The City robbed its employees’ pension fund to help pay for the 1996 Republican National Convention. Government labor unions went along but later got their reward. In the early 2000s, the city council gave workers extra benefits that the City could never pay if the economy went south. It did — decisively. A federal government agency and several consultants lashed out at the bureaucracy for concealing the City’s woes from bond documents. Some employees were charged criminally but got off. Now the City owes the pension fund more than $200 million a year, rising to more than $300 million annually in 2014 and $500 million in 2025.
With property, sales, and hotel taxes likely to be weak for a long period, there is no way the City can pay these sums, although it will continue to raise fees, slash services, sell assets, cook the books, and perhaps raise sales taxes. Meanwhile, safety workers are retiring at age 50 and 55, some with six-figure yearly pension payments, while other City retirees are getting more than $15,000 a month.
Can this picture get any worse?
Why yes, it can, and is already getting so. That’s because San Diego is a microcosm of the United States. Many other municipalities and states have similar problems, and these pension commitments are considered to be locked in stone legally. Only a bankruptcy court could break the contracts, and any such decision would probably go all the way to the United States Supreme Court. Ergo, this problem will be around quite a while, in San Diego and elsewhere. That will put pressure on the already-ailing federal government to bail out states and cities. San Diego is a woebegone jurisdiction, but it has too much company to count on federal help.
On September 10, Orin Kramer, a hedge fund manager who is chairman of the council overseeing the deeply troubled and scandal-wracked New Jersey public pension system, wrote an op-ed for the New York Times. Kramer shocked New York by declaring it was essentially insolvent because by any reasonable accounting standards, the state’s pension system is underfunded by tens of billions of dollars. Kramer went on to say that public pension budgets are based on economic fictions, including excessive expectations of future investment returns and measuring assets “based on average values looking back over a period of years,” not based on current market values, as private sector assets are calculated.
State and local government pension shortfalls are $1 trillion, said Kramer. If governments used the same accounting standards as companies, the figure would be a whopping $2.5 trillion. Since private sector standards are also too lax, realistically government funds could be $3.5 trillion in the hole. Whew!
In a separate communication with me, Kramer said that when he took office eight years ago, he and his board decided that the state’s “actuarial expectations were bogus, and we would ignore them.” But media did not report the shocking decision. One reason, he feels, is that “the consequences of understanding the math involve addressing politically unspeakable choices.”
Yes, unspeakable. Example: the City of San Diego’s pension fund expects to earn 7.75 percent a year. It has made 4.5 percent annually over the past ten years — not even close. If it lowered the expectation to a reasonable 6 percent a year, then the City would have to plunk far more into the fund each year, and it can’t afford what it is putting in now. According to a recent study, even with an unrealistically high 8 percent expected return, Illinois, Louisiana, New Jersey, Connecticut, Indiana, Oklahoma, and Hawaii will run out of pension fund money in ten years.
Thomas Gober is a national insurance fraud investigator and forensic accountant who recently relocated to San Diego. “Accounting for pensions is very similar to accounting for insurance companies,” says Gober. “Because of the long-term nature of their promises, there are supposed to be significant checks and balances in place. But as with insurance companies, regulators appear to be asleep on the job; I fear their lack of diligence makes them complicit in the deceptions.”
He particularly mentions how pension funds hide liabilities. Says Gober, “Insurance companies and pensions both sit on enormous amounts of assets that are earmarked for liabilities — promises — far into the future. The temptation is great to delay recognizing those obligations until a later date — put off the bad news until it is on someone else’s watch.”
Former city attorney Mike Aguirre believes that Mayor Jerry Sanders is doing just that. In 2005, he set up a five-year plan for putting money into the pension system. In 2007, he even declared that the City was paying in more than was required. Then came the crash. The fund lost 4.7 percent in fiscal 2008 and 19.1 percent the next year. Sanders’s highly publicized personnel and pension cuts were in fact minimal. The present value of future benefits in fiscal 2009 (the last reported) shot up to $7.2 billion, more than double the market value of assets of $3.5 billion. The unfunded liability at that time was more than $2 billion, and the system was 66.5 percent funded, versus 78 percent for such pension funds nationally.
Now the mayor has endorsed a sales tax increase — something he said he would never do — to help close the gap. The proposal, which goes on the ballot November 2, promises spending cuts, “but not one of the [cost-cutting] proposals addresses investment policy or the pie-in-the-sky pensions,” says Aguirre, who wants more conservative investment strategies as well as more realistic pensions. “Raising the sales tax doesn’t make sense. We can’t bail out pensions 100 cents on the dollar.”
Powerful public sector unions are blocking reform. Since 1973, public sector unionization has grown from 23 percent to 37.4 percent, says A. Gary Shilling, New Jersey–based economist. By contrast, private sector unionization over the same period went from almost 25 percent to 7.2 percent. Public sector wages and fringes have zoomed. According to the Bureau of Labor Statistics, average wages in the public sector are $26.25 an hour, compared with $19.58 in the private sector. Government workers get benefits of $13.56 an hour, far more than their private sector counterparts’ $8.15.
San Diego’s private sector is a mere 5.3 percent unionized, while the public sector runs at 45 percent, according to a recent study by the University of California Los Angeles. Compare that with the state’s 9.7 percent and 56.1 percent, respectively.
Although San Diego’s government employees are less unionized than those elsewhere in the state, government plays a bigger role in the local economy. Government is 17 percent of the San Diego economy, compared with 13 percent nationally and 12 percent in California, says Kelly Cunningham, economist for the National University System Institute for Policy Research.
The irony is that while pension commitments to City of San Diego workers may have to be adjudicated in a Chapter 9 bankruptcy, money from Washington D.C. and Sacramento pours into the local economy, softening the blow a little bit.