MOORLACH UPDATE — Obtain Prepayment Sizzle — May 17, 2017

The Governor’s proposal to borrow funds from a surplus account to prepay CalPERS is garnering plenty of reactions (also see MOORLACH UPDATE — SB 671/Prepayment — May 14, 2017 may 14, 2017 john moorlach). The first piece below is mine, at the behest of Fox & Hounds, which also appears in the Record Searchlight out of Redding. The second piece, from the California Policy Center, would be a good counter.

The initial analyses of the Governor’s proposal all express a healthy skepticism of this being done right. The Legislative Analyst’s Office put out a report on the Governor’s proposal and suggests that the Legislature give their due process and not rush to pass this with the budget package on June 15. This is consistent with my encouragement of the Governor to negotiate a solid deal with CalPERS and that the Legislature should be a part of the discussion. I want to fix pensions. And on this issue, I prefer a “Yes, but” approach to simply saying “No.”

I have found it awkward when colleagues on the other side of the aisle speak ill of President Ronald Reagan whenever he is honored in a Senate Resolution. Consequently, I stayed politely quiet when President Barack Obama was honored and I even voted for the bill. My votes usually are not called out, but the Pasadena Star-News did in the third piece below.

In the fourth and final piece, the Daily Pilot hints at a potential third run for Costa Mesa City Council, this time for a newly created Mayor’s seat, by someone who has already dedicated sixteen years of his life to this community. It caught me by surprise, as no one, including the former Mayor, discussed the possibility with me. The fun life continues.

Prepaying on CalPERS Massive Unfunded Liabilities

John Moorlach

By John MoorlachState Senator representing the 37th Senate District

Governor Brown wants to prepay the California Public Employees Retirement System (CalPERS) with $6 billion beyond what most had expected.

The source of the funds is the Surplus Money Investment Fund. Don’t ask me why a state with a $169 billion unrestricted net deficit has some $50 billion in a low interest bearing account with such an odd title. Perhaps the University of California Chancellor can explain how her system and the state can better pull these things off?

Also, don’t ask me why the timing is so odd. The Legislature just approved an annual $5.2 billion gas and auto tax increase, and now the Governor has $6 billion for non-road repair expenditures?

Despite these concerns and anxieties, I like the proposal. It’s about time that the Governor got serious about the state’s spiraling unfunded defined benefit liabilities, but, I would postulate that this proposal needs a little more sizzle to make it an even more interesting opportunity.

Let’s address the cash flow components of this idea. The state currently has funds that are earning less than 1 percent per year. Paying down a 7.5 percent loan would provide a bigger bang for the buck. The spread of more than 6.5 percent will provide significant savings to the state’s general fund.

It’s true that whatever is deposited into a defined benefit pension plan by a plan sponsor is irretrievable. That is, it’s not a loan to CalPERS, it’s a payment. Once it goes in, the state cannot ask for it back. But, this will be a prepayment. Consequently, should the state have a cash flow emergency, it could simply stop making the regularly scheduled payments into CalPERS and slowly accumulate back this advancement.

The upside? The state gets to pay down its liabilities sooner, which will have the potential of reducing the annual required contributions in future years. The state obtains the 6.5 percent spread in savings. CalPERS can allocate the funding to meet its own cash flow needs and reduce transaction costs by doing it in bulk. The state wins. The taxpayers will win. And CalPERS wins.

What could go wrong? For the answer to this question, you should ask former New Jersey Governor Christine Todd Whitman. In 1997, she issued $3.4 billion in pension obligation bonds. This is a risky technique that converts a soft debt to the pension system into a hard debt to bondholders.

The idea is similar to Governor Brown’s proposal, in that the cost of the money is cheaper than the current 7.5 percent investment assumption rate of the plan. In the late 1990s, this may have been a brilliant move. But, when the “” boom turned to bust, pension plans lost a significant amount of plan funds invested in the internet-related industries.

The big risk the Governor will have to face is the possibility that the investment markets may tank after making the contribution prepayment. Remember, if you lose 50 percent on your investments this year, you have to earn 100 percent next year just to break even on your principal. Will Rogers put it best, “I am not so much concerned with the return on capital as I am with the return of capital.”

