California’s Bad Bet Makes JPMorgan’s Look Minor – Bloomberg

I was casually catching up on some blogs and found this gem at Bloomberg. This led me to the article, SB400 pension boost: uncanny forecast unheeded, on Wow! For a long time I have been wondering how we got into this mess with defined benefit pension plans and there is probably no better example of the problem than the largest pension fund in the United States, Calpers. From the SB400 article we can see in retrospect the legislators were overly optimistic about investment returns versus expenses. The legislators were expecting an annual average of 8.25 percent and they got a 3.1 percent return according to according to a Wilshire consultants report in March 2010. In the latest Calpers Fact at a Glance the latest ten year total return is listed at 5.7%. According to Calpers the assets went from $172.2 billion in 2000 to $237.5 billion in 2011. Although this looks good at first glance, the compounded rate is only 2.97%. It is pretty obvious that if you are spending like you are getting a 8.25% return and you are getting somewhere between 3.1% and 5.7% returns you are going to be in trouble. Then I tried to compare Calpers to the savings in my 401K. If my calculations are correct the average wealth saved per participant(237.5 billion/1.6 million participants) in Calpers is $148,000.  This doesn’t look too good but it is about the same number reported about Calpers in the pension plans article in Wikipedia. If we look at only the current retirees(536,234) this number goes up to $448,000. This is an ugly number for those people expecting something close to 50% of their salary over a 20 year retirement . Regardless of how you want to slice and dice these numbers to come up with the more precise actuarial values, there is too little money in the fund for the retirees’ benefits. Something has to give. The interesting part of examining the problems facing Calpers is that it reminds me of another bubble, residential real estate. Both bubbles received bipartisan support for overly optimistic outlooks about the future. In one case it is residential real estate appreciation and the other it is stock market performance. The irony is that the warning symptoms in both bubbles were apparent early on. That is where it takes the contributions from a lot of very smart people to turn a bad decision into a really big, bad decision. Finally the solution to these bubbles require very difficult political choices. So even though it is relatively easy to identify the cause of the bubbles, finding legislators willing to try and fix the consequences from bad decision making in the past is particularly difficult. It appears we have a decision making system in which bad decisions are too easy to make considering that it takes decades to undo their consequences. I can’t wait to see how the health care decisions turn out!

 Winking smile

I will leave you with what David Crane wrote in the Bloomberg article, California’s Bad Bet Makes JPMorgan’s Look Minor.

The pension deal was a stunning example of nondisclosure. The legislators didn’t inform the taxpayers that:

1. The state was on the hook for deficiencies if actual investment returns fall short of assumed investment returns.

2. The assumed investment returns implicitly forecast that the Dow Jones Industrial Average would reach about 25,000 by 2009 (it barely made it over 10,500 that year) and 28,000,000 by 2099.

3. Potential costs to the state were uncapped.

4. Members of the Calpers board had received campaign contributions from beneficiaries of the legislation.