Monday, April 23, 2012

Public Sector Pension and Retiree Health Mismanagement ... Effects on Future Taxpayers

Widespread public sector financial mismanagement, if not fraud, will prove to be extremely harmful to all current and future American taxpayers and citizens.

It is concentrated on retiree pension and health care benefits promised by government leaders at all levels.

Whether that mismanagement is more attributable to the incompetence, simple neglect or just plain fraud by government officials isn't the issue.

Whatever the cause, it's a total breach of the fiduciary trust owed to taxpayers by public sector leaders and one which will negatively impact citizen taxpayers for years to come in countless ways.

We'll focus on the example of the city of Stockton, California in today's discussion. How Stockton, California Went Broke in Plain Sight says this:

"What does it look like when a city of almost 300,000 flirts with becoming America's largest ever city to go bankrupt? Welcome to Stockton, Calif. . . . Stockton exemplifies the fiscal hole that many municipalities have dug for their taxpayers. . . .

The city's fiscal history "has eerie similarities to a Ponzi scheme," says Bob Deis, the city manager Stockton hired in 2010. Over the years, the city promised employees huge—and unfunded—salaries and benefits, so when trouble struck officials began cutting back on services such as police and fire protection, plus libraries and parks.

Stockton's current leadership, which has already suspended some payments to bondholders and is negotiating with creditors and unions, is frank about its past shortcomings. In last year's budget, Stockton admitted that its biggest problem has been a lack of transparency resulting in a host of "hidden costs" in labor agreements for "obligations that are often difficult for citizens to identify or understand." . . .

Stockton safety employees with 30 years of service receive 90% of their highest working salary as a pension, with cost-of-living adjustments up to 2% annually for the rest of their lives. And while the state requires workers to contribute between 7% and 9% of their salary toward pensions, Stockton agreed in a series of agreements with various municipal unions going back to the 1990s to pay the worker portion of the contribution along with its 20% employer share.

Stockton couldn't afford this rich program even in boom times, so officials played risky investment games. In 2007, the city borrowed $125 million and put the money into Calpers, the giant California pension fund, betting that investment managers could earn more than the interest Stockton owed on the debt. When the market tanked, Calpers lost 24%-30% of the loan's principal, according to city budget documents.

Now Stockton is stuck with interest costs on top of pension obligations that pile an additional 48% onto basic employee pay. Thus a public safety worker earning $70,000 annually costs the city another $33,000 in interest and pension-borrowing costs.

Perched precariously atop this mountain of obligations are retiree health benefits. Stockton officials awarded these to city employees in a series of votes in the 1990s but made no effort to fund them, intending simply to pay costs out of their budget as workers retired. As hundreds did just that over the years, the costs grew. Next year, the city's fiscal documents project, retiree health costs will surpass those of the city's regular work force. At last count the city's unfunded liabilities for retiree health care are above $400 million.

Stockton Mayor Ann Johnston voted for these expensive measures when she served on the city council. "We didn't have projections into the future what the costs might be," she told the Record, a Stockton newspaper, earlier this month. She added, "I learned that you don't make decisions without looking into the future."

Council votes to approve ever-greater benefits were often unanimous, according to Record columnist Michael Fitzgerald. "Nobody gave thought to how it was eventually going to be paid for," says Mr. Deis, the city manager.

The future is bleak, as the city has only $165 million in its general budget to provide police, fire and other basic services to 292,000 citizens. The police force has shrunk by about 100 officers, or about 25%, in the last two years. Residents report long wait-times after making 911 calls, and police only respond to emergencies. . . .

The big question is whether Stockton is only the tip of an iceberg. The 50 states alone have promised their employees retirement health-care benefits amounting to a $627 billion future liability—and funded only 4% of that cost, according to a recent accounting by Bloomberg Data. Unfunded state and municipal pension liabilities range up to $4 trillion, depending on what future investment assumptions you make.

Most local governments may never reach insolvency, but the rising costs of these benefits already crowd out other spending, including on police and fire protection. Thanks to unaffordable promises made by politicians who never bothered to total up the costs, we're in a new era of local government in America: Taxpayers can expect to pay more but get less."

Discussion and Analysis

Teachers, police, fire fighters and others all believe they have earned the benefits promised to them by city and other government officials in labor negotiations.

Here's my question: Who told the future taxpayers what they have been obligated to pay by their elected and duly appointed representatives in public office? And here's my answer to that question: Evidently nobody.

In other words, current workers were frequently promised lavish future benefits by city officials but the money to pay those benefits wasn't collected and then properly set aside. Accordingly, it's government mismanagement for certain and quite likely incompetence as well. In any event, either the benefits won't be paid as promised or the future taxpayers will have to pay exorbitant amounts in taxes to fund the promised benefits and necessary city services as well.

Summing Up

This disgraceful financial debacle is playing out across America and will be for many years to come.

As a city council member, the current mayor of Stockton, as well as her public sector colleagues, voted for the benefits without considering any "projections into the future what the costs might be." Think about that comment. It's disgusting.

She admits that she voted for something without having any idea what the eventual costs would be. At least she's honest, even if incompetent.

We can only wonder how many other city, state and federal officials have taken similar actions.

Thus, they acted as if the benefits would somehow be free-- and they in fact were free to the city worker, the city official and the union leadership. Only the future taxpayer would get the bill. That's where the free lunch ended.

But it was even worse than that. The city made the public sector employees' pension contributions, often by borrowing the funds to do so, and then lost that money by investing poorly, thus making an awful situation even more awful.

And retiree health costs across the nation are woefully underfunded as well.

My bet is that we have no idea how bad this will all turn out. Yet while we don't know what the final bill will be, we do know that it was all avoidable. That's why it's such a disgraceful situation.

In simple terms, the retiree benefits were promised to certain employees to be paid in certain amounts at certain times in the future. The mayor and her cohorts could have collected and set aside taxpayer dollars and employee contributions each year. They then could have invested that money in order to pay the benefits by assuming a certain average annual investment rate of return.

Then they could have monitored the actual investment performance of the funds as well as the salaries of the workers over time and made adjustments to the contribution levels from time to time. That way they wouldn't be sticking future taxpayers with the painful alternative choices of reducing benefits, city services or materially increasing taxes paid.

Why didn't they take the straightforward path? Probably because they didn't want the taxpayers to know about the financial obligations they were assuming. So they made the promises without disclosing them properly and obligated future taxpayers to make good on them.

If that's not fraud, it's close. But that's exactly what they did. And what many other governments have done across the U.S. as well.

And that's also what has happened at various levels of government throughout our country--Social Security and Medicare included.

Whether we are now faced with an unfunded amount of $100 trillion or some higher astronomical number isn't the point.

It's huge and it's unknown, but it's always been knowable. That's why it's financial mismanagement at best and fraud at worst.

The poor taxpayer has been fleeced again, but the "poor" public sector employees will be the ones getting the sympathy of the public. And the government officials will do everything possible to escape responsibility for their actions, as always.

That's a crock, my fellow citizens.

Thanks. Bob.

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