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Oct. 11, 2010 - Freedomain Radio - Stefan Molyneux

19:40

1768 Trouble Brewing: The Disaster of California State Pensions - An Interview with Robert Enlow

An interview with Robert C. Enlow, President and CEO of the Foundation for Educational Choice, about California's looming state pension crisis.

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	Hi everybody, it's Stefan Molyneux from Freedomain Radio.
	This is an interview with Robert Enloe, the President and CEO of the Foundation for Educational Choice, the School Choice Legacy Foundation.
	Of Milton and Rose Friedman.
	He is the co-author of a number of books on school choice.
	His articles and quotes have appeared in numerous publications, including The Wall Street Journal, New York Times, Arizona Republic, National Review, and USA Today.
	But we're not talking about school choice.
	We're talking about a very interesting report, a chilling report, that has been produced by his foundation called Trouble Brewing, The Disaster of California State Pensions.
	Well, thank you so much for taking the time, Robert, and thank you so much for having the cojones to release this rather damning report that has slow, cold-footed spiders crawling up and down my fiscal spine.
	Can you just talk a little bit about the history of this looming crisis, how long it's been going on for, and how it's managed to remain out of the public eye for so long?
	Well, I appreciate you having me.
	Thanks very much. And everyone in California should have that feeling of cold, dark spiders crawling up their fiscal spine because This is a real problem in California.
	We put together a study which was generously funded by the Corrett Foundation in San Francisco and the goal here was very simple.
	How much do Californians actually owe in their unfunded pension liabilities and what was the history of it?
	How did we get there? We got there in two ways.
	One, public pension unions and teacher unions have had lockstep control over the bargaining process for the last 25 years or so, in fact even longer.
	And so what they were doing in the legislature when we had these boom years is instead of paying teachers more of what they were worth, they were paying teachers to find benefit programs at the end of their career.
	So there are about 12,000 public employees in California that are earning over $100,000 a year in retirement benefits.
	And that's coming because they're making 90% of their end-year salary.
	That's how they do it. They create these rules where 90% of their end-year salary is what they're going to get for all the rest of their lives.
	And they're not putting anywhere near that kind of money in, nor are they taking the risk.
	So what happens is you have the union controlling the bargaining process, creating a defined benefit program rather than a defined contribution program, and then hiding all these numbers from the public.
	And here's the other thing. What they've been doing on their investment portfolio for the public unions and the teacher unions is saying, hey, we're going to get an 8% return every year.
	Now, I don't know about you, but I haven't had an 8% return on anything I've been doing for the last decade.
	Nor has anyone else because there's been a zero growth in the last decade.
	The fact is they've been projecting these incredibly rosy returns for the last over 20 years now.
	And not even the private sector by law is allowed to do that.
	So you've got these incredible amounts of money that are being projected to rake in tons of interest that's just not there.
	The union official who's the head of the CalSTRS, which is the California State Teacher Retirement Program, actually said this year, That they would have to have a return on their money of over 20% for the next 5 years in order to fully fund the program in 30 years.
	It's just pie in the sky so they get to control these processes and you end up with a $326 billion hole.
	Right, and a lot of this, if I read the report correctly, came out around 1999 in order to, let's not use the word bribe, let's use the word incentivize.
	In order to incentivize the public sector employees and to pacify the unions, the government passed These laws which, again, provided, as you say, fixed income, which is where the entire risk for any losses in the portfolio or even less than, as you say, these stellar 8% gains is borne by the taxpayer.
	So rather than give raises which show up in the budget immediately, Governments, as they want to do, shift the burden forward into the future by saying, we're going to pay you massive amounts when you retire in 10, 20 years, and therefore that pacifies the unions and the public sector employees in the moment while shifting the burden forward in the future, which is fairly sleazy, but I must say, in a democratic government, somewhat inevitable.
	Well, it is something that happens all too often in our government.
	You know, they kick the can down the road, they kick the can down the road, but what's happening in California is they kick the can down the road and they kicked it into the wall.
	So you get a situation in California where the public just can't afford these benefits anymore.
	And the Supreme Court doubled on top of that and said, well, you can't really take away these defined benefits because if you do, then you have to replace it with something as valuable.
	So instead of paying teachers what they're worth on the front end exactly, having to show up in the budget right away, they pay them on the back end.
	And that doesn't even include the health care benefits.
	This is just retirement benefits.
	And so it's a real problem in California.
	And in fact, California is just the tip of the iceberg.
	The entire country has this problem.
