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Jan. 15, 2021 - Epoch Times
37:29
How California's Unfunded Pension Liabilities Could Lead to Bankruptcy | Sen. John Moorlach
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You believe that we have a pension crisis in California.
Is it true?
Should we use the word crisis for pensions in California?
Or we put the word existential before the word crisis.
So from what I understand is the cities are paying in for these retirement benefits, but what they're paying is not matching what the employees would get out of the plan.
After they retire, right?
They're about 30% short.
And because the assumption is that they're going to get a 7% return, but they're not getting that return in the markets, right?
That's part of the problem.
And how is it affecting these cities?
As those pension costs go up, other areas get crowded out.
You may not see your roads repaired as quickly as You should, you may see your fire department having a reduction in personnel and the same with the police department.
So you mentioned the laborers, the unions.
What are they doing?
Why is this happening?
Can you explain it more in detail?
Unions collect dues and those dues are used to pay for the leaders of the union, but they are also used for political contributions.
Is this happening across California in all levels of the...
Absolutely.
And how can we break out of it?
How can the voters do something about this?
What should they do?
Well, you've got to look at the way your city and your school district is being managed and you have to see what you can do to change things because it will eventually impact you.
Because the last thing you want at 80 years of age is a postcard that says, we're sorry, we're going to have to cut your pension by, you know, fill in the blank, 30% or whatever.
And that may be very difficult for a lot of people.
Are many cities in California potentially facing bankruptcy?
My guest today is California State Senator John Morlock.
In 1994, he predicted the largest municipal bond portfolio loss and bankruptcy in U.S. history.
He will discuss with us the severity of unfunded pension liabilities in California, the consequences of not addressing them, and if it's possible for the state to recover at a time when special interest We play a big role in funding elections.
Welcome to California Insider.
CMAC, it's an honor to be with you.
So when it comes to the word crisis, I hear this word all the time.
And anytime media tries to get attention to something, it's this crisis, that crisis.
You believe that we have a pension crisis in California.
Is it true?
Should we use the word crisis for pensions in California?
Or we put the word existential before the word crisis as well.
And so what is the real existential crisis?
What is the crisis in California?
Is it climate change?
Is it our finances?
What is the issue?
We have implemented defined benefit pension plans at about every level of government.
There are a few exceptions where there will be a defined contribution plan.
A defined contribution plan is a 401k type of structured retirement plan where you put in so much every month and it builds.
A defined benefit plan says we'll put money away based on some certain assumptions.
How many years you will work, what your ending salary will be.
We will give you a multiplier of your years of service times your ending salary times a factor and that will be your retirement Plus a cost of living adjustment.
So you have to fund for that liability as the employee works for the company.
Most Fortune 500 companies have dropped to find benefit pension plans because one of the key components of your assumptions is And we have had years where you have no return or a negative return, which means then you have to catch it up in future years.
And if you assume a high rate of return, then you will have a tough time catching up.
Over time.
It's also imperative that you do not change the formulas in the middle of the game.
And regretfully, that was done in California.
Back in 1999, Governor Gray Davis signed what was called SB 400, which allowed California Highway Patrol employees, public safety employees, to improve their defined benefit pension formula.
So let me kind of do some math and keep it real simple here.
But they were getting 2% at 50.
2% at 50.
Which means that they would retire at age 50 and if they were making $100,000, you multiply the $100,000 by 2%.
And then you multiply that, say, by 25 years.
So they would get $50,000 a year as a retirement.
Not bad at an early retirement.
But most people at 65 would be really glad to get maybe 60% of their income.
But in 99, they said, let's change that to 3% at 50.
Because in the late 90s, we had enjoyed the dot-com boom.
Yeah, yeah.
And so the market was generating 20% a year, 25% a year.
And people are kind of funny.
They think that yesterday is today is tomorrow.
And if my investments earned 20% last year and they earned 20% this year, they're going to earn 20% next year.
Well, that's not how it works.
And so...
Gray Davis signed the bill and it was retroactive to the date of hire.
So that person who was going to retire with $50,000 now found himself retiring with $75,000 a year.
But that wasn't funded.
The plan was funded for $50,000 a year, not for $75,000.
