Much of the focus on government debt over the past few years has revolved around the federal government. No doubt, this is a stunningly large amount. Yet the government has the ability to finance this debt through the U.S. Treasury and Federal Reserve with a buffet of choices. You have direct bailouts to Wall Street, quantitative easing, and systematically dismantling the U.S. dollar. But one issue that is rising to the top is that of state and local government debt. States do not have the ability to print money at the whim of any central banker. And the state and local government debt market is up to a whopping $2.3 trillion. At this point, trillion is the new billion.

Let us examine the growth of this debt over the last forty years:

The growth in local government debt has exploded since the 1970s. We went from $295 billion in 1968 to $2.3 trillion today. But as Greece is demonstrating, there is such a thing as having too much debt and at a certain point the markets no longer have an appetite for so much borrowing. Average Americans probably have a hard time examining the large numbers being thrown around. Yet state and local governments are now finding a hard time balancing their budgets. In many cases, the ability to balance their budget goes in direct conflict with paying out pension distributions. Or in many cases states need to raise taxes or cut services.

Wall Street enjoys exploiting this fact because they actually loot the public sufficiently with golden parachutes and ridiculous bonuses that they never need any sort of pension. Yet the truth is, many of the gold plated pensions are just another side of the Wall Street mentality coin. That coin relies on having others pay for your bailout or extended retirement.

Now Wall Street has implemented the biggest transfer of wealth in history with the $13 trillion in bailouts and backstops. But many pension funds also bought into what Wall Street was pushing. Let us examine the California state pension systems.

California Pensions – $500 Billion Underfunded

The Stanford Institute for Economic Policy Research issued a stunning report on the three largest pension systems in California. The report was titled Going for Broke and what we find is a rather daunting mountain that California has to climb if it seeks to remedy their pension system.

Let us look at the three largest systems:

In total these cover 2.6 million of California state workers. These are CalPERS (the largest), CalSTRS, and UCRS. But if you look at the funds performance through the crisis, all of the funds saw 23 to 25 percent declines. These declines only exacerbate the shortfall of the system.

The odds of shortfalls are virtually assured for all systems. We are now entering a stage where many workers will be retiring and drawing into the system. Expectations for deficits are large:

Part of this stems from the notion that markets will always return a standard rate. As we have seen with the massive market volatility, markets are largely unpredictable especially when they become casinos for the wealthy.

As the report finds, these funds do not have the flexibility required in an unpredictable market:

“A public employee’s pension constitutes an element of compensation, and a vested contractual right to pension benefits accrues upon acceptance of employment. Such a pension right may not be destroyed, once vested, without impairing a contractual obligation of the employing public entity.”

It becomes a matter of law to pay even if the economy has rendered a new reality. As Greece is showing, having very early retirement rates with generous packages is not supportable with a younger generation that isn’t having larger families. The math doesn’t work but good luck changing that. Some will argue that people contribute into these systems. This is true but not anywhere to cover the actual payout over time:

In other words, there is a shortfall of coverage and a market decline only pushes the problem to the surface for all to see:

“As mentioned earlier, the pressing nature of California pension shortfalls is due in part to the losses CalPERS, CalSTRS, and UCRS sustained in the mar­kets over the past 18 months. CalPERS expects an average annual investment return of 7.75 percent, CalSTRS targets 8.00 percent, and UCRS expects 7.50 percent.”

Those expected rates of return are simply too optimistic. These funds are expecting 7.5 to 8 percent annual returns in a market that is giving 0 percent rates to savings accounts and 4 percent for 30 year fixed government debt. Instead of realigning to this low yield environment fund managers went all in to the market and gambled on Wall Street:

It is amazing that many fund managers look at the above as “safe” but it is anything but safe if you are losing 23 percent. Part of the bets were flat out risky:

“(LA Times) SACRAMENTO — The value of residential real estate investments owned by the country’s largest public pension fund has plummeted 35% — a paper loss of $3.3 billion for current workers, retirees and their state and local government employers. The California Public Employees’ Retirement System reported Wednesday that in the year ended June 30 its real estate portfolio declined to $6.08 billion from $9.36 billion, based on 461 independent appraisals of its investments in 288,000 housing units across the country.”

Housing, both residential and commercial has not recovered. So these losses are still likely part of the funds new reality. The massive rise in equities probably has helped but it is a long way from that 7.5 to 8 percent annual return:

Past performance is no indication of future returns especially when more and more retirees are going to draw from the system:

“In 1999 California passed Senate Bill 400 (SB400), substantially raising benefit factors and lowering retirement ages for public employees (see Table 3). Based on a National Institute on Retirement Security report, average monthly public pension benefits in California were $2,008 in 2006, the eighth highest nationwide.”

Now that $2,008 monthly benefit does not factor in additional healthcare benefits which cost a lot and are also provided. Just do the quick math, let us assume someone retires at 55 and lives to 85 and receives that $2,008 monthly benefit:

$2,008 x 12 = $48,000 $24,096 x 30 = $722,880 in total paid out

We are also assuming no COLA adjustments which some of these plans have. We aren’t adding the added healthcare cost which an older retiree will be using up. Something tells me that a state worker did not even come close to putting in $722,880 over their working career. And you wonder why these pension funds combined are projected to have a $500 billion shortfall? And good luck if the stock market turns lower or simply remains stagnant for years. California is only one example of many.

The paper lays out a few suggestions including higher contributions, a hybrid 401k/403b system, and safer investments but also a tiered system. In reality, Wall Street has not wanted to deal with reality and has used the taxpayer as a bailout for their wealth protection. Now that taxes are being talked about including a value added tax (VAT) people are getting angry. You didn’t think bailing out Wall Street was free? The same reality will hit the state pension systems. Younger workers are going to enter a tiered system where they have to pay out more with no future guarantee while they watch older workers take on funds that they will never see. I’m sure that is politically going to go over well.

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