CalPERS must make their 7.75% annual growth rate or taxpayers must make up the unfunded difference. The CalPERS funded level as of June 30, 2011, for different hypothetical returns are:
7.75% return = 74% funded => $86B unfunded = $7K per household debt
7.1% return = 67% funded => $118B unfunded = $9.7K per household debt
6.2% return = 58% funded =>$170B unfunded = $14K per household debt
4.5% return = 45% funded => $289B unfunded = $24K per household debt
(from page 19 of the "Nation Report")
For comparison, Governor Brown's proposed 2012 CA state budget is $92.6B.
To have even a 75% chance of fully meeting its obligations, CalPERS would have to make 12.5% return on investments Every Year for the next 16 years. This is absolutely inconceivable. Not going to happen. Beyond the realm of possibility. In the last 30 years CalPERS has averaged 7.1% - slightly less than the S&P500, with dividends reinvested.
CalPERS widely publicized their 21% return for one year but to see how pathetically inadequate this is, you need to consider how compound interest works against you if you have a loss.
Consider the great crash of 2008. For every $100 invested, CalPERS was supposed to end up with $107.75 had they made their 7.75% annual return. Instead, CalPERS lost 23% and that $100 ended up as $77. Just to get that $100 back to its original value of $100 they had to grow that $77 by 30% (!)
But it was actually worse - much worse. The year after that 23% loss, they were supposed to have grown that $107.75 (that they didn't make but were supposed to) to $116.10 (1.0775 * $107.75). To get that $116.10 from $77 they needed a 1 year return of *51%* (!!??). CalPERS has never, ever, made 51% return on their investments in a year and they never will.
They are so deep in the hole now they will never get out and the question is only how much will taxpayers get stuck with to make up CalPERS unfunded liability.
(to be continued)
Dr. Nation's report is available here:
http://siepr.stanford.edu/system/files/shared/Nation%20Statewide%20Report%20v081.pdf
Governor Brown's 2012 Budget summary is here:
http://www.ebudget.ca.gov/pdf/BudgetSummary/FullBudgetSummary.pdf
Sunday, January 8, 2012
Saturday, January 7, 2012
If CalPERS can't make their numbers... (Part I)
A lot hinges on whether CalPERS makes that 7.75% rate of return they promise. It's like a mortgage in that a small change in the % return on CalPERS investments makes an enormous difference in how much is owed. If CalPERS can't make 7.75% (it's made 5.5% for the last 10 years), then retirement liabilities will keep mounting as CalPERS continually fails to make its targets. Tax money will have to make up whatever the gap is between the projected earnings and the actual earnings, tax money that would otherwise go to schools, roads, parks, aid to the elderly and poor, etc., etc.
What is the likelihood of making that 7.75%? Less than 1 in 5, based on the average stock market returns from 1900 to 1999 (excluding the two recent big bubbles and their collapse). Dr. Joe Nation (former Democratic legislator from San Rafael) in a Stanford Economic Institute for Economic Policy Research report recently calculated the probabilities of the 3 largest retirement funds making their targets and what happens if they don't. Looking at stock market returns over the 100 years 1900-1999 he found the average return on investments is 6.2%. Meaning CalPERS has a 50% chance of making that. The higher the return required, the lower the probability of making it. 7.75% has an 18% chance.
At that 6.2% rate, this means state retirement funds are currently underfunded by 3 times the current estimate based on a 7.75% return. A powerful testament to the multiplying power of compound interest. This translates into triple the pension liability, and the annual payments to make up that gap tripling from the current $4.8 Billion to $14.6 Billion. That is larger than Brown's proposed 2012 budget for the UC, CSU, and all the Community Colleges in CA ($9.8B), bigger than the entire prison budget ($10.7B), nearly 3 times the CA budget for "Natural Resources" and "Environmental Protection" ($5B).