	So, you know, California is just going to be the first to go down a sinkhole in this.
	Right. Now, I'd like to just take my listeners step-by-step through the problem of the discounted rate, right?
	So, if I understand it correctly, they're projecting between 7.75% and 8% growth, which, as you say, the stock market is about the same as it was 10 years ago, so it's been effectively 0% growth.
	So, by having a higher percentage projected income from their stock market investments, they claim that they need less money now to pay more for benefits later, because they're going to make all this money in the stock market.
	And if you take, as I think Gatsby recommends for private sector pensions, 4% and change, this is where I think you tacked on, you know, some of the seriously deranged numbers to the 70 to 80 billion deficit that's projected.
	And I wonder if you could take us a little bit through that logic and how that works.
	Yeah, so in the private sector, they're really only allowed to go to the bond rate, the high quality bond rate, which was in California 5.2%.
	So if you look at the difference between what the state and the governments project around the country of 8% or 7 to 3 quarters of 8% and what the private sector is allowed to project as income for 30 years, you get this massive difference between the actual amounts that is unfunded.
	So the state itself recognizes in California a $75 billion difference.
	But the actual difference between the private sector, let's be very clear, it's linked to bonds and it's linked to a real percentage that is likely to happen over a 30-year period.
	So the fact is what the governments are doing is kicking the can way far down the road and presuming a massively rosy return.
	So just the difference between the 7.75% and 8% and the 5.2% amounts to $282 billion.
	Let's also be very clear, this is not just about market losses.
	Our report finds that only $44 billion of the total 326 is due to market losses in the last few years.
	Right, so this isn't just that the market fell apart and look how bad it is.
	This is just assumptions that are bad by the government based on these discount rates.
	Right, and for most, I mean, for most people with any kind of portfolio, if you were going to assume higher rates of return, you also have to assume that there's going to be more volatility, because you, I mean, this is a basic law of economics, is you're not going to get higher returns without higher risk.
	Otherwise, that's where everybody would put their money, thus driving the interest rates down, or sorry, the rates of return down.
	And, of course, what's chilling is that there is this assumption of zero risk, despite the fact that there are multiples of the expected returns on investment from these portfolios, which is completely deranged and, as you say, would not be allowed through any reasonable accounting methods in the private sector.
	Look, this is the real problem.
	These defined benefit programs that have no association with risk whatsoever make it impossible for us to have any kind of real change.
	It's really radically Radically bad for taxpayers that we pay all these defined benefit programs instead of defined contributions.
	You and I pay into our own personal pension and assume a risk for a higher return.
	And we could lose our shirts if we want a high, high risky thing, but we could also gain a lot.
	But the fact is that's not what's happening in the government sector because the government sector says, well, we have to, by law, pay you anyway.
	So even if we assume a low risk, we still have to pay you if we don't meet our burdens.
	So the current public employees are not even paying a fraction of what they owe.
	In New Jersey, for example, Governor Christie just fought one of the bloodiest fights ever politically that I've seen just to get the public employees and teachers to go from zero putting into their pension, 0%, to 1.5%.
	I mean, that's the kind of power and the kind of fighting you're up against.
	It's just insane. Right, right.
	And can you just give the listeners who may not be aware of sort of arcane intricacies of California budgets, the hundreds of billions of dollars in shortfalls that these pensions represent, how does that relate to the discretionary spending that is available to California to patch up these holes?
	Well, so the amount that we found in terms of the unfunded liability of $326 billion is three times more than they say it is.
	It's four times more than all of the general fund income they're going to bring in in 2010.
	And here's what's shocking.
	You'll get this. It is more than the combined gross domestic product of Ireland, Vietnam, and Nicaragua.
	It's more than the gross domestic product of Finland, for example.
	It's huge numbers, mind-boggling numbers, that the taxpayers are going to have to pay.
	Let's be very clear. Every taxpayer in California is going to have to pay it.
	When you look at San Francisco, The actual burden per resident in San Francisco is $27,000.
	It's more than the cost of a Prius.
	In UCLA and Los Angeles, in the UCLA area, it's about $15,690, or about the cost of books and tuition at UCLA. I mean, these numbers are staggering when you look at what California's owed, and there's no way around it.
	They have to pay it. So, you know, I guess what they're going to do is just say, knock on wood, and hope the market does really well.
	Right, yeah. Well, that's not exactly a fiscal plan that makes a lot of sense.
	That's the government plan, right?
	That's right. Cross your fingers and pray to the saints.