So you had a 100% funded plan, thanks to the dot-com boom.
But when you increase benefits by 50%, you're now two-thirds funded.
And here we are two decades later, and CalPERS, the The California Public Employee Retirement System, the main retirement provider for state and local employees and also probably the largest pension system in the U.S., not the world.
But it now found itself two-thirds funded and is still at about 71%, 70% 20 years later because it's never been able to catch up.
We dodged a real bullet.
This year, with COVID-19, the stock market dropped dramatically in March, but by June, it kind of came back.
So, CalPERS has a June year-end, and instead of earning the 7% that they're supposed to earn, they earned about 4.7%.
Don't meet your target, then future years, the contributions that the employer and the employee have to make go up.
And so the issue is, can we keep earning 7% On investments every year going forward and it gets more difficult and it has been very difficult for pension plans around the world when interest rates are so low.
Most pension plans that are of a defined benefit nature should probably invest in bonds.
But bonds have been paying very little interest.
So if you have a 7% bogey and 40% of your portfolio is at 2% or 3%, you have to rely on the stock market to make up the delta.
And that gets really dicey and it's speculative and it's risky.
And the more risk you take, the higher the returns.
But you can, as we say, you could win big, but you could lose big too.
And when that happens or occurs...
Then these pension plans will have a real difficult time.
And then the employer will have to pay more into the plan.
And that's what's happening in California.
So you mentioned just this year, as an example, you mentioned the return on the investment was 4.7%.
Usually they're supposed to get seven.
They're estimating seven.
When there is such a discrepancy, do they make the employers chip in right now, pay for it, or would they wait until the people retire?
Well, that's why we have actuaries.
And so the actuaries will look at the data and say, okay, one year you made 8%, one year you made 6%, one year you made, you know, and every year it kind of changes.
They kind of look at the fluctuations and they use a term called smoothing.
How do we take all these volatile numbers and how do we determine what's going to happen in the future and how do we then catch up where we need to and the actuaries will then determine How much more the employers will have to pay into the plan?
So if you have a year that you miss your target, you can anticipate in about two years you're going to see a contribution increase.
So we're seeing cities that are finding their pension plan contributions become such a large component of their budget because Most of the budget is salaries and benefits for police and all the services that are provided, say, by a city.
And so as those pension costs go up, other areas get crowded out.
You may not see your roads repaired as quickly as You may see your fire department having a reduction in personnel and the same with the police department.
So we're seeing police forces and fire departments become smaller because of all these additional employee costs.
A public safety official They're fighting for cities that they're paying about 50 cents plus for every dollar that they pay in salary.
So that gets to be an onerous cost.
There are some cities that a lot of the cities in California are facing challenges right now.
Can you tell us more about what type of challenges they're facing financially?
Yeah, we've got this COVID lockdown, and so it has shut down our amusement parks.
It's shut down our key malls.
It's just been devastating.
So if you look at Anaheim, which already is a city that is sort of in the bottom percentile of cities in Orange County from a financial health perspective, when you shut down Disneyland,
And the resort, and you shut down Anaheim Stadium during the baseball season, and you shut down the Ducks games, you shut down the convention center, then you're shutting down hotels, and you're shutting down restaurants and all the revenues that are related.
Hotels, when you stay at a hotel, you pay a transient occupancy tax.
It's a A hotel tax, say 10% of the room rate, and that's maybe a million dollars a day to the city of Anaheim.
You cut that off, and they're already in a dire financial strait.
They're going to have some difficult times going forward.
A CARES Act, you know, some kind of relief may be soothing and may be a little bit helpful, but it's not going to cover what they've lost in revenues.
So they're going to find whatever reserves they've had depleted.
And they may be a candidate for Chapter 9 bankruptcy.
I don't want to be negative, but my own city of Costa Mesa, where my district office is located, they were already just 61% funded in their pension plan.
And they've seen South Coast Plaza shut down for months.
And the sales tax revenues that come out of that little facility, it's one of the highest grossing sales Shopping center opportunities in the nation.
So they're going to see a significant drop in their revenues.
And they're already, for whatever reason, 34th place out of 34 cities in Orange County.
So it's going to be real difficult for them to try and regroup and come back.
