and numerous municipal bankruptcies in California.  It now appears that I may have understated the risk for California. 

The California Public Policy Center (“CPPC”) just released a report analyzing the impact of the Moody’s new policy on six Northern California counties (Alameda, Contra Costa, Marin, Mendocino, San Mateo, and Sonoma).  Their conclusion is that when the new rules are applied, the annual cost of pensions will increase from the equivalent of about 50% to 100% of these counties’ net property tax income.  With the state running new deficits after already raising state income taxes to the highest level in the nation, Californian homeowners should be prepared for their politicians to try to overturn Proposition 13 that for 35 years has limited California property tax rate increases.

Given that California has only 11% of the U.S. population, but issues 20% of all of the nationwide municipal bond volume, Moody’s warned they would be re-assessing the financial condition of all California counties and cities "to reflect the new fiscal realities and the governmental practices".  Moody’s that a greater share of municipal bankruptcies are expected to come from California.  California State Treasurer’s office tried to reassure the public by calling the Moody’s warning "a little hyperbolic" and stating that "No city's going to blithely skip into bankruptcy court to avoid its obligations."  But today over 50 of 482 California cities have declared a “Financial Crisis” and have considered filing for Chapter 9 municipal bankruptcy.

CPPC’s analysis used data from the most recent county Actuarial Valuations to produce four core restatements of solvency – total pension debt, unfunded pension debt, government normal yearly contributions, and amortization payments of unfunded pension.  CPPC determined that for the four adjustments Moody’s is expected to make – two would have very significant impact on county solvency:

  • First, pension debt would be adjusted using a high-grade long term corporate bond rate (5.5% for 2010-2011) instead of a Pension Fund’s target rate of return (7.75% more or less)
  • Second, government payments to Pension Funds would be adjusted to reflect the lower discount rate, the need to fully fund pensions by the time employees retire, and a 17 year level-dollar amortization of unfunded pensions.

In their Actuarial Valuations, the counties claim they have conservatively banked 78% of their pension liabilities in cash and securities, leaving only $4 billion in under-funding.  But with the Moody’s adjustments will increase the unfunded pension obligations by $6 billion, balloon the unfunded liability to $10.2 billion and the cash and securities funding down to a speculative level of 58%. 

At a 78% funding level, the six counties are only required to contribute 29% of their payroll, or about $640 million, to fund their pension plans each year.  But under the new Moody’s formula that will drive down their funding level to 58%, the counties required annual pension cost will sky-rocket to 63% of payroll, or $1.4 billion per year!

California has run huge budget deficits for the last decade.  Recently voters passed Proposition 30 as a $6 billion state income tax increase on top earners in hopes of rescuing schools by balancing the state budget.  But according to the California State Controller’s just released December financial statement, state spending is $900 million over budget and state tax revenue is at least $360 million under budget.  

For the last 35 years, California politicians have been forbidden from jacking up property taxes by the 1978 voter approved Proposition 13 Initiative.  The initiative has been so popular with homeowners that it has been referred to as the third rail of California politics.  But as the CPPC study demonstrates, the annual cost of pensions will soon increase from the equivalent of about 50% to 100% of these counties’ net property tax income.  With the state already running new deficits on top of the highest income taxes in the nation, it is my belief that California politicians will soon try to over-turn “Prop 13.”  

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Reader Comments (9)

You gotta pay for what you get....eventually.
January 13, 2013 | Unregistered CommenterJaneb
No Jane B. You can always force your children to suffer for your own greed. This is of course, a standard conservative debt-fear-mongering line, but it is conservatives from the baby boom generation who have shown they have no respect for generations x and y. After their generation was gifted an extraordinary set of public services to grow up and prosper with (including nearly free higher education here in Cali.), they turned around and stomped their feet and said "Hell no; we're all self-made. We won't pay for that with our hard-earned money!"

There were alternate forms of property tax reform on the table in the late 70s that would have stopped the major problems without turning California into a slow-motion trainwreck. But the rising Reagan-Revolutionaries opted for the most radical, disruptive "solution" in Prop. 13. As a result, the decline in services for the children of the middle class has been extraordinary. The debt burden on young college graduates today is ridiculous, especially considering that Reagan-Era neoliberalism has made middle-class careers exceedingly rare and far less stable. Meanwhile, who are the biggest beneficiaries of the law? The extremely wealthy and corporations that can "lease" buildings for a hundred years and pay taxes as if it was still 1979.

Much of the destruction of sane governance in California can be traced back to Prop. 13.
January 13, 2013 | Unregistered Commenteremptyfull
I guess, since we live in a Democracy, we get the government we deserve. There is no doubt that suffering is going to be spread amongst everyone. The blame goes to numerous policies. Student loans, sub prime mortgages, over generous pensions, etc.

When I do my yearly calcs on my retirement money I don't even count social security.
January 14, 2013 | Unregistered Commenterjohnnygeneric
Jesus christ! I thought it was Bush's fault. Going back to Reagan is just ridiculous.
January 14, 2013 | Unregistered CommenterChinga
California's future is the fulfillment of your politics. More people will leave, the state will go broke, and those remaining will blame others. You will get what you deserve and the rest of the country will watch and be sad as a once great state becomes another Greece....and you still won't get it.
January 15, 2013 | Unregistered Commenterhawk
Dear Hawk,

Thank you for your entirely contentless rebuke. Your vague assertions do nothing to convince me.