	I was surprised in your recommendations that, given, as you say, that the deficit is about the size of these four countries, that California shouldn't invest in a navy, invade these four countries and simply take over their GDP to pay for it.
	I guess that's in a supplementary paper that's coming down the pipe, right?
	Well, that and the fact that they're probably looking at these countries to buy their bad debt.
	Right, right, right.
	That's probably what's happening right now already.
	I mean, look, California has a real problem.
	And what the governor just tried to do in terms of pension reform and the budget is really not going to be enough.
	He's trying really hard, and what he's doing is to try and get new employees.
	New employees have to go on a defined contribution program.
	There's just no doubt about that. This problem will continue until you actually have each employee sharing the risk that they have.
	But that still doesn't solve the problem with the $326 billion hole they have.
	Now, it struck me that your estimates were fairly optimistic.
	Now, I know that you're saying it's conservative and what that means, I think, in the context of this report is you're not going to assume that they're going to get a 0% return on investment over the next 10 years.
	In other words, it's not good to mirror.
	The past 10 years. Now, I think that you could make a good argument as to why that could be the case.
	Now, of course, if it's still going to be zero, they probably would shift their investments elsewhere, so it's not going to be exactly zero.
	But, I mean, we've had a zero percent growth in the stock market prior to, you know, all of the debts that have been incurred through these various wars and the deficit financing that has been going on and they're simply expanding.
	The idea that the stock market is going to pick up When the US is, you know, double in debt what it was before the stock market began, its sort of flat rate of return, you could, I think, make the argument that the returns are going to be less than the 5 and change allowed by Gatsby, and you could say it's going to be, you know, 2%, 3%, in which case, I would imagine the numbers get much worse.
	Well, they do get worse. In fact, Stanford did a study where they looked at using the T-bill rate, the government treasury bill rate, which is about 1.5%, which is awful low.
	But they came up with using the government treasury rate and found that the unfunded liability was about $500 billion.
	Let's be reasonable. Somewhere between $300 and $500 billion is what California taxpayers owe for bad government management of funds.
	That's what they owe. And frankly, California should kick every one of these folks out of office.
	Milton Friedman had this great comment.
	He said, the problem with government is you have the iron triangle of legislators, lobbyists, and lifelong bureaucrats.
	And that's exactly what you have in California, that are basically all cozied up and got a relationship, and these problems start to happen.
	And you could almost say that, I mean, whether it's $300 billion or $500 billion is somewhat immaterial, given that probably you could not effectively pay even half of that, because tax rates are so high, businesses are fleeing, and you're going to get that inverse Laffer curve, right, where higher taxes is going to drive out more business, and I don't know what the population growth is like in California, but if it's anything like the rest of the U.S., It's fairly close to not being able to reproduce the population as a whole.
	Plus, of course, you've got a lot of people shifting into retirement.
	Even the people who are paying taxes right now who are shifting into retirement are going from these net contributors to net beneficiaries.
	Of course, the healthcare costs are only going to go up for these retirees as they age.
	In a sense, to me, tell me if I'm wrong, does it really matter whether it's 300 or 500?
	If I'm in debt for 10 million or 12 million, does it really matter if I only have 50 bucks to my name?
	Yeah, so when you're absolutely bankrupt, it doesn't matter whether you owe $10 or $10,000.
	Until California starts to deal with the hard choices of whether it's going to raise taxes even further, which of course you know would disincentivize businesses, really radically reduce services, or frankly, and this is the hard one, make public pension and public employees and teachers pay more for what their share is.
	Until they make one of those three hard choices, that's the other thing they could do.
	They could fire everyone. But they're not going to do that because that would lead to major chaos.
	So really, they have three choices.
	Raise taxes, totally reduce services, or make the public employees pay more of their fair share.
	And the fact is, they're going to have to do the last one.
	They're going to have to make them pay more of their fair share.
	Otherwise, they will stay broke for the rest of their existence.
	Well, okay, let me just examine this and let me pay devil's advocate here.
	I mean, if you say, well, we're going to make the public sector employees pay more for their own retirement, that's not going to be the case for the people who already have their contracts.
	As you say, the California Supreme Court has disallowed changes in contracts without the addition of equivalent benefits.
	So this $300 to $500 billion hole is going to be there no matter what.
	Is that right? Because it's around the bulge of people who are close to retiring?
	Or does that include people who are starting out?
	No, that includes starting out.
	And here's the deal with the If you're not going to pay more into the program as you're going into retirement, those people who are already retired need to have reduced benefits.
	They're getting 90% of their benefits, their last year's salary, which is their highest rate.