It’s not a good idea to time the market. It’s better to dollar-cost average, which means investing the same amount at regular intervals over time.

We cannot see the future. It’s obvious that CalPERS cannot, based on their recent repositioning out of certain equity markets last September, which has cost it more than $900 million in lost appreciation. It makes one wonder if they were concerned about Hillary Clinton winning the November election. Had they assumed that Donald Trump was going to win, and held firm, they would have earned nearly 17 percent on equities since the Presidential Election.

Had Governor Brown recommended this prepayment move last year, he would be a hero right now. So, he has to determine how serious he is about claiming a recession is around the corner.

To make the proposal more interesting, Governor Brown should ask the Board of CalPERS what type of incentive they will give the state for the prepayment. CalPERS will benefit from the large influx and should provide at least a 3.75 percent reduction on the actuarially calculated required contribution. This would provide a $225 million savings to the state, using the $6 billion figure, thus providing some sizzle.

Investing is not difficult, but it is also not for the faint of heart. You have to live with your decisions. Trust me, I managed a $7 billion portfolio and sat on the Board of one of the nation’s largest public employee pension systems.

While serving as the Treasurer of Orange County, I assisted in constructing a prepayment vehicle for the pension system. Instead of 26 regular payments during the year on biweekly pay days, the County paid the full amount up front, less the negotiated incentive. The County borrowed the funds, at an interest rate lower than the investment assumption rate of the retirement system and has realized some $100 million in net present value savings over the last 11 years.

How did the County do with its investments over this time period, with the change in the regular payment intervals? It actually out-performed what would have occurred under the normal protocol.

We should always remember that past performance is not an assurance that future performance will be the same or better. But, prepaying CalPERS’s massive obligations is something that should be strongly encouraged. Pension plan debt is an expensive liability in the current low-interest rate environment. Consequently, public employee retirement stakeholders should enter into a good debate on this proposal.

I see nearly $400 million in opportunity savings by taking low to no earning funds and paying down a 7.5 percent loan. I see the plan more efficiently investing the $6 billion. And I see lower plan contributions as the unfunded actuarial accrued liability is reduced. Those are strong arguments.

I would encourage the Governor to move forward with his proposal. But, I would also tell him to get more sizzle to the deal by negotiating with the CalPERS Board before writing the check. And, if he is concerned about market volatility, he may want to encourage the Board to consider allocating the funds towards fixed income investments that provide income commensurate with the investment assumption rate.

If the Governor is really serious about the state’s pension plan liabilities, he would figure out how to increase the annual contributions to CalPERS by $6 billion every year, even if it has to come out of the general fund. Doing anything else is only deluding everyone about the seriousness of this rapidly growing and all-consuming obligation.

Thanks for thinking outside the box, Governor. Now, take it to the next level.

Forget fiscal responsibility: Jerry Brown embraces pension shell game

Steven Greenhut

The Jerry Brown administration last week released its revised May budget and, lo and behold, it has finally decided to (kind of, sort of) tackle the state’s massive and growing level of unfunded liabilities – i.e., the hundreds of billions of dollars in taxpayer-backed debt to fund retirement promises made to the state’s government employees.

It’s best to curb our enthusiasm, however. The governor didn’t have much of a choice. This was the first state budget that is compliant with new accounting standards established by the Governmental Accounting Standards Board that requires states to more properly account for retiree medical and benefits beyond pensions.

Because of those new standards and low investment returns, the state’s unfunded liabilities (including the University of California retirement system) soared by an astounding 22 percent since last year. But even this new estimate of $279 billion in liabilities is on the optimistic side. Some credible estimates pin California state and local governments’ pension liabilities at nearly $1 trillion, based on more realistic rate-of-return predictions.

The pension system invites eyes-glazing-over debates about the size of the liability. That’s because debts are calculated on guesswork about future investment earnings. The California Public Employees’ Retirement System (CalPERS) recently voted to lower its predicted rates from 7.5 percent a year to 7 percent. The lower the predicted rate, the higher the liabilities, which is why CalPERS and the state’s unions are so bullish on Wall Street.

