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California Sounds Retreat in War on Arithmetic

California is staging a limited retreat in the war on arithmetic—but it’s vowing to fight on.

Just like in New York, where the state legislature recently vetoed a plan to put the state’s wobbly pensions on stable footing, California is facing a crisis borne out by numbers. The problem bedeviling California is the gap between the money it has promised to pay retirees and the money it has—or expects to have—to pay the claims, estimated at about $500 billion late last year. For years, California politicians and union leaders rallied around a lie: They promised big benefits to employees while telling taxpayers that it wouldn’t cost a lot of money. They took less money out of current tax receipts than required to honor the pensions, and they assumed unrealistically high rates of return on the assets they did sock away. The wood fairies and the forest elves were going to make up any shortfalls.

The trouble with math, of course, is that it is so implacable. You can tell it anything you want; the numbers don’t change. If you don’t put enough money away, and it doesn’t grow as fast as you tell yourself it will grow, you won’t have enough money when the time comes to write the checks.

That is where California is today.

Despite the best efforts of public unions and government planners to deny the hard truth, in some combination, payouts will need to drop and other contributions will need to rise to keep the funds from running out of dough.

Calpers, the most important California retirement fund and one of the largest pension funds in the country, is responding to the crisis with a partial recognition of reality. For the first time in nearly a decade, it is lowering its estimates for return on investments to 7.5 percent.

This will be an extremely painful adjustment for a state where budgets are already strained to the breaking point. The Wall Street Journal reports that state workers will likely see layoffs and increases in their pension contributions. New pension obligations are expected to cost the state an additional $303 million per year, and many local governments face price increases of two to three percent.

Yet this may not even be the worst news for California. One Calpers actuary believed that the penion plan only had a 50 percent chance of achieving a 7.5 percent return and suggested that a more realistic number should be 7.25 percent, which would place it among the lowest in the country. The only reason these estimates weren’t lowered further were concerns at Calpers about the government’s ability to pay. Clearly, something is wrong, and as much as California employees would like to ignore it, the arithmetic doesn’t lie.

Wars on arithmetic never end well.

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  • http://facingzionwards.blogspot.com/ Luke Lea

    From the headline I thought this was going to be about California’s requirement that every high school graduate take Algebra.

    This has a high opportunity cost of course for the half of the population that will never go to college, namely, the opportunity to learn kinds of skills they could actually use to earn a living in our society. Or as a ghetto youngster in one of John Updike’s novels put it when he was asked why he wasn’t in school: “They don’t teach you none of the shit you need to know.”

    These kinds of unrealistic expectations are just one more example of the ways our undemocratic yet still governing elites ignore the needs and interests of ordinary people.

  • http://facingzionwards.blogspot.com/ Luke Lea

    Sorry. That Updike quote is here.

  • WigWag

    “One Calpers actuary believed that the penion plan only had a 50 percent chance of achieving a 7.5 percent return and suggested that a more realistic number should be 7.25 percent, which would place it among the lowest in the country. The only reason these estimates weren’t lowered further were concerns at Calpers about the government’s ability to pay.” (Via Meadia)

    If Calpers can’t achieve an average annual growth rate of 7.5 percent for its portfolio something is seriously wrong with the people managing the pension fund.

    For the past 20 years, Harvard has managed an annualized growth rate of 13.1 percent; for the past 10 years, in a challenging investment environment, the annualized rate of return for it’s endowment has been 9.4 percent.

    In October, 2011, Yale reported that the annualized growth rate for its portfolio was 10.1 percent measured over a ten year period.

    In light of this, an assumption of a 7.5 percent rate of return on Calpers investments seems perfectly reasonable.

  • Kenny

    7.5% is pie in the sky.

    Time will prove this.

    Well, strike that. When Obama/Bernanke inflation gets going, 7.5% might be achievable.

  • Tom Holsinger

    And state tax receipts are down again.

    “Throughout history, poverty is the normal condition of man. Advances which permit this norm to be exceeded — here and there, now and then — are the work of an extremely small minority, frequently despised, often condemned, and almost always opposed by all right-thinking people. Whenever this tiny minority is kept from creating, or (as sometimes happens) is driven out of a society, the people then slip back into abject poverty.

    This is known as “bad luck.”

    Robert A. Heinlein”

  • Kris

    “The trouble with math, of course, is that it is so implacable.”

    Reminds me of the short story “The Cold Equations” and the short non-fiction piece “The Jet that Crashed Before Take-off”.

    Luke@1: If high-school students aren’t going to study algebra, then I honestly fail to see the point of high-school itself.

  • Gary L

    The wood fairies and the forest elves were going to make up any shortfalls..

    An obvious solution would be to get those laissez faire fairies and elves to start paying their fair share of taxes. Perhaps each elf and fairy would pay a per capita assessment based on the size of their unicorn herd.

  • http://inthisdimension.com alex scipio

    @WigWag.

    Yeah.. but these are CA public employees here. We’re talking sub-100 IQs. 7.5% is probably reaching. Besides., they probably get told by Sacrademento pols that they must invest in Green stuff or other socially responsible organizations… not that any public unions are socially responsible, right?

  • Dobby

    California tax revenues have plunged.

    http://globaleconomicanalysis.blogspot.com/2012/03/california-tax-revenues-plunge.html

    Besides businesses leaving CA for more tax friendly states, another problem they face is falling gasoline tax revenue. Gas prices are rising and people are driving less and less. Many states with the highest gasoline taxes are those “blue states” that are already deep in debt. They’ll need to find other revenue to replace gas taxes or will have to finally start doing massive cuts which they should have done years ago.