The assumed return on investments of 7.75% was set by the CalPERS governing board. Of the 13 current board members, 11 are also beneficiaries of the CalPERS retirement plans giving them a vested interest in keeping the projected actuarial assumptions high so that benefits can appear to be well funded. No professional or technical proficiencies are required to be a board member.
(To be continued)
Dr. Nation's report is available here:
http://siepr.stanford.edu/system/files/shared/Nation%20Statewide%20Report%20v081.pdf
Governor Brown's 2012 Budget is here:
http://documents.latimes.com/californias-new-budget-plan/
What is the likelihood of making that 7.75%? Less than 1 in 5, based on the average stock market returns from 1900 to 1999 (excluding the two recent big bubbles and their collapse). Dr. Joe Nation (former Democratic legislator from San Rafael) in a Stanford Economic Institute for Economic Policy Research report recently calculated the probabilities of the 3 largest retirement funds making their targets and what happens if they don't. Looking at stock market returns over the 100 years 1900-1999 he found the average return on investments is 6.2%. Meaning CalPERS has a 50% chance of making that. The higher the return required, the lower the probability of making it. 7.75% has an 18% chance.
At that 6.2% rate, this means state retirement funds are currently underfunded by 3 times the current estimate based on a 7.75% return. A powerful testament to the multiplying power of compound interest. This translates into triple the pension liability, and the annual payments to make up that gap tripling from the current $4.8 Billion to $14.6 Billion. That is larger than Brown's proposed 2012 budget for the UC, CSU, and all the Community Colleges in CA ($9.8B), bigger than the entire prison budget ($10.7B), nearly 3 times the CA budget for "Natural Resources" and "Environmental Protection" ($5B).
The assumed return on investments of 7.75% was set by the CalPERS governing board. Of the 13 current board members, 11 are also beneficiaries of the CalPERS retirement plans giving them a vested interest in keeping the projected actuarial assumptions high so that benefits can appear to be well funded. No professional or technical proficiencies are required to be a board member.
(To be continued)
Dr. Nation's report is available here:
http://siepr.stanford.edu/system/files/shared/Nation%20Statewide%20Report%20v081.pdf
Governor Brown's 2012 Budget is here:
http://documents.latimes.com/californias-new-budget-plan/
Monday, January 2, 2012
CalPERS: A bunch of clowns or what? Part 3
So far we've looked at CalPERS incompetence and corruption. But they do have new management since then. In "Cleaning Up CalPERS" by Robinson and Marois, 10/2010, CalPERS missteps are described in some detail and the new head, Joe Dear, is quoted saying he has "7.75% burned in his brain" as the goal he has to reach to keep CalPERS on track. That was in October, 2010. So it's a year later - how are they doing now? According to CalPERS their total returns for the last fiscal year ending in 9/30/2011 were 7.0%, for the last 3 years they were 2.2%, for the last 5 years 1.0%, and for the last 10 years 5.5%. The figures before 2011 don't subtract the hefty fees they were paying so they are smaller than they appear. They are not making the 7.75% and there is no reason to suspect that they will in the future.
From the above article: "'Calpers should retreat from making high-risk bets and accept that it won’t outperform the Standard & Poor’s 500 Index and other key benchmarks over the long haul,' says Frederick Rowe, the former chairman of the Texas Pension Review Board" "'It’s folly to think a $200 billion pension fund is going to do better than the economy,' says Rowe ... 'To move out on the risk spectrum to beat the market is imprudent; it’s like running your retirement from Las Vegas.'"
Same article: "As a group, state retirement systems earned a median 3.4 percent annualized return for the 10 years ended on June 30, [2010] ... That about matches the performance of U.S. Treasury bonds."
As CalPERS continues failing to make 7.75% it will fall further and further behind, and it's unfunded liability will grow greater and greater. At some point reality will set in and the actuarial assumption of 7.75% will be AGAIN revised downwards. At that point, the state and employers like Sunnyvale will be hit with a hugely bigger bill in order to make up the unfunded liability.