And so Chapter 9 may be the remedy to then try to fix all of these problems with the pensions, with the retiree medical issues.
Because when you become a union town, you've got to get out of that grip and Chapter 9 may be the solution.
A couple of years ago, I wrote to CalPERS and said, what would it look like if I had your actuarial data?
And we said maybe that retirees do not get a COLA increase if, say, the pension isn't at least 80% funded.
They put together a committee meeting of CalPERS board members for their finance committee to discuss my request.
And about 12 plan sponsors, cities, showed up to discuss it and said, you know, we need more tools in our tool chest to negotiate with our employees, and not granting cost-of-living adjustments to retirees would perhaps help us.
But what was interesting, some cities got up and said, you know, we've already cut our police force by Twenty-five percent.
Our fire department's running at 75 percent.
And we know the month and year when we're going to run out of cash based on trying to provide our services.
That's kind of a scary thing.
Most municipality directors would never want to admit that they might be looking at bankruptcy if they can't seem to figure out how to manage all of their costs.
Is it in the recent, in the next year or in the next few months?
Is that how they've been calculating?
It depends on the particular city.
Because this has become so prevalent, we have 482 cities in California.
So we've just taken all of their, we try to get every city's audited financial statements.
We call it a comprehensive annual financial report.
And just to see how these liabilities are impacting them, And we have cities where 60% of them have an unrestricted net deficit on their balance sheet.
In the business sector, if you had retained earnings that were negative, you'd be a bankruptcy target.
You would go on there.
Yeah, that's what happens.
So where does the funding come from?
Who's lending?
Who's borrowing?
And so we have a good number of cities that really need to be looked at to see how can we manage their finances.
We've had San Bernardino, Stockton, and Vallejo already file for Chapter 9 bankruptcy, which is What municipalities can do.
You have chapter 7 and 11 in the private sector, but chapter 9 for governments.
They've already filed just to work out arrangements with their pensions and their retiree medical liabilities.
John, there are some people that argue that if we cut these pension plans, we won't be able to hire the right police officers and the good police officers and the good firemen.
Is that true?
No, that's not actually true.
But the pension plans that they get are very attractive, very nice, much nicer than other states.
The protocol for public employee unions is that if you need to make layoffs, you lay off the most recent hire.
You don't lay off the most troubling employee.
You lay off the last person who was hired.
We do this with teachers.
When we had the recession, The new teachers were laid off when we had to make cutbacks.
And now the state wonders, why can't we find teachers?
Well, because you lay them off when they show up.
You know, you shouldn't be doing this last in, first out approach.
And so a lot of police officers understand this.
They wonder, why did the city council adopt this 3% at 50?
Because they tend to be the first ones to be laid off.
And they wonder why.
Because cities are contracting, right?
And they have to Lay off somewhere.
So it's the new hires.
So these pension plans, they're very generous, but because they come at a real price, it has an impact on the workforce.
And so if this is such a big deal, and let me actually recap it.
So from what I understand is the cities are paying in for these retirement benefits, but what they're paying is not matching what the employees will end up earning after.
They're not matching what the employees would get out of the plan.
After they retire, right?
They're about 30% short.
And because the assumption is that they're going to get a 7% return, but they're not getting that return in the markets, right?
That's part of the problem.
And what happens is that if you lower the 7%, then you raise the contributions because you're sort of assuming that your investments will take care of funding the plan.
And if you're assuming that that isn't the case, if you lower it, then the The contributions have to go up, and that would cause too much stress.
But that becomes real, right?
Isn't that become real?
That's the reality, right?
Exactly.
But you don't, there's, the secret is you don't want to make it real.
Because if you raise the contributions, then cities will have less money for raises and benefits for current employees.
And the current employees are organized, and they are unionized, and they help elect the city council members.
So there's a lot of pressure to not lower the investment assumption because it will harm cities and the employees will be upset that they may have to have layoffs.
But eventually this is going to catch up to them, doesn't it?
Yes.
So at some point...
And so you mentioned laborers, the unions, and they're organized.
What are they doing?
Why is this happening?
Can you explain it more in detail?
Sure.
It's rather simple.
Unions collect dues from their employees, from the employees of the city.