"I" will get what "I" deserve? My point is that conservative boomers and Reagan Revolutionaries pulled the rug out from my generation and (even moreso) the Millenials, all with an insufferable Randian-style selfish bravado about how they were self-made and therefore (unlike their parents) owed nothing to building the infrastructure for future generations (they still, of course, demanded services for themselves). Prop. 13 was the single-biggest factor in making California government a basket-case.

I'm of the opinion that grownups should be more concerned with the welfare of future generations. You're free to disagree with my ideas, but try actually making an argument next time.

All best,
January 16, 2013 | Unregistered Commenteremptyfull
I don't think you can blame only the conservatives. I happened to be in San Francisco at the time. I was visiting my girlfriend and I stayed in a house on Twin Peaks. Incredible view, by the way. The husband worked for the city in the tax assessing department (sorry, I don't know the exact was a long time ago). He discussed what was happening. I was only 18YO at the time and although I didn't completely connect to what was happening, I listened and absorbed the information.

The whole city was up in arms. You'll recall this was when inflation was really starting to take off (I think this was 1976 that I was there???) Protesters and mobs formed at city hall. People were furious at the astounding rate property taxes were going up. The city workers would sneak out the back for fear of being attacked.

Last I checked, Proposition 13 was voted in by the people, not the government. The main issue was older residents at that time would be pushed out of their homes that they owned for decades. This would be those who predated the baby boomers. Maybe you should blame them.

The Republican governors you had could not be considered conservative. They were all just the opposite. They were big SPENDERS. Throw Gov Moonbeam in there for allowing public servant unionization, you have the makings for a disaster. These guys and the Progressives in CA congress are to blame for the absurdly high CA tax rate, absurdly high CA business tax rate and absurdly high CA electricity rates, absurdly high CA pensions, ghastly high gasoline prices - would you like me to continue?

But now, lucky you, the Leftists are really running the show now. Compare this to real conservatives. Conservatives would be for less government oversight and less regulations. Hourly wage laws in Ca are the worst in the nation and really need to be reformed. Do you honestly think the Leftist will ever loosen the ropes to allow you to breathe? So far, the only new law that I thought was good was the cottage baking/cooking law.
January 16, 2013 | Unregistered Commenterjohnnygeneric

I was born in '76, so I don't exactly have personal memories of the protests, but I was raised in the aftermath of Prop. 13. Yes, it was a voter-passed proposition, and yes spiralling property tax increases were a problem that needed to be solved (there were many plans for how this could be done). The right-wing Jarvis folks wrote Prop. 13 and threw in multiple grenades that made it harder to raise revenue in any but the most convoluted, inefficient ways, while leaving spending powers basically untouched.

Electricity deregulation was a mostly Republican plan that exposed us to extraordinary abuse by the Enron guys -- which is pretty much what all of post-Reagan deregulatory reform has succeeded at doing. The idea that removing cops from the white-collar crime beat will somehow make capitalism work better has been disproven, I think, by recent years. All deregulation does is give advantages to unethical, fraudulant (but often politically-connected) businesses, which in turn crowds out honest actors.

The union issue is more convoluted (the prison guards' union is a nasty group -- but I'm far more sympathetic e.g. to the teachers' unions, despite occasional absurdities). Nonetheless, the weakening of unions on a national level has been an almost unmitigated triumph for conservatives -- and been one of the macro-political reasons that the middle classes are falling apart and income inequality has reached such dangerous levels. When only a small group reaps the benefits of the economic structures of a society it is virtually inevitable that corruption will dominate that society. Capitalism should not (as Marx predicted) simply return us to aristocracy; yet that remains a genuine danger.

Since I have yet to meet a "real conservative" who actually has a realistic plan to cut spending that would work outside of the oh-so-wonderful economic structures of the nineteenth century (which Republican politicians clearly understand, since they just rail against abstract "waste" while cutting taxes for the wealthy whenever possible), I am dubious about your claims that such people would do a better job. I think your post rings of the old line about how conservatism can not fail, it can only be failed.

Meanwhile, one of the major reasons for the "pension death star" is that conservatives passed tax cuts without bothering to worry about the contractual obligations the goverment had incurred. So it will be my (late Gen X)generation and Gen Y that has to deal with this mess. Instead of "starving the beast," conservatives just passed the buck. Meanwhile, liberals got way too tied up in cultural politics and let the delusions of neo-liberal economics gain virtually unopposed control of our institutions. Now the younger generations have to pay the price.
January 17, 2013 | Unregistered Commenteremptyfull
Funny, the problems you're describing aren't happening here in Texas. We had a budget crisis a couple of years back, but we handled it. We have high property taxes, but despite efforts to reform them with some sort of proposition 13, they've been unsuccessful. We have no income tax. Our gasoline is not the cheapest in the nation, but it is certainly not the most expensive. Our electricity rates aren't the lowest, but with deregulation, companies vie for our business and offer good rates. Right now I earn Frequent Flyer miles for every dollar of kH power I use.

I am involved in the energy industry and I can tell you that Louisiana is slightly easier to deal with than Texas. I think mainly due to the EPA clamping down on Texas in relation to clean air regulation.

To build a fast food restaurant in Texas takes a whopping 6 weeks from planning and permitting to finished building. In California it takes SIX MONTHS.

I think I can easily argue that Texas is without a doubt far more conservative than California is or ever was. Your anger is completely misplaced in blaming your present predicament on spoiled baby boomers.

To you, I only have two words of advice:

Get. Out.

Get out of California and move to North Dakota. In ND the people there are too busy to complain about their plight in life. They're too busy making money. Isn't that what you want?
January 17, 2013 | Unregistered Commenterjohnnygeneric

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