Sunday, November 11, 2012

The Scariest State

In the last chapter of his story on global fiscal recklessness, Michael Lewis makes a very compelling argument that the financial problems of California (and more broadly the United States) are in fact symptoms of a much more serious and scary disease: the American culture itself. We, as Americans, succumb to the desire to overindulge and reap rewards in the short run, sacrificing long-term interest. Lewis points to the idea that as long as this culture is in place, out financial problems will persist. Since Lewis highlighted California’s Public Employee pension woes in this chapter, I decided to take a closer look at the state of pensions in California to see whether this mindset is beginning to change. California is spending $6.6 billion this year on retirement benefits, up from $2.7 billion a decade ago. The tab will continue to increase as the state amortizes its $225 billion unfunded liability. On top of this, pension and retiree health benefits consume more than a third of many local government budgets, forcing cuts in services and public safety, and in some cases bankruptcy (as in the case of Vallejo). The below graph shows this rapid increase in the costs associated with California’s Public Employee Pension.

By comparing the yellow and black lines on this below graph (Average Pension Payment and Average California Income, respectively), we can likewise ascertain the drastic amount that pension payments have jumped in the last two decades.

Over the past year, California Governor Jerry Brown pushed forward pension reform legislation that contains a cap on benefits for future hires of public safety officers at $132,000, a later retirement age to 57 for public safety officers, a rolled-back pension formula and higher contributions from some state employees.  The fact that a pension plan of any shape or form is passing in California forces us to ask the question of whether this pension reform plan indicate a change in the California culture? The answer to this question is … maybe. While these reforms push California in the right direction, they do not push California far enough.  The roughly $50 billion in anticipated savings won’t take place for another 20 or 30 years, as most reforms affect future employees. Critics of Brown’s pension plan highlight that comprehensive pension reform has to do more to address current employee benefits. This fact in itself indicates that the current ‘mindset’ of legislators is still very much focused on ensuring that their own indulgence is satisfied; the present generation gets to spend while the next generation is forced to sacrifice. This in itself embodies Lewis’s assertion that the importance of long term interests pales in comparison to the allure of short-term reward. Moreover, this reform plan will not impact the pension benefits of the majority of CalPers (one of California’s largest funds) members (i.e. it will not reduce California’s pension bill either).

While the evidence strongly points to the fact that Lewis is indeed correct in saying that pension problems are one of many resulting symptoms from the American cultural disease, the fact that other states like Rhode Island, New Jersey, Wisconsin, and Illinois are pushing through pension reform while California still lags behind indicates that either this ‘disease’ is not as pervasive throughout the United States as Lewis assumes, or that Californians are more indulgent than most.

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