In Chicago, Mayor Rahm Emanuel reminds people that had past mayors properly funded pension promises, that city would not be laying off teachers today. In Detroit, retirees will receive just a fraction of retirement benefits because past leaders did not properly fund promises. In both cases, ordinary citizens today are suffering for political sins of the past.
California in 2014 is in the same position as Detroit and Chicago were in 1994. The California State Teachers’ Retirement System, CalSTRS, has built up a large deficit and has asked Gov. Jerry Brown and the Legislature to authorize a cash injection of $240 billion over the next 30 years, starting with $4.5 billion per year now.
There is no debate over whether CalSTRS needs the money. In fact, financial economists think CalSTRS needs more than it’s asking for. But here’s the problem: Even if Brown and the Legislature continue to ignore CalSTRS for now, nothing visibly bad will happen for more than a decade. This is because CalSTRS has plenty of money with which to meet retirement promises for now.
Think of CalSTRS as a reservoir: There’s enough water to provide service for the near future, but if there’s no precipitation, one day the reservoir will run out of water. Until that day, everything seems fine. Then, all of a sudden, there’s no water.
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Or, as Berkshire Hathaway Vice Chairman Charlie Munger puts it, it’s like someone who jumped off a 100-story building being asked at the 50th story how things are going and responding “fine.”
There is an appalling lack of understanding of the CalSTRS issue. When I asked a state senator who is notable for global warming legislation about CalSTRS’ need for money, she responded that “CalSTRS is having a good year this year,” which is the equivalent of suggesting global warming isn’t a problem if the Earth has one year of below-average temperatures. A former member of the Assembly now running for the state Senate told my colleague not to worry because markets would provide all the investment earnings CalSTRS needs to erase its deficit. Presumably neither has read CalSTRS’ own report. If they had, they would understand the following:
According to CalSTRS, the fund will run out of money in 2043, at which point school districts would have to make the benefit payments now being made by CalSTRS. By then, the present value of the liability would be a massive $600 billion, which means school districts would have to divert most of their operating funds to meeting the promises. The net result: massive layoffs of then-current teachers and little money for the education of millions of K-12 students.
And that’s the optimistic scenario, which is based on CalSTRS’ high investment return assumption. If instead it earns the lower return Warren Buffett expects for his pension funds, it will run out of money more than a decade earlier.
If you think Brown and the Legislature can delay acting, think again. Einstein wasn’t kidding when he said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” CalSTRS’ liabilities compound at a very high rate, currently causing the deficit to grow $22 million per day. It’s like an unpaid credit card bill that accrues more expensive interest every day. This is why CalSTRS’ actuary warns that “the longer it takes for the additional contributions to begin, the greater the increase will need to be.”
When CalSTRS’ reservoir runs out, some cynics hope school districts will simply declare bankruptcy in order to reduce or void the pension promises. But that’s obviously cruel and unfair to teachers who rightfully expect the promises to be met. Also, the state could be required to back up the promises, which would devastate the state budget at that time.
Make no mistake about it: If Brown, Speaker John A. Pérez and President Pro Tem Darrell Steinberg continue to ignore CalSTRS, they will be joining the Political Hall of Shame occupied by past leaders of Detroit and Chicago. Their legacies will be like those of the General Motors executives who likewise made but didn’t properly fund pension promises to assembly-line workers, setting up that company and its employees for failure.
To add insult to injury, by ignoring this issue they are continuing the baby boomers’ assault on the next generation. Isn’t it time for our generation to pay for the promises we made? When we don’t, we condemn future generations to poverty, poor public services and confiscatory levels of taxation and fees.
Our leaders’ reluctance to act is understandable. But they have a duty to protect future citizens from catastrophe and to keep costs as low as possible. If they delay just one year, they are boosting the cost by billions of dollars. That’s a terrible price to impose on others just so one can skate through the next election.
Acting now will be painful, but it’ll be less agonizing than delaying. The initial amount ($4.5 billion per year) sought by CalSTRS is less than 5 percent of California’s current general fund. It doesn’t take an Einstein to comprehend that’s a tiny fraction of the share of future budgets that will be required if they delay.
Our leaders need to do the right thing – now.