The cover of Barron’s Magazine the week of March 15, 2010 illustrated a retired firefighter and police officer (in uniform) lying on the beach of a tropical island. The words above the illustration read: Investors, Beware. The Barron’s cover and the words above the image struck a chord with me.  Being a Californian, I’ve become more and more aware of the budget crisis our state is currently dealing with.  As I read the article, which I will discuss in the following paragraphs, I realized it is time to share with you a series of articles that are considered possible solutions to California’s financial crisis. This specific article will focus on the $60 billion dollar unfunded pension liability in California and the $2 trillion dollar municipal-bond crisis America is facing.

Before we look at the story behind the Barron’s cover, we are writing this article to bring awareness to the debate. I (we) are not taking sides or justifying either argument. Instead, our office is concerned with both the financial crisis California is facing and the well-being of California’s teachers, firemen, police officers, and public servants. We are writing this in the hopes we can spark a discussion or political reform, which will equally benefit our beloved public employees and California’s economy.

Here’s the debate:

In California, like in nearly all of the US, public employees, which include police officers, firefighters, teachers and garbage collectors, are enjoying “guaranteed” pensions while most American’s ignore that these pension plans are being paid by taxpayers and are crippling the municipal-bond market.  According to Barron’s, “Most public employees, if they hang around to retirement, can count on pensions equal to 75% to 90% of their pay in their highest-earning years. And many public employees earn even more in retirement than their best year's base compensation as a result of "spiking" their last year's income by working ferocious amounts of overtime and rolling in years of unused sick and vacation days into their final-year pay computation” (Barron’s Article: The $2 Trillion Hole, March 15, 2010). If a police officer in San Francisco retires making $100,000 a year, based on the current pension plan, they will receive $75,000 (at 75% of his last year’s income) a year in retirement for the rest of their life. Is this paid through credit? Partially, yes. The state is paying this pension payout through “good faith credit” and invested funds.

In California alone, there are 15,000 public employees getting ready to retire making between $100,000 and $200,000 per year. In other words, roughly $1.5 billion will be paid out annually for this specific group of employees. Can California really afford this?

As an office, we aren’t going to make any moral or ethical judgments about if this is deserving compensation. However, it is important to be aware of how and why this conversation is causing a debate and makes the cover of a Barron’s magazine.

According to Barron’s article, “Some 80% of these public employees are beneficiaries of defined-benefit plans under which monthly pension payments are guaranteed, no matter how stocks and other volatile assets backing the retirement plan perform. In contrast, most of the taxpayers are footing the bill for these public-employee benefits (participants’ contributions to these plans are typically modest) have been pushed by their employers into far less munificent defined-contribution plans and suffered the additional indignity of seeing their 401(k) accounts shrivel in the recent bear market in stocks.”

The debate lies with the type of pension plan. Public employee’s pensions are “guaranteed”. However, pensions for workers in the private sector are not always guaranteed. (Please visit www.pbgc.org.) Furthermore, guaranteed payouts over the last 20 or so years have resulted in debt defaults, possible bankruptcy filings, and the unsettling $2.7 trillion municipal-bond market. Many will argue that the bill due on state pension funds will bankrupt California.  According to financial professors, Robert Novy-Marx and Josh Ruah of Northwest University, the current investment portfolio for California and the current pension payout obligations have only a 1 in 20 (5%) chance of being met.  George Mason University law professor Todd Zywicki said, “In many ways, some of our states are like General Motors before its bankruptcy, suffering from falling revenue, borrowing money to cover operating expenses and operating under crushing legacy health and pension liabilities. It’s entirely possible, given the gigantic size of the pension liabilities, that some states might do what was once the unthinkable at GM and default”(Barron’s Article).  ~ Start the 401K ~ Stop the Defined Benefit!

