Buck up, California, and learn from Rhode Island’s big pension reforms

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Rhode Island is a tiny state with just over one million people in one thousand square miles. California is 37 times more populous and many times that size. And yet, when it comes to public employee pension reform, the tiny state of Rhode Island is acting both bigger and bolder.

For years, Rhode Island lawmakers watched fearfully as the state’s required pension contributions, the second-fastest-growing line item in its budget, exploded, doubling from 2003 to 2010. Without significant reforms, the liability was on track to double again by 2013. Lawmakers knew that if the pension liability remained unchecked, it would severely limit funding for other budget priorities.

California finds itself on a similarly unsustainable path. Earlier this month, the California Teachers’ Retirement Board announced that the $152 billion pension fund faces a $64.5 billion shortfall over the next three decades, an increase of $8.5 billion from last year. To put this in perspective, California spent $64.4 billion on K-12 education during 2010-11. Unless California acts to make its pension system more sustainable, the K-12 education budget – along with other important government priorities – will likely be carved up to feed the ever-growing pension deficit.

In Rhode Island, despite the growing recognition of the pension problem, the political obstacles to fixing it were high: The state is heavily unionized, and Democrats have held the legislature since World War II. But faced with numbers that threatened to devour the rest of the state’s $8 billion budget, an unlikely alliance between Gov. Lincoln Chafee (elected as an Independent), State Treasurer Gina Raimondo, a Democrat, and legislative leaders who were getting pressure from their home-district unions to avoid making any significant changes to the pension system, proposed and pushed through historic pension reform, saving $4 billion.

While most states just patch over their pension problems by slashing new teacher pensions or trimming minor provisions, Rhode Island made painful but necessary changes to its whole system. The reform law raised the retirement age for most workers and created a hybrid plan that combines a 401(k)-style account with a smaller defined benefit. The law also suspended cost-of-living increases to retirees for five years; after that, retirees will receive increases only if the pension fund is healthy. These changes, crucially, apply to new, current, and retired employees. While the law likely faces a legal challenge, the lawmakers wrote the bill to deflect that. They ensured that the reforms reflected a critical financial situation, used a temporary adjustment, and sought to share the burden across current employees, retirees, and taxpayers – a formula that also worked for similar reform in Minnesota.

California should take Rhode Island’s example to heart. Last fall, Gov. Jerry Brown acknowledged California’s dire financial situation when he released a bold 12-point proposal for pension reform. The proposal includes fundamental fiscal reforms such as raising the retirement age for new employees from 55 to 67, enrolling new employees in a hybrid plan, and increasing employee contributions to one-half of total pension contributions. The Democratic-controlled Legislature, however, continues to punt on substantive reform, focusing instead on relatively insignificant measures like eliminating pensions for convicted felons.

But while the political will is lacking, public will is not. In a nonpartisan poll last December, 83 percent of Californians thought that public pension costs were a problem. Sixty-eight percent of adults and 64 percent of public employees favored switching to a 401(k)-style plan. And earlier this year, in a surprising piece of political one-upmanship, the Republicans in the Legislature announced a package of bills identical to Governor Brown’s proposal.

California’s Democrats are beginning to look dangerously out of touch with budget realities – and with their constituents. Bipartisan support is crucial for pension reform, if only because the bar for implementing the governor’s proposal is high. Since teachers’ pensions are not subject to local collective bargaining, it will take nothing short of an amendment to the state constitution – a high bar indeed.

While California should recognize the serious consequences of pension reform for state employees and retirees, the state must act to secure pensions and protect its budget. Rhode Island is small but played big. California is big, and it needs to stop playing small.

Sarah Rosenberg is a policy analyst at Education Sector. Her research interests include teacher quality, public employee pensions, school improvement, and rural education. Before graduating from Duke University with a master’s degree in public policy, she taught high school English in rural North Carolina as a Teach for America corps member.