Here's how that works: Say you invest $100 hoping for 7.75%/year to get $445 in 20 years. If you get 5.5% (like CalPERS), you will have $171 after 10 years. In order to get that $445 you wanted, in the remaining 10 years you need to earn 10% annually. If instead you continue to average 5.5% you will have $292 at the end of 20 years. An unfunded liability of $153 = 34% of the expected return. Except that the sums are waaayy bigger.
This is one of those things that everyone knows but doesn't want to admit. To admit this would mean that every city, and county would have to start NOW making up that unfunded liability when they all feel stretched as it is and are dipping into reserves. Pretending that CalPERS will get 7.75% keeps costs low now - and later?? Later a miracle happens. People go around quoting a single good return from a biased source (like CalPERS) when everything around them is screaming "slooowww growth". Where is that miracle going to come from? Europe (the continent voted most likely to go bankrupt)? US Manufacturing rebounds? (what US manufacturing?) Housing rebounds? (Defaults are increasing in number, house prices are still dropping.) China? (They propped up their economy in 2008 by starting a housing bubble - which is now about to crash, and burn taking much of the world's economy with it).
When that unfunded liability comes due in all it's glory, hiring freezes will become massive layoffs, and bankruptcy will start to look like a good option. With bankruptcy will come a further decrease in tax revenue since no one will be particularly eager to set up shop or buy a house in a bankrupt city which can offer no services.
It would be far better to get out of CalPERS now while the "getting is (relatively) good" and have all city employees be put back on Social Security with a 401K like most people in the US. Better for the taxpayers and better for the employees.
From the above article: "'Calpers should retreat from making high-risk bets and accept that it won’t outperform the Standard & Poor’s 500 Index and other key benchmarks over the long haul,' says Frederick Rowe, the former chairman of the Texas Pension Review Board" "'It’s folly to think a $200 billion pension fund is going to do better than the economy,' says Rowe ... 'To move out on the risk spectrum to beat the market is imprudent; it’s like running your retirement from Las Vegas.'"
Same article: "As a group, state retirement systems earned a median 3.4 percent annualized return for the 10 years ended on June 30, [2010] ... That about matches the performance of U.S. Treasury bonds."
As CalPERS continues failing to make 7.75% it will fall further and further behind, and it's unfunded liability will grow greater and greater. At some point reality will set in and the actuarial assumption of 7.75% will be AGAIN revised downwards. At that point, the state and employers like Sunnyvale will be hit with a hugely bigger bill in order to make up the unfunded liability.
Here's how that works: Say you invest $100 hoping for 7.75%/year to get $445 in 20 years. If you get 5.5% (like CalPERS), you will have $171 after 10 years. In order to get that $445 you wanted, in the remaining 10 years you need to earn 10% annually. If instead you continue to average 5.5% you will have $292 at the end of 20 years. An unfunded liability of $153 = 34% of the expected return. Except that the sums are waaayy bigger.
This is one of those things that everyone knows but doesn't want to admit. To admit this would mean that every city, and county would have to start NOW making up that unfunded liability when they all feel stretched as it is and are dipping into reserves. Pretending that CalPERS will get 7.75% keeps costs low now - and later?? Later a miracle happens. People go around quoting a single good return from a biased source (like CalPERS) when everything around them is screaming "slooowww growth". Where is that miracle going to come from? Europe (the continent voted most likely to go bankrupt)? US Manufacturing rebounds? (what US manufacturing?) Housing rebounds? (Defaults are increasing in number, house prices are still dropping.) China? (They propped up their economy in 2008 by starting a housing bubble - which is now about to crash, and burn taking much of the world's economy with it).
When that unfunded liability comes due in all it's glory, hiring freezes will become massive layoffs, and bankruptcy will start to look like a good option. With bankruptcy will come a further decrease in tax revenue since no one will be particularly eager to set up shop or buy a house in a bankrupt city which can offer no services.
It would be far better to get out of CalPERS now while the "getting is (relatively) good" and have all city employees be put back on Social Security with a 401K like most people in the US. Better for the taxpayers and better for the employees.
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