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California Dreaming

One percent a year returns won’t be enough to pay state pensions.

Jul 30, 2012, Vol. 17, No. 43 • By MARK HEMINGWAY
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“To this day, the California funds instigate a dizzying number of proxy fights at the companies in which they invest, focusing not just on governance-related issues like executive pay but on everything from carbon taxes to divestment from companies that do business with Sudan,” observed Jon Entine of George Mason University in an article in Reason magazine. This politically motivated investment strategy has not worked out well. Entine noted one example among many: In 2003, “CalPERS rejected a recommendation from its financial adviser, Wilshire Associates, to invest in the equity markets of four Asian nations​—​Thailand, Malaysia, India, and Sri Lanka​—​based on their alleged misdeeds.” That decision cost state retirees $400 million.

Angelides left his job as state treasurer in 2007 and launched an unsuccessful bid to unseat Arnold Schwarzenegger as governor. That same year, the Los Angeles Times reported that CalSTRS had ousted investment banker David Crane​—​“a close friend” of Schwarzenegger​—​from its board for repeatedly questioning whether the pension fund was irresponsible to assume an 8 percent annual return. In 2009, President Obama appointed Angelides to head the Financial Crisis Inquiry Commission, which was tasked with writing a report detailing the causes of the 2008 financial crisis. Looking at the wreckage of California’s pension plans​—​which were heavily invested in AIG, Citigroup, Lehman Brothers, and other major players in the meltdown—one might say that Angelides’s chief qualification for investigating fiscal crises is instigating one.

The recession does appear to have been something of a wake-up call, and states are slowly starting to address the pension problem. Between 2009 and 2011, 43 states cut benefits, increased employee contributions to pension funds, or did both. In 2010 and 2011, 18 pension plans in 14 states lowered their return assumptions. Still, most pension reforms have been piecemeal and inadequate. 

Further complicating states’ pension woes is the related problem of retiree health costs. While the numbers aren’t as big, the actuarial problem is even more acute​—​in 2010, state retiree health care liabilities were $660 billion, but “states had assets to pay $33.1 billion, leaving a $627 billion hole,” according to Pew. Only 7 states have funded more than 25 percent of their retiree health care obligations.

Along with Wall Street, angry taxpayers might help get state pension funds under control, as they slowly realize they are on the hook for astronomical sums. There are already signs that this is happening: In addition to Scott Walker’s recall election triumph and union reform success in Wisconsin, San Jose and San Diego residents have specifically voted to rein in public employee retirement packages this year.

But things are likely to get worse before they get better. Following the announcement of California’s dismal returns last week, Fitch released a report saying that the ratings agency “expects numerous systems to report similarly disappointing returns.”

Mark Hemingway is a senior writer at The Weekly Standard.

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