Hoisted From E-mail: “Shock Doctrine Against CalPERS”

Yves here. As railroad speculator Jay Gould said, “I can hire one half of the working class to kill the other half.” The stoking of jealousy among members of the 99%, to keep their eyes off the 1%, seems to be working out according to plan in efforts to undermine one of the last vestiges of security for the middle class, that of the defined benefit plans at public pension funds.

What goes unsaid is that the fallback, of having workers fend for themselves by trying to save and invest personally or rely on employer 401 (k) plans, will result in far more income for Wall Street at the expense of workers. Public and private pension funds have vastly lower costs than retail investors. Any student of John Bogle knows that paying higher fees over the twenty to thirty-five year investment time horizon of most investors makes a large difference in results. So the sleight of hand is that the general public is being successfully manipulated to press for a race to the bottom in terms of retirement security, when we should be demanding better (such as strengthening Social Security).

And unfortunately, CalPERS is playing into the hands of its opponents. For decades, it has been buying the rope that is being used to hang it from private equity. Not only have private equity firms been systematically cutting and eliminating pension benefits at companies they buy, making public pensions harder to defend, but they’ve also been cutting wages and employment, which hurts municipal and state tax bases, again making the cost of government services of all sorts relatively more costly. As reader beth wrote in comments two days ago:

I watched PE destroy the middle class jobs on an entire city of 250,000 or 300,000 in the ’80s. At the beginning of the ’80s this city had 7 fortune 500 companies headquartered there. All were broken up with some remnants left by 1990. Talking to research engineers whose good/great ideas ignored and dropped was painful. Also, these firms had their over-funded pension funds raided.

CalPERS, as the most visible public pension fund, is becoming a magnet for attacks. Unfortunately, the public pension system seems to have forgotten how the cognitive bias called the halo effect works. People have a strong propensity to see institutions as all good or all bad. So when CalPERS insists being one of the plans that Bogle describes as “idiotically” sticking to a 7.5% return target, and repeatedly has staff caught out lying in board meetings (for instance, general counsel Matt Jacobs on public comments, or chief operating investment officer Wylie Tollette last year on whether CalPERS could obtain carry fee data), it prejudices observers to think the worst of CalPERS in other contexts.

Two weeks ago, we took apart a New York Times article on CalPERS that was so error-fillled that it was the first time in the history of this site that we’ve called for a retraction. We weren’t alone in that view. Several economists wrote us to tells us they’d complained about the story to the Times’ public editor.

The piece grossly misrepresented how the California public pension fund treats agencies who contract their pension fund management to it and later decide to leave the system. As we showed, documents on CalPERS’ website disproved the main assertions in the article.

Similarly, a breathless Los Angeles Times article the same weekend, which I did not have the time to debunk, was similarly false in its major claim, that a 1999 bill SB 400 was a large culprit in CalPERS’ underfunding. While SB 400 did increase benefits for workers who retired relatively early (in their mid-40s, typically cops), that group is small and the impact on total system costs is marginal. The big reasons for CalPERS underfunding is that it was politically impossible to charge ongoing contributions during the dot-com bubble, when CalPERS was overfunded, and the system took a big hit as a result of the financial crisis. An additional, not as significant cause of its current woes is that it’s made a bad investment bet. It put 50% of its public equity portfolio, or roughy 25% of its total investment, in foreign stocks, and they’ve been laggards in recent years.

Via e-mail, reader and CalPERS beneficiary Sluggeaux flagged another hit job and identified its larger context:

Arnold Family Foundation stooge, former San Jose mayor Chuck Reed, has an op-ed in the San Francisco Chronicle this morning criticizing CalPERS for underfunding. Of course the piece fails to mention that, as mayor, Reed drove San Jose’s city-operated pension fund into near bankruptcy via the classic Arnold strategy of bringing in private managers to steer investments into the hands of cronies, racking-up the worst performance of any public sector pension plan in the state of California. Al Jazeera America ran an excellent Matthew Cunningham-Cook expose on this classic “Shock Doctrine” play in 2014. However, that was a feature not a bug, because Reed (funded by Arnold) then attacked police and fire pensions in San Jose, causing a mass exodus of experienced police officers to the point that the current mayor (a Reed crony) has had to declare an “emergency” suspension of the police labor contract and has rushed a repeal of Reed’s “pension reform” onto the November ballot.