And those dues are used to pay for the...
Leaders of the union, but they are also used for political contributions.
And unions are extremely involved in races for city councils, for school boards, for state legislators, for governors.
Meg Whitman ran against Jerry Brown.
She had personal wealth.
She may have put $175 million of her own personal wealth into that race.
But Jerry Brown just kind of sat back and relied on the public employee unions to fund his campaign and they did and he got elected.
And so they fund politicians and then they end up negotiating with them when it comes to dealing with pensions and things like that, right?
Correct.
The classic conflict of interest.
Do you see What do they think will end up if they continue like this?
What is their perspective?
Do they think that they can collect more taxes down the line?
Or how do they see it?
They understand that this problem exists, budgetary.
Cities don't have enough money to pay for it.
What are they thinking, in your opinion?
The honest ones will tell you that they're seeing that they have to come up with more money.
And that's why you see Prop 15 on the ballot in November of 2020.
They're looking for any kind of new revenue.
And raising property taxes on commercial property is one of those areas that they see as a vulnerability.
And they market it as not to pay off pensions.
They wouldn't call it a pension tax.
They would call it more funding for students.
This is to help the schools.
LA Unified School District, one of the largest school districts in the country, is relying on Prop 15 so they can give pay raises to their unionized teachers.
It's sort of a sad sort of game, but the public isn't aware.
They're not aware of what's really inside a budget.
They're raising kids.
They're working every day.
They're not digging into comprehensive annual financial reports.
To see how their government and their school district is operating.
So the honest union leaders are saying, yeah, we need to increase taxes.
Those that are not as knowledgeable, they say, oh, the investments will take care of it.
We'll be fine.
It'll do well.
And then, you know, the bold ones will say, well, and if it doesn't, then we will tax more.
What is that going to do to, what's the problem with taxing more?
Some people may say, you know, I'm willing to pay for it, you know, but where does it go and how does it affect the state?
Yeah, and we've got states that are struggling like New Jersey and Illinois because of these same issues.
Connecticut, you have some problems.
One, we already have the highest We have the highest personal income tax rates in the country.
We have the highest sales tax rates in the country.
So, property taxes, we're getting kind of close.
And so, where do you raise taxes?
So, states like Connecticut decided we should raise income taxes on our wealthiest residents.
In California, 1% of our residents pay 50% of the personal income tax.
Sort of true in Connecticut.
So they raised the tax on the wealthy.
The wealthy know how to manage their money.
They know how to use effective financial planning.
They know how to buy tax-exempt bonds.
They know how to set up family foundations and shift their assets.
So Connecticut found that its personal income tax from their wealthiest residents declined by 50%, which meant then that they had to go back and raise taxes again, but then it hit the middle class.
We're seeing the same discussion in New Jersey.
We've seen David Tepper, a hedge fund manager, a significant income tax provider for New Jersey, moved to Miami, Florida.
Florida is a zero income tax, personal income tax state.
The state of New Jersey had to hold a meeting with their finance director just because this guy made so much money that he was a Significant donor.
But he went to a state where, you know, you get an automatic pay raise, right?
We have people in Silicon Valley moving to Incline Village.
They're going to get a 9.3% pay raise.
I had another financial manager out of Newport Beach who said, look, I'm paying...
13.3% on my money.
But with not being able to deduct SALT state and local taxes, I've got a marginal tax rate of 23%.
Why would I pay California one out of every $4 I'm making?
So these people will leave.
A few of these people will leave.
They move to Miami as well.
And then what will happen?
Then the middle class will have to suck it up.
If our wealthy 1% say enough is enough.
Because wealth is movable.
And just this year alone, Sacramento introduced two bills.
One to raise the personal income tax rates from 13.3 to 16.8.
Another 3.5% saying that the wealthy aren't paying their fair share.
And another bill that said, if you have a net worth of $30 million or more, you're going to pay a wealth tax.
And not only are you going to pay it, but you're not going to be able to get away from it if you move out of state for the next 10 years.
So when you message something like that, People that would love to move to California to start a business, if they're entrepreneurs, kind of take a big gulp and say, I don't know if I want to move from Colorado or everywhere and come to California to set up a business if I'm going to be taxed so severely because we don't have a capital gains tax deduction.