While some states have changed their public employee problem by reforming their pension policies, for example, “increasing retirement ages, cutting pension-benefit formulas, boosting employee contributions, curbing income “spiking” and partially switching employees to less costly defined-contribution plans,” most have not.  Many states are restricted by their own state constitutions, which guarantee public pension payments, or laws which have been passed to do the same.  These guarantees lead to a slippery slope, as the same judges and state attorneys who would be asked to call into question these policies also benefit from them in retirement.  Combine that with campaign contributions and donations from public employee unions, and we find nary a politician willing to go to bat for the constituents they represent.  “Public employees should receive a fair level of pay and decent retirements, but they should not be able to use their political muscle to secure absurd compensation levels, or be allowed to engage in dubious pension-spiking schemes to get such rich deals that future generations of Americans are going to be stuck with the debt” (Steven Greenhut, author of Plunder: How Public Employee Unions are Raiding Treasuries, Controlling Our Lives, and Bankrupting the Nation.)

The responsibility ultimately lies with the individual taxpaying voter, who would be much more likely to scream for change if they realized these overgrown pensions weren’t in place to make up for a career of low wages in the public sector.  The Bureau of Labor Statistics states that “the average state and local employee out earns his private sector counterpart with an hourly wage of $26.11, versus $19.41.”  Adding in benefits drives this gap even higher.  It used to be that citizens would trade a lower wage for a guaranteed job in the public sector.  More recently it has turned into a win-win situation for the government employee, while the taxpayer is left holding the bag.

Assuming that, like the writer of the Barron’s article, the typical citizen of this state has a soft spot in his or her heart for the jobs being performed by firefighters, policemen, teachers, etc, it is hard to argue the validity and importance of their work.  However, when 500+ people are in line for one opening at the local fire department, the deal might be just a little too sweet.  In addition to plush wages, time off, and that eventual cushy pension, one can often find a fire engine (which costs taxpayers upwards of $400,000 each plus the cost of diesel), idling outside of Safeway, Jamba Juice or Starbucks, and with no smoke in sight.  While team outings are known to boost morale, we propose a mandate requiring the use of their own personal vehicles to run errands.  Should tax payers simply allow this to happen or should political discourse ask the question: “Is it ethical for public service unions to misuse public resources and abuse their power?” We need these public services in order to guarantee the safety of our citizens, however, like GM, it is time to trim some fat in order to survive. Reminder! Don’t shoot the messenger. I am just exposing an obvious issue.

Another option for cutting costs can be found by looking outwards.  In other countries, like Hungry, Germany, Denmark, Angola and many others, civilians are required to provide either (or both) military or non-combatant service for 6 months and up to 2 years. Non-combatant, or unarmed service, includes firefighting, police, medical response, etc. If we are having a hard time paying our firefighters and police, maybe we can assess some type of mandatory non-combatant service as an option. Many believe that this works in other countries, and might be worth consideration here in the states. 

We have been writing about California’s revenue issues for years. In 2003, we wrote an article published in Physician’s Money Digest entitled “Stock Options Fuel California’s Fire”. We have also included in our newsletter multiple pieces that discuss the importance of improving both our economic conditions and social environment. As a college student, I worked with a program called S.O.S that fought against cutting school sports programs. Our office has been trying to fight against school budget cuts by sponsoring events like Cal High Sports Awards Banquets (this year’s Valentine Capital/Cal High Sport Award Banquet will be May 28th at EA Sports in Redwood City.) We have also donated time and funds to shelters, food pantries, schools and other non-profits in order to help fight the good fight. But there should be a balance between state funds that should be spent on programs benefiting the public and funds guaranteed to those providing that service. The responsibility shouldn’t be solely on charitable donations and taxpayers.

What Californians are currently allowing in the public sector isn’t working.  We are in a statewide financial crisis, and it is time to dig deep to find solutions.  We either need to reform the pension policies and procedures for civil workers, or we need to explore a different way to acquire public social service employees.  There needs to be a complete restructuring of the state system with possible incentives to help save and support sports and music programs, Special Ed curriculum, mental health services, etc. Ultimately, it is time for a new political movement— grassroots bi-partisan action where everyone who is concerned about the state and its citizens join together to figure out a better plan. I don’t have an absolute answer, but if we come together we might find one.

California’s economy is ailing, and it’s going to take a team effort to bring us back to prosperity.