	So here's one thing you could do.
	Instead of having an average of the last year for your benefits, you could have an average of your lifetime salary.
	That would dramatically reduce the amount of pensions paid out.
	But California law, again, this is going to have to go to court.
	So one way to do this, here's a novel way that's been bounded around the country.
	Why not, when the federal government gets overhauled this November in our country, why not have Congress pass a state bankruptcy law that allows states to go into bankruptcy, and as long as it has teeth, you can abrogate all the pensions and contracts.
	And that would be part of the law.
	That is one way to do this, is have the federal government come up with a state bankruptcy law.
	Because right now, states can't go into bankruptcy.
	Right, right. I guess, you know, sort of spitting out my disaster scenario, one of the challenges of that is that in order to keep civil order, you would need a lot of police.
	The police, of course, would be bound by those very same contracts that you're trying to abrogate, so may not have the greatest enthusiasm to control the population's riots when, you know, your controllers are under the same gun as everybody else.
	Well, of course, the best and most effective and longest term way to solve this all problem, and I know we have a huge problem right now, $326 billion in California, But the most effective long-term way is to really radically revolutionize our K-12 education system in America through parental school choice.
	So if you can get a same quality or higher quality education at half the price, that's going to radically transform all these problems and all these debt burdens in states.
	If you look at a state like California, if it shifted 20% or even 30% of its population into private schools using a voucher worth about $5,000, which is the average cost for elementary schools, they would basically cut their deficit in half.
	Well, I think it's fair to say, and I appreciate your school choice comments, I think it's fair to say that we're either heading to a whole lot less freedom or a whole lot more freedom, because this existing snowball is not going to work.
	And I agree with you that there's a lot of very interesting libertarian experiments going on around the world, some radical privatizations, charter schools, school choices, other forms of privatization of government services.
	It seems to me that that is going to be how it's going to have to go.
	I mean, I think we can't really act with the premise that we're all going to slide off into a big pit of fascism.
	I think that's less likely.
	But I do think that putting forward sort of radical privatization ideas Is going to be what's going to have to grab the public's imagination.
	And given the public's general distrust of government at the moment, it seems the most likely to me.
	So I think it's a good thing that you're out there pushing for.
	I think it's fair to say libertarian or free market solutions to these government issues, because that seems to me the most likely outcome.
	Well, I think that's right. And in fact, I think that's one of the great things I like about being in this country, right?
	So in Wall Street Journal today, there was an article about called Europe the Intolerant.
	And the fear, of course, is that America will always be the one that is intolerant and go down the road to fascism.
	But in fact, it's Europe who always gets there, and America doesn't.
	And the fact we don't get there is because we have this history and this tradition of entrepreneurship and innovation and privatization, so where individuals can make a difference.
	And so there's a big snowball heading down the road towards a fork, and it's my job to make sure it heads down to privatization and school choice fork.
	Yeah, I mean, not to psychologize entire continents, but my experience has been that if you confront an American with his unjustly earned income, he will sort of hang his head and kick his feet.
	You know, like, you know, the money that you're getting comes from state programs or protectionism or government unions.
	There's a kind of, yeah, well, but, you know, whereas in Europe, it's like, yeah, and that's how it should be.
	You know, there's this pride in socialism in Europe that there just really isn't in America.
	And I think that has a lot of resonance when it comes to that fork in the road.
	I think that's right. I think that's right.
	And I was just wondering if you could talk a little bit about your website and the resources that are available for my listeners to come by and check out what you've got.
	I appreciate it. Look, so our website is www.edchoice.org, and we are the nation's leading school choice organization in the country in the United States.
	Wall Street Journal has said so, so it must be true.
	Excuse me. Our organization was started by Milton Friedman and his wife Rose, and we have one issue and one issue only, and that is universal school choice for every child in America.
	So our website's all about all these kind of numbers that show how bad the monopoly is, like the study on California pensions.
	In fact, this California pension study comes off the heels of a national pension study, which found about a trillion dollars in deficits around the states.
	And so our job is to show how bad the monopoly is and how much privatization, school choice, and markets do a good job of solving those problems.
	It's edchoice.org, and there's all sorts of resources for everyone.
	Fantastic. And maybe after this latest media flurry is through, I'd love to have you back on the show to talk more about school choice, because I think, as you say, the future belongs to the education of the children, and I think that that's very interesting work that you're doing.
	Thank you very much. I appreciate it.
	We'd love to do that. Thanks so much.
	All the best. Thank you very much.

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