CalPERS’ latest investment returns were below 1 percent, but the agency insists there’s nothing to worry about and no need to do the unthinkable (reduce future benefit accruals for current employees). That’s the same CalPERS, of course, that in 1999 assured the Legislature that a 50-percent retroactive pension increase wouldn’t cost taxpayers a dime. I suppose CalPERS was right. It didn’t cost a dime, although it did cost many billions of dollars. Their returns were then yielding 13.5 percent a year, and CalPERS figured the heyday would go on forever.

The other reason to be skeptical of the Brown administration’s commitment to solving the problem can be found in the May revise itself. The budget “includes a one‑time $6 billion supplemental payment” to CalPERS, according to the Finance Department. “This action effectively doubles the state’s annual payment and will mitigate the impact of increasing pension contributions due to the state’s large unfunded liabilities.”

Where is the extra $6 billion coming from in a budget that supposedly is so pinched that the governor recently signed a law raising annual transportation taxes by $5.2 billion?

Simple. The state is borrowing the money to pre-pay some of its debt. “The additional $6 billion pension payment will be funded through a loan from the Surplus Money Investment Fund,” according to the budget summary. “Although the loan will incur interest costs (approximately $1 billion over the life of the loan), actuarial calculations indicate that the additional pension payment will yield net savings of $11 billion over the next 20 years.”

In other words, the state will be borrowing the money at fairly low interest rates and then investing the money and earning, it hopes, higher rates. The difference will help pay down some of those retirement debts. Even the well-known pension reformer, Sen. John Moorlach, R-Costa Mesa, lauded the administration for embracing that idea.

But it’s something of a shell game. It should work out well, provided the markets do as well as the state expects. In doing this, however, the state is taking out new debt that will need to be repaid. There’s no free money here. A number of localities have embraced a similar strategy with pension-obligation bonds, which are a form of arbitrage, in which the government is borrowing money and betting on future market returns.

This gimmick is similar to the one people will embrace in their personal lives. Are those credit-card debts crushing the family budget? Then borrow money from the home-equity line of credit at 5 percent and use it to pay down the 10-percent credit card loans. It makes sense, but it doesn’t deal with the real problem of excessive consumer spending.

“This is the Band-Aid,” said Dan Pellissier, a former aide to Gov. Arnold Schwarzenegger and well-known state pension reformer. “The surgery everyone is trying to avoid is on the California Rule – changing the benefits public employees receive in the future.”

When it comes to pensions, everything comes back to that “rule,” which isn’t a rule but a series of court precedents going back to the 1950s. In the private sector, companies may reduce pension benefits for their employees in the future. An employee can be told that, starting tomorrow, she will accrue pension benefits at a lower rate. The California Rule mandates that public employees, by contrast, can never have their benefit levels reduced.

That limits options for reform. In 2012, Gov. Brown signed into a law the Public Employees’ Pension Reform Act (PEPRA), which promised to address the pension-debt problem by primarily reducing benefits for newly hired employees. A reform that affects new hires will reduce contribution rates but won’t make an enormous difference until they start retiring.

“Gov. Jerry Brown’s attempt at pension reform has failed,” opined Dan Borenstein, in a recent East Bay Times column. The reason: the rapidly growing pension debt. “The shortfall for California’s three statewide retirement systems has increased about 36 percent. Add in local pension systems and the total debt has reached at least $374 billion. That works out to about $29,000 per household.”

CalPERS rebutted Borenstein by arguing that he “greatly oversimplifies and needlessly discounts the real impact that Governor Brown’s pension reform has had since it took effect in January 2013.” The pension fund insists, “PEPRA already is bending the pension cost curve – and will keep doing so with greater impact every year going forward.”

Yet the growing liabilities and the administration’s latest budget plan suggest that whatever minimal cost savings PEPRA is achieving aren’t nearly enough. Of course, union-controlled CalPERS’ goal isn’t protecting taxpayers or the state general fund – it is to enhance the benefits of the state workers whose pensions it manages.