Ironically, Reed’s original strategy was designed to cover-up the collapse of San Jose’s municipal and redevelopment bonds in the wake of Governor Jerry Brown’s winding-up of local redevelopment agencies, which had been used state-wide as piggy-banks by developers. San Jose’s redevelopment agency was run for the benefit of downtown property-owners who had spent 20 years lining their pockets via deceptive bond issues that restructured and laddered previous spending to “develop” their properties in San Jose’s pathetic gang and bum infested downtown.

Reed is a false-flag Democrat who changed his Republican registration in order to run for mayor, and he is now using his “credentials” as cover for his real paymaster, John Arnold. He had worked for years for developers, but branded himself an “environmental lawyer” — a classic piece of truthiness, since (among other things) he was working to keep leaking fuel tanks IN the ground.

The useful idiots on the CalPERS Board are playing directly into the hands of the “reformers” who want to loot what’s left in the bank using the “full funding” canard as their Trojan horse.

Here are the key sections of the Matthew Cunningham-Cook 2014 story on the role of cronyism in the implosion of the San Jose pension fund:

The city’s political leaders say the pension cuts are a necessary step to save San Jose from bankruptcy. The Silicon Valley city spends one-fourth of its $1.1 billion budget on pensions and retiree health care. To help meet those costs, say officials, San Jose has cut more than 20 percent of its staff since 2009. Many libraries that used to be open six days a week are now open four, while fire and police departments have shrunk, pushing up response times.

But experts and an Al Jazeera examination of the city’s two pension funds suggest that the San Jose’s investment strategy — shifting money from stocks and bonds to high-risk, low-transparency “alternative investments” such as private equity, hedge funds and real estate — may be a bigger factor in the financial crunch.

“The missing link in debates about pension reform is poor investment performance,” says Edward Siedle, president of Benchmark Financial Services and a former attorney with the Securities and Exchange Commission. “San Jose’s officially reported 2012 and 2013 performance was absolutely atrocious. Any discussion about the unsustainability of benefits must come after discussion of radical market underperformance.”….

The San Jose case could be precedent-setting. It is the first attempt by a municipal body to cut pensions on this scale while not in bankruptcy. And unlike in Detroit, taxpayers in the San Jose metro area aren’t struggling financially: It has the highest per-capita income in the nation, according to the Census Bureau….

Federated City Employees Retirement System, one of the two funds, returned -3.2 percent at the end of fiscal year 2012, compared with an average of 1 percent among public funds nationwide. This was the worst of the statewide pension funds surveyed by Al Jazeera, and the worst of any public pension fund in California. The S&P 500, meanwhile, returned 5 percent during that same period.

Similar results held for 2013. Nationwide, only one major statewide public pension fund, the Indiana Public Retirement System, underperformed the San Jose Federated City Employees’ 8 percent return. (The stock market rallied that year, with the S&P returning more than 20 percent.)

The Police and Fire Department Retirement Plan, the other San Jose public pension fund, also underperformed funds in other states and cities, returning -0.5 percent in 2012 and 9.6 percent in 2013. The average public pension-fund return in 2013 was 12 percent.

Perhaps more than other types of investments, the city’s holdings in alternatives contributed to poor performance. The San Jose Federated City Employees Retirement System’s investments in “real assets” — indirect investments in real estate, including securities and derivatives — returned -10.9 percent in 2012 and -10.1 percent in 2013. No data is yet available on the performance of San Jose’s hedge-fund investments, but as a whole, public pension funds’ investments in hedge funds have performed poorly.

Public pension funds have plenty of ideological enemies. Underfunding puts the funds in a weak position; behaving in a manner that can be (correctly) depicted as short-sighted or self serving only makes matters worse. CalPERS needs to start thinking and acting strategically, and not tactically, as it has to date. The unions made the same mistake, of thinking the rationale for collective bargaining was so obvious that they didn’t need to make a case for it. If CalPERS fails to learn from the labor movement’s mistakes, it is destined to share its fate, of diminished legitimacy, power, financial resources, and members.