15 Comments

  1. It is a shame that Sara Rosenberg wants to trample on both the US and California Constitution in her quest to shower Wall Street with teacher’s hard earned retirement funds.  Her advocacy for a 401K is a recipe for disaster for teachers, firefighters, nurses and police officers.
    70-years of California case law, with many cases on point, say that pension benefits are vested the first day a worker starts their job, period.  The state or local jurisdiction can’t unilaterally change those benefits because they want to spend on other items, it’s called keeping a promise.
    Sara’s Solution: Turn the retirement fund over to the very people that ripped off America, gambled with our money, set up shady trading schemes and reaped profit while most Americans suffered.  That’s right, send the money to Wall Street because they will look out for teachers…hogwash.
    What is needed in California and in local jurisdictions is a common set of principles that guide an honest dialogue about the issue.  Using real numbers and not inflated, bogus projections will frame the discussion.  Most public servants I know have already sacrificed and are willing to do more if it is an honest attempt at solving the pension issue.  The problem is that Wall Street has their eye on the money that will flow into their coffers, they have mouthpieces that spew their rhetoric (see above) and they have taken no responsibility for causing the vast majority of the problem by crashing the market and bringing our nation to its knees in 2008.
    What should be the replacement income for public workers that do not get social security?
    That is a key question that Sarah does not address and it should be the first place to start.
    The answer is not 401K’s or running to Wall Street, it should be honest and open negotiations.
     
     

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  2. There is no easy solution to the challenges faced by the Golden State, but Sarah Rosenberg is on the right track.  Our public servants are a heavier and heavier burden to the taxpayers of the state, and many of the most successful ones are leaving the state for place less taxing.  If changes are not made soon, we will end up with a lot of people riding in the wagon and no one left to pull the wagon.  All the screaming of public employee unions will not move it forward.

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  3. As usual, a short-term ‘solution’ to a long-term problem. This will ‘achieve’ only two things:
    - getting the cost of retirees off of our radars (even though that cost will still be waiting for us)
    - thus making the cost for dealing with their poverty status even more expensive when the time comes.
     
    To use your analogy hannah, that cart has a trailer and everyone you kick out of the cart ends up in the trailer. Standing to the side and refusing to pull the wagon and the trailer even though you can will not make it move either.  In fact, your analogy is maybe too fitting. Ironic that the goal is to end up pulling around an empty trailer in the name of ‘progress’. Sad.

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  4. 401k plans don’t make money appear out of the air. In fact, they guarantee a larger part of the money will go to Wall Street firms in New York, because management fees for those accounts are larger than the expenses that CalPERS or CalSTRS can achieve. There’s also a larger possibility that some of the money will evaporate due to unlucky timing.
     
    Raising the retirement age will likely increase the number of teachers who stay on as teachers when they’re becoming physically frail and maybe not up to the day-to-day rigor of the classroom. Some people will be hale and hearty and brilliant into their 70′s, and some will start to need regular medical appointments (during the week) in their 60′s. If teachers stay on and create administrative hassle, or if they go on disability, we haven’t achieved cost savings. If they end up on Medicaid and in other safety net programs, we haven’t achieved cost savings.
     
    Making the system more compatible with and portable to Social Security might ease the situation for some people who would like to change careers. That’s a change that might potentially be a net benefit for all stakeholders.
     
    Passing a bill isn’t necessarily the same as being successful at the end goal. I think you need a few years with it in effect to truly pass judgement on its effects.

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  5. That’s funny – 401k’s go to evil Wall St.  What do you think CalSTRS and CalPERS do with the money they have?  Stick it under a mattress?  CalPERS and CalSTRS invest the retirement money in Wall St. just like 401ks.  Mutual funds, hedge funds, vulture capital funds (like Bain Capital), funds of funds.  CalPERS spent $1 Billion (with a ‘B’) last year on outside management fees.  I can’t tell with CalSTRS because they do everything they can to obscure their numbers but it is tweedle-dum and tweedle-dee in everything with those two.
     
    And for corruption, take a look at what happened with CalPERS a few years ago.  It is really disgusting – several former CalPERS staff at the very highest level are under investigation, indictment, or in jail.

