In less than five years California will have over 10 million residents who are over the age of 55 (ref. U.S. Census, California Demographics). If every one of these people were to receive a pension equivalent to what the average public employee in California can now expect after working full-time for no more than 30 years, it would cost taxpayers nearly $700 billion per year. To put this in perspective, $700 billion is 40% of California’s entire gross domestic product.
When spokespersons for California’s public sector unions claim that pension reformers are “trying to destroy the middle class,” they should be asked this question: How on earth can any system of retirement security – not even including health insurance benefits – possibly expect to consume 40% of the entire economic output of the state or nation in which such benefits are being provided, and yet remain financially sustainable? Universal and equitable retirement security in America will never be realized by offering everyone the deal that public sector employees currently receive. Their benefits must be reduced. But instead, government worker pension funds are making riskier investments.
Public sector pension funds rely on investment returns to make up for the shortfalls in taxpayer revenues. But can investment returns really hope to sustain public sector pensions when there are as many people drawing pensions out of the fund as there are people (and taxpayers) contributing money into the fund? That tipping point, where there is as much money going out as there is going in, has not yet been reached, since most pensioners in the system currently are drawing benefits that were calculated when pensions formulas were far less generous. For example, a teacher who retired in 1985 and is still alive will receive today a pension of barely $30,000 per year. A teacher of the same seniority retiring in 2010 after a 30 year career will receive a pension on average of $70,000 per year. This same sort of disparity applies across all public sector disciplines, and is the reason there is still more money going into public sector pensions than is being paid out. Once these pension funds start selling as many securities as they are buying, even more downward pressure will apply to stock prices than already applies.
As we documented in “What Payroll Contribution Will Keep Pensions Solvent?,” for every 1.0% that the rate of return for a pension fund falls, the required contribution into the pension fund must increase by about 10% of payroll. This means, for example, that if CalPERS lowers their projected rate of return from 7.75% per year down to 6.75%, the contributions their members (or taxpayers) will have to invest in CalPERS every year will rise from (for example) 20% of payroll to 30% of payroll. It is difficult to overstate just how dire the pressure is on public sector pension funds to claim they can continue to earn 7.75% per year.
One way that public sector pension funds are trying to maintain their rate of return is by investing in hedge funds. These virtually unregulated funds utilize manipulative tactics to extract larger than market returns – often at great risk. But to beat the market, someone else has to lose. Public sector pension funds investing in hedge funds are encouraging a phenomenon – market manipulation – that is driving value investors and small private investors out of the market altogether. As reported in the Wall Street Journal on October 18th in an article entitled “Traders Warn of Market Cracks,” the dominance of program trading and other manipulative tactics is taking taking liquidity out of a market that is already in trouble:
“One surprising element of the fall-off in liquidity is that one key set of players actually appears to be more active in recent months: so-called high-frequency traders. These hedge funds use computer models to trade at a rapid pace. In recent years they have replaced brokerage firms as the go-betweens when investors trade stocks. But with so many other players stepping back from the market, the liquidity that high frequency traders are providing isn’t creating much of a cushion, traders say. In fact, some say they may be making matters worse.”
Yet public sector pension funds have to invest in hedge funds. They have to be high-risk players, exploiting the tactics that value investors would never consider and small investors could never afford – and THIS is the reason they claim they can outperform the small investors – because without these high-risk, manipulative, barely-legal, market-killing, short-term acts of desperation, they would already have to admit they cannot possibly earn 7.75% per year. And their actions only postpone that admission....Finish reading at UnionWatch - other states discussed at end of article