  • http://tomatopundit.com TomatoPundit

    I was there in the 1990’s – literally in the room – when California public union officials celebrated their “victory” in getting employee retirement pay based on the single highest year of compensation. Everyone knew, but nobody would say it, that such a formula couldn’t work in the long run. They were wholly invested in the lie … and employees at the time were ecstatic.

    This is what happens when union lawyers become legislative leaders and government personnel directors – the unions essentially control both sides of the bargaining table. It’s a sham that both sides love, and it will be difficult to fix because California voters appear to be irredeemably dependent on promises that never pay off…

  • Boyd

    My teenage daughters love to use, “anything is possible” to argue againt my dictates about the unfeasability of their decisions. My response, “2+2 will never equal 5. It’s a fundamental business proposition that business’s go out of business for one reason and only one reason – they run out of cash. But I believe the people running things in California are smart enough to know this, they just don’t care. Their goal is take the money and run and like all Ponzi schemes the first out do make money. And then it dies. Farewell California. It was nice to know ya’.

  • SamC

    @WigWag

    Calpers, the land where every public sector union pension fund manager is above average of every public union pension fund manager.

    In other words, Oz.

  • Darren

    Wouldn’t it be cheaper to just place the money in a broad stock market index? It would be cheaper overhead for sure.

  • styrgwillidar

    Wasn’t it Ayn Rand who wrote something along the lines of:
    “In an argument between two reasonable people, reality will be the final arbitrator” ?

    Unfortunately, the government of California and the unions are anything but reasonable and will continue to argue with reality even when outcomes are obviously disastrous.

  • Brian

    Math is racist, sexist and anti-gay, obviously.

  • Rick Caird

    Wars on arithmetic always end well. Arithmetic always wins.

    I have added “Wars on arithmetic never end well”to my list of quotes. I have a feeling it will come in handy.

  • John

    The answer is so simple: A 100% tax on all government retiree benefits for any retiree under the age of 67.

    The law says we have to give it to you. It doesn’t say we can’t take it back. Pension eligibility for government employees should match that of SS eligibility.

    They can retire anytime they want, they just can’t collect keep the benefits until 67. Nor should their monthly pension payment exceed that of the national average SS check. Then government employees would be motivated to make society richer, not enrich themselves at its expense.

  • jim

    This kind of thing is why EVERY pension plan should immediately transition to a defined contribution plan. That way, no elected official or company official can over promise benefits and these budgetary time bombs won’t exist in the future.

    This is not advocating employee-only contributions to a 401K. I am in such a plan with TIAA-CREF as a university employee. My employer matches my contributions and the money is in my name from the time of deposit.

    The argument has been made that defined benefit plans are more lucrative to the worker. Well, it’s not magic money and has to come from somewhere.

    jim

  • Rick Caird

    @wigwag

    That is somewhat misleading. Because 2001 was a bad year, the the 10 year number now excludes that year. If it were still included, the return would drop to 7%. Second, the loss to the Harvard endowment fund in 2008 was $11 billion dropping the value from $37 billion to $26 billion. The recent gains have brought it back to $32. billion.

  • EvilBuzzard

    Let’s see. Bernanke has the Fed pegged to ZIRP from now until 2014. They could hire Mr. Madoff to get them 7.5%. Oops, Ok, maybe not….

  • koblog

    Now, Dr. Mead, tell us the story of why those same LAUSD teachers that are driving California broke with their pension costs also achieve a remarkable 50% dropout rate.

    Talk about throwing good money after bad….

  • Otto Maddox

    Just wait until California voters approve three initiatives this November that raise taxes on the rich and the upper middle class. After that the only people living in California will be the welfare recipients and tax revenues will fall by 90%.

  • CatoRenasci

    California pays more and gets less from its employees than almost any state, and taxes its citizens and business more than any state.

    Other than the weather and the wine, no sane person would live there.

    I’m sure my Forty-Niner ancestors are rolling in their graves!

  • mac

    The scariest thing about all of this financial carnage coming is that everybody involved KNOWS it’s coming AND STILL WON’T ACT!

    I’ve lost track of the number of times I’ve written my Congressman and Senators telling them how disgusted I am with their fiscal mismanagement. The first rule of getting out of a hole is to stop digging but those of us shouting that at TPTB are simply being ignored. The kind of stupidity I’m seeing now at the Federal level makes me very, very worried for the future of this country. I think Prof. Mead’s vision of things ending well in the post-“Blue” period is far too optimistic. There will be more than one “Detroit” before we see the end of this mess.

  • Gary Kitts

    I am reminded of a math observation one of my statistics professors used at Indiana University: ‘Figures don’t lie, but liars figure.’ Seems about right, under the circumstances in California.

  • Jim.

    @22-

    I doubt the tax initiatives on the ballot will pass. CA is the land of Prop 13, after all.

    It will be fun watching this kicked back to the legislature.

  • WigWag

    “That is somewhat misleading. Because 2001 was a bad year, the the 10 year number now excludes that year. If it were still included, the return would drop to 7%. Second, the loss to the Harvard endowment fund in 2008 was $11 billion dropping the value from $37 billion to $26 billion. The recent gains have brought it back to $32. billion.” (Rick Caird; March 16, 2012 at 1:10 pm)

    You make a fair point, Rick, but to be fair, the market decline in 2001 was mostly the result of the attack on our country that took place on September 11th. That was obviously a highly unusual if not unique occurrence and I am not sure that including the stock market return that year really provides a better indicator of what types of returns can be anticipated in the long run.

  • http://www.libertasfilmmagazine.com/ Patricia

    Something eventually around 7% might be more accurate, but the actions Calpers is taking against cities who want out of the system are telling: Hotel Calpers, you can never check out.

    Actions speak louder than words.

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