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  6. CalPERS expense ratio is 0.18%. Most 401K plans are more expensive even than ordinary mutual funds, and are over 1%, sometimes approaching 2%. The cheapest public mutual fund I’m aware of is the Vanguard S&P 500 index fund, which IIRC is at 0.19%.

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  7. @Tom Saggau:

    I’m not familiar enough with the California State Constitution, but how does the U.S. Constitution have anything to do with public worker pension funds?  Talk about a red herring…

    Your points are based on a number of fallacies:  first, that CalSTRS doesn’t “send the money to Wall Street”.  CalSTRS is a trust fund with a portfolio that includes stocks, bonds, real estate, and short-term investments.  It holds stock in 3800 companies, as of 2009.  Do you understand how a trust fund works?  They make investments hoping to make returns that will meet the required 7.75% rate of return.  Due to mismanagement STRS had only a 2.3% rate of return last year.  That is fiscally insolvent, when they don’t get the returns they need they depend on the money coming in from current teachers to make the payouts to retirees.  That is the definition of a Ponzi scheme.

    The system is fraught with moral hazard.  The state legislature can borrow from STRS to pay the bills, then raise taxes or take money from other programs to meet the payments as more teachers retire.  They guarantee payouts as a percentage of the final salary when really they should be based on the rate of return of the trust fund.  It’s not just bad for the tax-payers, it is also completely immoral to promise these benefits to teachers and then devise a system in which there will be no way to pay them back without bankrupting the state.  Social security is just as bad, probably worse.

    You also fail to understand the causes of the economic crisis.  Financial firms would not have been taking the risk on all the speculative hedge funding and credit default swaps if it weren’t for the guarantee by the Federal Reserve Bank to bail them out.  If they did, they would have gone bankrupt, and the market would have corrected itself faster and those responsible would have been punished instead of rewarded.  Through programs like TARP, the government was simply enabling firms like Leiman Bros. to do all those immoral risky activities.  It is cronyism in the government that is at fault.

    Retirement benefits are not and should never be a guarantee of future income.  They are a protection against the risk of the inability to gain employment due to age.  The best retirement plan is to have options and diversify investments.  CalSTRS and Social Security are monopolies that people are forced to pay into that provide a false sense of security and entitlement and are cruelly mismanaged to the detriment, not only of the beneficiaries, but of all tax-payers.  They should be replaced with individualized plans with private firms that state governments cannot dip into.  If state employees want the employers to help them set that up, that is fine.

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  8. Rhode island, huh? I assume astute politicians are looking at Wisconsin, and the various re-call initiatives, with more interest.
     
    Reading some responses makes me wonder if Ayn Rand is alive somewhere and sharing a condo with Elvis. Unfortunate that we get so many rehashes of Ayn’s social-Darwinism and so little good rock-and roll.
     
    As previously stated, it makes little sense to look at the fiscal well being of PERS or STRS while still in an economic trough created by Wall Street’s efforts to relive the Gilded Age.
     
    Until real, legally enforceable, reforms come to the financial and investment sectors it is plain silly to suggest public employees trade significant parts of their current defined benefit pension systems for defined contribution, or “hybrid” systems. It would be like taking your retirement savings to Vegas to throw down on double-zero. Then again, Vegas is likely more honest.
     
    Now we get to all the squawking about what’s not available in the private sector.: that being defined benefit programs. Which brings up the real question: why doesn’t the private sector have pensions anymore? It’s not like we have too many people with secure retirements. Ever see the profit margins of modern corporations? Those are dollars that should be going to to wages and retirees. The private sector workers allowed their unions to be eliminated  and, as a consequence,  their secure retirements were eliminated. The 1% took their wealth right out of the wages and pensions of the 99%. Get your unions back and get your secure retirements back.

