David Crane makes one last plea to legislators to stop Jerry Brown’s $6 billion loan to CalPERS
A letter sent today by David Crane:
Dear Legislators,
In my essay the other day I provided an alternative to Governor Brown’s pension loan — actually pay down pension debt.
You could do that by offering to redeem future pension payments for cash today. Provided the amount you pay is no greater than the present value of those future pension payments using the discount rate CalPERS uses to present value those payments, then you would actually pay off debt. If you wanted to save the citizens you serve even more money, you could start by offering less than present value.
Ideally such a pay-down would not be paid for with borrowed funds but if you insist on borrowing, then at least swap the floating rate loan from the special fund into a fixed rate loan so you actually know your cost and don’t subject citizens to floating rate loan risk. Together with the redemption outlined above, a fixed rate would lock in savings equal to the difference between the loan rate and the discount rate.
You should understand that the path proposed by Governor Brown and embraced by Treasurer Chiang and Senator Moorlach–a path you are about to embrace–is no different than the path mortgage lenders induced borrowers to take before 2008: i.e., a “teaser” low interest floating rate loan the proceeds of which are invested in assets (houses in that case) expected to grow at a higher rate and earn big profits for borrowers. Just see the stunning language from Brown’s budget below. That language goes beyond representations made by mortgage brokers and is eerily similar to assertions made by the state when it enacted SB 400 in 1999 (eg, “will not cost a dime”).
Public officials should not lead citizens down similar paths. You should actually pay down pension debt or you should not proceed with the current proposal.
David Crane
From page 7 of Governor Brown’s May Revision: “The May Revision proposes a $6 billion supplemental payment to CalPERS through a loan from the Surplus Money Investment Fund. This payment is expected to earn a 7 percent return from CalPERS, compared to the less than 1 percent currently earned from the fund. Over the next two decades, this supplemental payment will save an estimated $11 billion . . ..”
June 15th, 2017 at 6:43 am
I agree with the basic analysis. If the State can pay off long-term debt that in effect costs 7% (i.e. pension obligations) at par it should do so whenever it can, as a first step to actually reducing the size of the obligation. But is it practical?
Maybe some pension beneficiaries would go for the deal, either because their personal discount rate is high (e.g. they really need the cash now) or they don’t understand the significant loss they’d incur by selling at par. But I’d guess that most won’t — and I’m sure the unions (who have an interest in keeping them invested) will discourage it. They might even explicitly point out that a AA investment @ 7% is a ‘unique’ benefit, though perhaps this is politically a bit tricky.
Still, by proposing a par buy-down, you are highlighting the fundamental problem with the SMIF loan — if a 7% long-term return was in any way realistic, then why wouldn’t beneficiaries be as well off by getting the par value now? The fact that most of them and certainly the unions know they wouldn’t be speaks volumes.
John
June 15th, 2017 at 10:16 am
While it might sound really foolish for retirees to elect a lump sum at a 7% discount rate (when reinvesting that sum at anywhere near that expected rate of return would be FAR more risky) we need to keep in mind that CA’s and CalPERS financial position could deteriorate rapidly in a market downturn. It’s certainly not anywhere near a 100% guarantee that the workers/retirees will get all that has been accrued for their PAST service. A bird in the hand is worth 2 in the bush.
That said, CA’s ONLY salvation is for the pension accrual rate for the FUTURE Service of all CURRENT workers to be materially reduced in “value upon retirement” (encompassing BOTH Plan “formulas” AND Plan “provisions” such as very young ages at which they can collect unreduced pensions , and COLA increases). Hopefully a COURT rejection of the “California Rule” will at least make that a possibility.
June 15th, 2017 at 11:12 am
Thank you, David Crane for trying to be the fiscally responsible adult in the room. The problem is that Governor Brown and legislators like him who believe you can spend your way out of all fiscal holes is that they get to experiment on the taxpayers’ dime again and again with NO accountability. People forget that Pete Wilson enacted reforms back in the mid-’90s after the little Hoover report was published. Those reforms were working. So the public unions dumped $$$ into the Gray Davis campaign which with his election gave us the 1999 Rollback of Wilson’s Reforms and the seduction of public entities with promises of lush pensions/benefits, no employee contributions and NO cost. We the taxpayers are left holding the bag. Shame on CA government!!