So if you sell your business or your real estate, you're going to pay 16.8% if it's $5 million or more in gains.
Maybe people that are trying to maybe end their careers and retire, they may just want to move to Nevada for a while before they sell their businesses, and then that tax revenue is completely gone.
So the maturity party in Sacramento isn't thinking about the consequences of going after wealthy people.
And then either eventually, so the middle class have to pay for it, or services may get cut, or bankruptcies would happen.
Yeah, and then if you go into bankruptcy, you have some solutions.
Stockton was able to eliminate their retiree medical, which is another component.
It's another significant liability on the state's It'll be $91 billion next year.
That's a lot of money.
But for the city of Stockton, in federal bankruptcy court, they were able to eliminate $500 million in debts.
So all these retirees that were expecting to get grant money to pay for their medical insurance premiums in their retirement years, Gone.
And so you can remove that.
You could try to modify your pension plan.
The state of Wisconsin adopted what's called a shared risk pension plan, which has- Which is not fixed anymore to that 7%?
No.
It has a much more reasonable investment return assumption, you know, like 4% or, you know, something where what's achievable in the current market without getting overly aggressive with your investments.
And if you do better than the 4%, let's say, then you can give cost of living adjustments and you can reduce employee contributions.
But if you're under the 4%, then no COLA's for the retirees and maybe the employees have to chip in more.
The Pew Charitable Trust does a listing every year of states on how well-funded the pension systems are.
And Wisconsin always seems to be at 100%.
Because they're running maybe a defined benefit plan using the appropriate assumptions.
More realistic assumptions.
Doing it as it should be done.
And everybody else has just kind of manipulated and twisted and abused these defined benefit pensions.
So this could eventually hurt the public employees, people that have worked in the fire department or the police department and they thought they were going to retire, they're going to get certain.
They've been calculating on that.
They're going to be hurt eventually.
It happened in the city of Detroit.
Detroit also filed for Chapter 9 bankruptcy.
And I believe it was Judge Rhodes who was the federal judge.
And other federal judges have said, look, you can change these benefits.
And Judge Rhodes actually reduced the retirement benefits that the retirees were getting.
So yeah, you could be like an Eastern airline pilot.
I don't know.
A lot of airlines went bankrupt and these pilots had worked for the company for decades.
And they get a little postcard and said, look, we only have 40% of the money that we should have had.
So we're going to reduce your Pension by 60%.
You're going to have to take the haircut because that's what happened.
And that could realistically happen in public pension systems, too.
You come to a point and say, hey, we just don't have it and we can't tax anymore.
We've taxed.
We're at the max rate in every category.
Where else are we going to go to fix this thing?
And now you're going to have to regretfully pay the price as well.
And that's...
What I'm trying to prevent.
You know, I'm not a person who's upset with public employees.
I used to be one for 20 years.
I'm trying to make sure that everybody wakes up and says, wait a second, we've got to modify going forward to protect what we have.
These have to be sustainable, because the last thing you want at 80 years of age is a postcard that says, we're sorry, we're going to have to cut your pension by...
You know, fill in the blank, 30% or whatever.
And that may be very difficult for a lot of people.
You brought up this cycle that the public employee unions are kind of helping politicians get elected, and then they negotiate with them.
And it seems like, the question I have for you is, is that the reason, or if it's not, what is the reason that The city councilmen, mayors and politicians that are in charge of these cities and positions don't deal with this.
Yeah, it gets to human psychology.
People want to be council members.
They're very insecure.
They know they can get on the council with the funding of the unions.
And if they don't do the bidding of the unions, then the unions can find someone else to run against them when their term is up in four years.
And they do.
They refer to certain elected officials as bobbleheads.
They'll just do whatever they're told to do.
This is true for Sacramento.
The Democrats that are in the legislature are there because they were funded by public employee unions.
And if you rock the boat or try to change the paradigm, you will pay a price.
I would refer to, say, Senator Steve Glazer out of Northern California, the Contra Costa area.
He did a bill that said, why don't we allow new employees a choice, either a defined contribution or a defined benefit plan?
And we'll try and be as fair as possible.
