"As California goes, so goes the nation"

The title of this article is an expression so often used it's become a cliché.  Do an Internet search on that expression and you'll find dozens of articles that cite it.  However, many of them are positive - saying that California provides leadership to the USA in progressive causes.  Tonight, we're going to look at two very negative examples.

Steven Malanga has written an extraordinary article titled 'The Pension Fund That Ate California'.  In it, he examines the incompetence, corruption and partisan politics that have led the California Public Employees' Retirement System (CalPERS) to the brink of bankruptcy.  If any of my readers are relying on a pension administered by CalPERS, you might want to consider alternative arrangements . . . quickly!  Here's a brief excerpt.

California taxpayers help fund CalPERS’s pensions and ultimately guarantee them, so they might wonder: How could a financially troubled former union leader occupy such a powerful position at the giant retirement system, which manages roughly $230 billion in assets? The answer lies in CalPERS’s three-decade-long transformation from a prudently managed steward of workers’ pensions into a highly politicized advocate for special interests. Unlike most government pension funds, CalPERS has become an outright lobbyist for higher member benefits, including a huge pension increase that is now consuming California state and local budgets.

. . .

CalPERS has also steered billions of dollars into politically connected firms. And it has ventured into “socially responsible” investment strategies, making bad bets that have lost hundreds of millions of dollars. Such dubious practices have piled up a crushing amount of pension debt, which California residents—and their children—will somehow have to repay.

. . .

Right now, the pension bill that Californians owe because of CalPERS is enormous. In a December 2011 study, former Democratic assemblyman Joe Nation, a public finance expert at Stanford University, estimated that CalPERS’s long-term pension debt is a sizable $170 billion if CalPERS achieves an average annual investment return of 6.2 percent in years to come. If the return is just 4.5 percent annually—a rate close to what more conservative private pensions often shoot for—the fund’s long-term liability rises to a forbidding $290 billion.

. . .

CalPERS’s advocacy for higher benefits and its poor investment performance in recent years have locked in long-term debt in California and driven up costs, problems for which there are no easy solutions. As former Schwarzenegger economic advisor David Crane, a California Democrat, has said of the fund’s managers and board: “They are desperate to keep truths hidden.”

There's much more at the link.  Illinois isn't far behind California in the condition of its state pension fund, and other states are deep in the danger zone as well.  I'm sure they'll ask Washington for a bailout - again! - but given the parlous state of the US and world economies right now, I'm not sure that'll be possible, even if they can get the quarreling parties in Washington to agree.

The scandal of CalPERS is echoed in another financial stratagem that's increasingly being used by cash-strapped California cities and states.  Walter Russell Mead examines the phenomenon of a type of municipal bond known as a 'capital appreciation bond'.

The next financial market meltdown may already be brewing: not in the housing market, this time, but in municipal bonds. Greedy bankers, opportunistic politicians and hobbled regulators are putting a time bomb in the muni market that could set off another devastating crash.

California is leading the way.

It is starting out innocently enough. Looking to expand a number of aging school facilities but loath to raise the taxes necessary to pay for it, California cities have opted to fund school construction projects with capital appreciation bonds, which allow school districts to borrow money now while putting off payments for decades. It sounds like a great deal, but it has one major drawback: The interest rates involved push the eventual price tag to many times the original amount—sometimes as much as ten times more.

. . .

This is irresponsibility on steroids, but it represents a dream come true for crony capitalists and Wall Street I-bankers. Fat fees, enormous interest, and the taxpayers won’t even know what hit them when the whopping bills come due.

But everyone involved should be put on notice: While not all of these bond issues are equally bad, as a class these bonds are toxic and likely to bring serious pain to everyone connected to them. Some of the deals already done will likely blow up in the future; bankruptcy will loom when the pension squeeze and the bond bomb both hit at full force.

But the worst danger is not from the relatively small number of deals already done but in the potential for this kind of finance to spread. Like the bad ideas that started off small but grew until they were big enough to blow up the mortgage market, dangerous practices can become more common and widespread in municipal finance.  More politicians will catch on to the magic of long term bonds that bring benefits now but will savage your town a couple of decades on. Other state legislatures will be pressured to follow California’s rash venture into muni madness as investment banks, construction companies and public sector unions lobby non-stop. Politically managed pension funds will load up on this dangerous paper. Investors hungry for yield will pile on and tell themselves that the market is safe. It will all look brilliant until the roof caves in.

. . .

Politicians who approve or recommend these bonds should be braced for a firestorm of public rage when and as voters realize just how badly they’ve been shafted. Nobody has an electoral mandate to saddle future generations in this way.

Again, more at the link.  It's well worth your time to read the whole thing.

What both of these crises reveal is that politicians, union representatives and bureaucrats are content to push their current profligacy onto the shoulders of generations to come - some not even born yet.  I don't think they realize just how likely those future generations are to repudiate the debts with which their parents, grandparents and great-grandparents saddled them, without so much as a 'by your leave'.  If I were them, I certainly would!  I believe that those relying on these impossible, 'pie-in-the-sky' pensions are going to find their cherished retirement benefits just aren't there any more;  and the cities that rely on ruinously expensive capital appreciation bonds to fund current civic expenditure will find that future residents will simply move to cheaper locations, leaving them without income to pay the bills.

"As California goes, so goes the nation".  In these two cases, I hope and pray that's not the case . . . but I fear it's already too late for basket-case states like Illinois.  They drank the California (i.e. progressive) Kool-aid long ago.  As for the rest of the USA, we'll just have to wait and see, won't we?

Peter