Earlier this week, we issued a report identifying the shortfalls at CalPERS, CalSTRS and the University of California retirement plan. The report shows cumulative shortfalls that vary depending on assumptions about investment rates of return.

In a scenario under which investments earn 6.2 percent per year, which is the long-term historical average for investors allocating capital in the same manner as pension funds, the shortfall is $290.6 billion, or about $24,000 per California household. Like a mortgage accruing interest that's not being paid, that shortfall grows every day the problem is not addressed.

This research effort was intended to bridge the gap among those with different opinions about public pensions and the need for reform. We created an advisory panel of academics, current and former elected officials, and public employee union representatives. We held constructive meetings in which panel members voiced their different perspectives and conducted more discussions by email.

Last year, after a group of Stanford students published a report detailing the estimated shortfall for California's public employee pensions, some people in Sacramento argued against the use of risk-free rates for quantifying the size of pension liabilities, despite strong arguments by economists to the contrary.

So, in an effort to build a bigger tent, this week's report shows the financial status of pension systems using rates ranging from 4.5 percent (risk free) to 9.5 percent (higher than even the most optimistic assumptions about future rates of return). At every rate, shortfalls are substantially greater than those estimated in early 2010.

Even at an assumed 9.5 percent rate of return, CalPERS and CalSTRS remain below CalPERS' own long-term target of 100 percent funded. Even more ominous, we show that CalPERS and CalSTRS would need to earn an average annual rate of more than 12 percent to be certain that assets exceed liabilities. That level of long-term return is Bernie Madoff territory. As Gov. Jerry Brown has said, the math is simple.

To my surprise, some people in Sacramento, such as Treasurer Bill Lockyer, expressed disappointment with the report and resigned from the advisory board, even though our findings are more optimistic than another recent report.

According to Alicia Munnell, head of the Boston College Center for Retirement Security and a Democratic member of President Bill Clinton's Council of Economic Advisers, CalPERS and CalSTRS are funded at only 56 percent and 39 percent pursuant to proposed rules to be issued by the Governmental Accounting Standards Board. Both figures are well below our middle case.

The advisory panel members who resigned seem fixated on just one issue, insisting that we present the numbers assuming only a long-term investment return of 7.75 percent. Notably, even at that rate, all three pension systems remain substantially underfunded.

The insistence on a 7.75 percent rate is precisely the reason that pension systems find themselves in poor shape today. Had they assumed lower, more realistic returns in the past, increased contributions would have improved their funded positions today. Instead they insisted on absurdly high assumptions, underfunding our pension systems for decades and, because of compounding, creating a much bigger problem.

Repeating that mistake now only digs California's financial hole deeper and ensures even higher long-term costs. We estimate, for example, the additional cost of not fixing the state's pension problem at $1.2 billion per year, roughly equal to the midyear budget cuts recently announced. And that figure will grow every day that they delay.

Across California, leaders are stepping up on this issue, despite the political heat. While Brown's 12-point plan is too modest in my opinion, at least it recognizes the problem and outlines a partial path to fiscal sanity. Mayor Chuck Reed in San Jose, San Francisco Public Defender Jeff Adachi, Long Beach Mayor Bob Foster – all Democrats – have risen to the challenge in the hope of preserving funding for critical public services. All of California's leaders should do the same.

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Joe Nation is a professor of the practice of public policy at Stanford University and a former Democratic assemblyman.

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