I said, I'll be a co-author of that bill.
That's what we should be doing.
And he had that bill killed in the first committee, Public Employment and Retirement Committee in the Senate.
He only got one vote, and that was mine.
It was a five-member committee.
My fellow Republican abstained.
The three Democrats voted no.
Last year, in the fall, Steve Glazer could not get the endorsement of the Democratic Party at their convention in Long Beach because of that bill.
They remembered that, hey, he was trying to fix something.
Jerry Brown wanted to do the same thing.
I did the same thing in 2009 as a county supervisor here in Orange County.
And Jerry Brown couldn't get it in his Public Employment Pension Reform Act of 2012-2013.
It's like you cannot offer defined contribution plans, 401Ks.
But Governor Brown was able to do it with Janet Napolitano, the Chancellor of the University of California.
And she wanted more funding.
And he said, fine, you can have more funding from the state, but you have to adopt it.
This defined contribution component.
Well, we're finding that 37%, maybe more, of new hires are going into the defined contribution plan because younger employees are millennial.
They don't stay with employers very long.
They want to transport that money to the next job and keep growing it as opposed to relying on a defined benefit pension plan somewhere way down in the future.
Now, you mentioned it's difficult for politicians to...
What will happen to a politician?
Do the unions spend a lot of money against them?
Do they lose their career?
Does their career end if they want to do something about this?
Well, you know...
There's so much money being spent by unions to elect their selected candidates.
And so if you see a mailer with a fire department or the police department and it says, you know, Police Officers Association or Firefighters Association, that's union money trying to back Someone who will disregard the financial detriments of what they want so they can keep things in place.
And so that is the dirty little secret of politics.
It was real interesting.
We had the George Floyd incident this year in Minneapolis, and there was a reaction by the public.
They then focused on police unions.
And what are they doing?
And someone did a little research and they went through all the campaign contribution forms of all 120 state legislators.
And only one, only one legislator out of 120 had no contributions from police unions.
That was me.
And so you will see the public safety unions coming after me big time.
The California Correctional Peace Officers Association, this is the union that runs our state prisons, has already put in almost a million dollars against me.
And how do they do that?
Do they have ads that they're saying, I'm a bad guy.
I'm a Trumper.
I'm anti-science.
But you pick whatever polls well, and I'm the bad guy.
So I'm going to be like Luke Skywalker in Rogue One.
They're going to have the cannons on me for a long time, and they're going to hope that they can get me down so that my no-name opponent, who has no record, But it fits their narrative until he can, you know, get even.
And then if they can spend enough, then I will lose my re-election.
Is this happening across California in all levels of the...
Absolutely.
And how can we break out of it?
How can the voters do something about this?
What should they do?
Well, they have to wake up.
They're busy.
And so a lot of them just have a shallow approach to politics.
If you're an R, I'll vote for you.
Or if you're an R, I won't vote for you because I don't like what the president's doing.
Or whatever simple surface stuff that we're looking at.
But you've got to look at the way your city and your school district is being managed.
And you have to see...
What you can do to change things because it will eventually impact you.
It'll impact your housing values.
Who wants to buy a house in San Bernardino or Vallejo?
I mean, you know, when the New York Times about 10 years, 20 years ago called San Diego Enron by the Sea.
Man, it froze things.
I mean, people freeze.
You need a good running city to attract businesses.
And if you're not going to do that, if you're not running well, you're going to encourage businesses to locate elsewhere.
So there's a price.
And if you're not paying attention, you will eventually pay the price.
Do you have any other remarks for our audience?
Well, I think what you see in California is that even though we have the highest sales tax rates, there's still room to raise them.
So you see a lot of cities that are putting measures on their ballots to raise the sales tax, and they'll tell you that it's for better public safety.
But what they're not saying is it's really a pension tax.
You are now paying the price.
For decisions that were made by former council members who probably aren't there anymore, but because they adopted such attractive pension formulas, increasing them by 50% for not only their police officers and firefighters, but for their Regular workforce.
That means that the city needs to find revenues to make their budgets balanced.
This is the crisis.
Poor fiscal management leads to one solution, usually, and that is higher taxes.
Okay, great.
Thank you.
You're welcome, C-Mac.
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