It's Not Accounting Fraud When the Government Does It: California Pensions Edition

Ever wonder why broke states like California have such a hard time doing anything about their monstrous unfunded pension liabilities? In addition to the usual corruption and irresponsibility we've come to expect from our government, Daniel Borenstein finds an interesting culprit in today's Contra Costa Times: sketchy pension-accounting practices. In general, differences in federal accounting rules between public and private pensions allow government plans to overstate their assets, understate their liabilities, and spread out debt payments over ridiculous lengths of time.

When determining how much money they have, pension plans typically "smooth in" the effects of gains and losses in investments, so as to minimize the impacts of market volatility. By the law, private pensions are only allowed to spread out the effects of changes over a two-year period, and only if the adjusted portfolio value doesn't differ from its actual value by more than 10%. In contrast, CalPERS spreads its gains and losses out over a 15-year period, and has allowed the adjusted value to deviate from the actual value by as much as 40%. As such, CalPERS has yet to account for the losses in investment holdings that occurred in 2008-09, and is assuming it has much more money than it actually does. When it comes to liabilities, private pensions are required to assume a conservative market return on their existing holdings in calculating the value of those assets toward future payments. According to people like Warren Buffett and the 20th century's record of returns, a reasonable rate of return would be about 6%. Yet CalPERS assumes a 7.75% rate of return, based on similar returns over the past 20 years (though it's only gotten a 4.3% return in the past 10). In other words, CalPERS is almost certainly assuming that the value of its assets will be exceedingly high when they're needed to pay retirees. And finally, when it comes to unfunded liabilities, private pensions are required to amortize these payments over a seven-year period. CalPERS, in contrast, amortizes them over a 30-year period, which pushes down the amount of each individual payment against these liabilities.

It's depressing enough that California's unfunded pension liabilities are now estimated at a half-trillion dollars. What's especially sad about Borenstein's analysis is that accounting for those liabilities in a straightforward way is probably politically unacceptable. As he points out, if CalPERS and other public pensions in California held to the same accounting standards as private retirement plans, the required payments would likely triple and devastate government budgets at all levels. Yet we're not so sure that that wouldn't be a better approach to continually whitewashing over the problem. Somehow we think the consequences will be much harder to accept when the money literally runs out.