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  9. When a weather forecaster predicts rain on Saturday, they are *NOT* saying “I like rain”, they are *not* saying “I don’t like you so I want to spoil your picnic,” they are *not* saying “Since *I* can’t have a picnic on Saturday I don’t want *YOU* to have a picnic” (picnic envy).  What they *are* saying is that the forces of nature, physics, and atmospheric conditions make it extremely likely that there will be rain on Saturday, so at least have alternative plans for your picnic.
     
    Mr Ravani is in the position of saying (like the good union man that he is) “You worked for your picnic, and all these doomsayers are really anti-union and want to take it away from you.”  Nope – we’re simply saying the money won’t be there for the picnic.
     
    Do.  The.  Math.    The book “DOW 36,000″ was a myth.   Pension bill SB400 was based on myths like that.  For the pension funds to be solvent the DOW would have to be at about 29,000 right now.  The DOW is 13,000 now – about the same as it was in the year 2000 and the NASDAQ is about half what it was then.  At what point do you face the reality of compound interest?
     
    The union is in denial.  At least I hope they are in denial because the alternative is that they want everyone to keep going along the current course long enough for the union leaders (generally older workers closer to retirement) to get their retirement and then (when the money runs out) leave the average teacher holding the bag and having their pensions cut.  I doubt Mr. Ravani is so duplicitous and Byzantine, though maybe the people that write his “talking points” are.
     
    This is not about the corruption of some on Wall Street, any more than it is about the corruption of the leaders of CalPERS .  Check out the report on the corruption at CalPERS here:


    http://www.calpers.ca.gov/eip-docs/about/board-cal-agenda/agendas/full/201103/srrr.pdf
     
    From that report: “CalPERS Chief Executive Officer Fred Buenrostro and placement agent and former Board member Alfred Villalobos…are now defendants in a law enforcement action brought by the California Attorney General in May 2010.”
     
    There are some eye-popping details about the misdirection of funds to “Friends of Fred”, special Vegas privileges, and about the huge placement fees and forgery coming from the top.  Wherever there is a lot of money floating around, there will be crooks stealing it.  Best to keep track of your own money, for your own safety.
     
    A retirement based on the assumption of phenomenal growth (like the two recent bubbles) when everyone (IMF, the Federal Reserve, the US Treasury) says we will have a long period of very slow to no growth is doomed to disappointment.
     
    Mr. Ravani is saying earthquakes can’t happen.  I’m saying be prepared, because they can.

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  10. From the Cleveland Federal Reserve:
    http://www.clevelandfed.org/Forefront/2012/winter/ff_2012_winter_08.cfm
    “Many funds will require significant reforms to reduce underfunding levels, with painful new contributions from employers and employees. Over the long term, a stronger, steadier economy would help a lot by supporting higher asset returns. Meanwhile, an imminent collapse of several large funds, accompanied by a shock to the financial system, remains improbable—though not impossible.
    “Over the longer term, the current low-interest-rate environment may be cause for concern. Fund managers will struggle to achieve 8 percent yields without shifting their portfolio composition toward higher-yielding assets, which are inherently riskier. Managers’ “reach for yield,” if practiced widely, would make pension plan sustainability particularly vulnerable to another negative shock to equity prices.”
     
    Translation from FedSpeak to to human speak – “Reform or die – another crash and pensions are kaput.”

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  11. Michael, sure sounds to me like you dont like picnics..   :-)
     
    I think the question of corruption is a lot more nuanced than you make it out to be. Even if the allegations turn out to be true, the alleged behaviors of any CalPERS officials clearly did not cause the world’s financial collapse. They are probably equally irrelevant to the question of CalPERS solvency. Personally, I see that as an important distinction. That’s obviously not to try to justify any behavior, just to clarify the reason the concept of ‘corruption’ is brought up.
     
    I also question the singular role of the Dow. If Im not mistaken, at one point, a huge portion of CalPERS losses were as a result of the stagnation/collapse of the real estate market. Those two things are obviously related, but they are not the same thing. I also think its misleading to ignore the impact of pension contribution holidays, which in many cases were likely a side-effect of some of the return assumptions to which you refer.

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