Gov. Arnold Schwarzenegger insists he won't sign a new state budget unless the Legislature rolls back a hefty increase in state employee pensions enacted 11 years ago.

It's the latest wrinkle in Schwarzenegger's years-long war with the California Public Employees' Retirement System and state worker unions over what he contends is an unsustainable and "inexcusable" pension system that's killing the state budget.

CalPERS and the unions respond, in effect, that the system is sound, despite multibillion-dollar investment losses, and that once the economy recovers, the nation's largest pension fund will resume hefty earnings to cover its obligations.

As the argument rages in the media and in the Capitol, it has spurred fresh examinations of how the 1999 pension bill, Senate Bill 400, came to be enacted by the Legislature and then-Gov. Gray Davis – especially whether CalPERS misled them about its long-term financial effects.

Ed Mendel, a veteran Capitol reporter who writes a blog about public pension issues at Calpensions.com, has found documents from a CalPERS board meeting on June 15, 1999, in which its actuaries provided three scenarios on investment earnings.

The board adopted the most optimistic scenario, told the Legislature that the system could easily absorb the pension benefit boost – and did not mention the less rosy alternatives. Davis' own personnel director conveyed the potential fiscal peril in a memo to the governor, but Davis signed the bill anyway.

As it turned out, the most pessimistic investment scenario became reality. The budget's pension appropriation has soared from $159 million in 1999 to $3.9 billion currently – almost exactly what the actuaries had said back then.

So should CalPERS have known that its investments were too risky? Yes, an article in the Wall Street Journal implies, because the head of the California Association of Highway Patrolmen, a major backer of SB 400, told CalPERS so.

Jon Hamm, the union's top executive, is also an amateur financial analyst. In 2003, he sent a letter to the top CalPERS executive, Fred Buenrostro, warning him that the housing bubble would burst and urging a more conservative investment strategy.

Hamm's warning went unheeded. CalPERS plunged deeply into housing and land speculation and lost untold billions of dollars. And Buenrostro, we know now, was playing footsie with placement agent Alfred Villalobos, a former CalPERS board member who was peddling risky investments for multimillion-dollar commissions.

Attorney General Jerry Brown has sued Villalobos for $95 million, alleging that he bribed Buenrostro and two other fund officials.

Mendel's revelations, Hamm's letter and Brown's suit portray dereliction of fiduciary and political duty on a truly massive scale.

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Call The Bee's Dan Walters, (916) 321-1195. Back columns, www.sacbee.com/walters

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