As Calpensions explained, that $6 billion of borrowed money doubles the amount of general-fund dollars that the state is paying to deal with pension obligations. Meanwhile, as the state borrows money to pay that tab, it raises taxes to fund transportation. If Brown and the Legislature had trimmed pension costs, it would not have needed to raise gas taxes and the vehicle license fee. And the problem reverberates for local governments, too.

The May revise also showcased the same old issue with the administration’s priorities. Los Angeles Times columnist George Skelton noted that “Brown’s entertaining rhetoric itself made him sound, as usual, like a skinflint, a penny-pinching scold. But the introductory document could have been written by Bernie Sanders, if not Depression-era Socialist Upton Sinclair, the losing 1934 Democratic candidate for governor who ran on the slogan ‘End Poverty in California.’”

The budget championed myriad big-spending programs, including higher pay for public employees. So the state has been spending like crazy, but can’t manage to deal with its pension problem – at least not without borrowing money to temporarily paper over its growing debt.

All these games are about avoiding dealing with the obvious fact that California’s public-employee pensions are absurdly generous, filled with costly and anger-inducing features (spiking, double-dipping, liberal disability retirements, etc.) and unsustainable.

In 2011, the state’s official watchdog agency, the Little Hoover Commission, argued to the governor that “Public agencies must have the flexibility and authority to freeze accrued pension benefits for current workers, and make changes to pension formulas going forward to protect state and local public employees and the public good.” Six years later, the governor is still just chipping away at the edges by embracing gimmicks.

Steven Greenhut is a contributing editor to the California Policy Center. He is Western region director for the R Street Institute. Write to him at sgreenhut.

Stretch of 134 Freeway in Eagle Rock could soon be renamed ‘Barack Obama Freeway’ after state Senate vote

By Steve Scauzillo, San Gabriel Valley Tribune

A resolution authored by state Sen. Anthony Portantino to name a segment of the 134 Freeway between Eagle Rock and Pasadena after President Barack Obama advanced one step closer to becoming official this week.

The state Senate approved the resolution on Monday by a vote of 35-1. Previously, it had been adopted by the Senate Transportation Committee and the Senate Appropriations Committee.

The resolution moves to the Assembly for approval, Portantino said. If approved by the Assembly, it would go to the governor’s desk for his signature.

“I am very pleased this freeway naming is gaining such support in the Senate,” said Portantino, D-La Cañada Flintridge. “President Obama deserves recognition for his years of traveling this freeway and his years of dedication to our state and to all Americans as a popular and successful president.”

The resolution passed with bipartisan support, picking up votes from a handful of Republican senators — Patricia Bates, R-Laguna Hills; Tom Berryhill, R-Fresno; Anthony Cannella, R-Merced; Ted Gaines, R-Granite Bay; John Moorlach, R-Costa Mesa; Janet Nguyen, R-Garden Grove; Jim Nielsen, R-Yuba City and Jeff Stone, R-Indio.

The lone “no” vote was cast by Sen. Joel Anderson R-El Cajon.

The resolution would require Caltrans to erect a sign between the 2 Freeway and the 210 Freeway declaring that segment the “President Barack H. Obama Freeway.”

The portion of the 134 Freeway lies just north of Occidental College in Eagle Rock, the small, private, liberal arts college Barack “Barry” Obama attended from 1979 to 1981. Obama lived in the dorms as a freshman and then in an apartment at 253 E. Glenarm St., in Pasadena as a sophomore.

Meeting a `Soprano,’ hitting the Press Club dinner, talking to Monahan about his run

By Barbara Venezia

Gary Monahan weighs mayoral run

And speaking of Costa Mesa, former Councilman Gary Monahan raised a few eyebrows Sunday when he posted on his Facebook page he was planning to run for mayor in 2018.

“OK I have Steve Mensinger, Jim Righeimer, Jim Fitzpatrick, Jim Fisler, Lee Ramos, Dana Rohrabacher, John Moorlach and a heck of a lot others behind me,” he wrote, “… Let’s do this. ”

When I emailed him Tuesday about his plans he wrote: “Nothing is final”.

Yes, the 2018 elections are going to be interesting, and not just locally.


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