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  1. John Merryman

    Where does this play out in the long run? Is virtually every public space to be privatized and the majority reduced to serfdom, or are there ways to turn the tables? The Shock Doctrine can work both ways.
    My argument has been that we are educated to think of money as a commodity that is essentially mined and manufactured, from gold to bitcoin, but the reality is that it functions as a contract, in which every asset has to be backed by a debt. Wolf Street has a very interesting article up(http://wolfstreet.com/2016/10/01/why-u-s-government-deficit-numbers-are-a-big-lie-national-debt/#comment-56333), in which he points out that over the last 13 years, over 4 trillion more has actually been borrowed by the government than they have actually deficit spent. Possibly to allow the Federal Reserve to keep buying bond and not have to go Japanese and start buying stocks to keep pumping free money into the financial system.
    So money is backed by public debt. And it is a public medium of exchange, just like roads.
    The problem is when we think of it as a commodity, it becomes a store of value and the entire capitalist system has mutated from the presumably efficient transfer of value, as the circulation system allowing a global economy, to a method of storing excessive amounts of notational wealth. Given the system is really just a giant voucher system, this should cause it to collapse, but what saves it is the government borrowing all that surplus out and putting it on the public bill.
    In the body, for instance, blood is the medium and fat is the store. We need a leaner, public system of exchange and just as monarchies showed government doesn’t function as private enterprise, so too do we eventually have to shed this current, bloated financial system.
    So the more they want to overreach, the bigger the blowback will eventually be.
    Off to work, so cut it off here….

    1. Wisdom Seeker

      Correction to “he points out that over the last 13 years, over 4 trillion more has actually been borrowed by the government than they have actually deficit spent”

      No, what Wolf points out – correctly – is that the government has borrowed AND SPENT over 4 trillion dollars more than has been revealed to the public in the form of the official budget. (If the money has not been spent, it should be sitting in an account somewhere…) Who got the money? Who knows? But it wasn’t given to the Federal Reserve, who actually CREATES the U.S. money and therefore doesn’t need to get it from anyone.

      But your broader point that “money” is really “debt” in the current (post-Nixon) regime is 100% correct. And the more the rich want to get “richer” (have more money), the more everyone else must go into debt…

      1. John Merryman

        No, he asks what it is spent on, because that is not known.

        The Federal Reserve buys the debt, in order to create the money. It probably doesn’t matter whether they spend the money building outrageous toys(f-35) or all just sit around playing poker with it. If it hadn’t been borrowed out of the regular economy, then investors would have had to find something else to invest in and that would have inflated asset prices even more.

        Consider Volcker cured inflation with higher interest rates, but they only slowed economic activity and reduced the need for money. It wasn’t until 82 that inflation really started to come under control and that year, the deficit topped 200 billion for the first time. Given one of the ways the Fed controls the money supply is to sell bonds it is holding, what is the real difference than the Treasury just issuing new bonds? Apparently, if there is a surplus of money in the economy, the logical place to extract it is from those with a surplus of money.
        It should also be noted FDR not only put a lot of unemployed workers back to work, he also borrowed much of the money to do so, consequently putting unemployed capital back to work.
        So then the Treasury buys this debt and give the banks more cheap money to play with, turbocharging the process and we have this cyclone of capital over everything.

  2. Tony

    Is anyone aware of any research investigating the relationship between the collapse of the defined benefit retirement regime with the overall decline in infrastructure quality?

    1. Adam Eran

      Ellen Schultz’s Retirement Heist describes in detail how U.S. workers, with well-funded defined-benefit pension funds had those funds looted to goose corporate profits and C-Suite paychecks at Fortune 500 firms. Lax enforcement from the Feds, and toxic, shareholder-profit-fixated corporate culture conspired to eliminate such pensions, making public employees some of the last Americans with defined-benefit plans (roughly twice as remunerative as defined-contribution plans like IRAs, 401Ks, etc.). Public employees are the last targets for the looters too. (And bonus! Such attacks disempower public sector unions, so it’s a two-fer.)

      We may also attribute the fact that the commons suffered to the rise of the beatified CEO. CEOs want to privatize and turn previously free goods into toll booths. Witness the privatizing of water systems in the South (Jefferson County, AL) and (e.g.) Bolivia, the (union-busting) charter schools, etc, etc.

      Privatizing cuts out the connection between pieces of the environment and/or economy to make those toll booths happen. Michael Hudson points out that it hurts the economy enormously, but makes a reliable profit for the rentiers.

      Short version: Plutocracy harms the environment because it devalues what’s shared. The Kochs explicitly target “collectivism”–the idea that groups can get together and do good.

    2. RepubAnon

      I’m surprised nobody’s mentioned one of the main reasons why defined-benefit pensions became disfavored in the private sector: corporate raiders declaring the pension fund “overcapitalized” and taking the “excess” money for themselves. (Funny how all those looted “overfunded” pensions were eventually unable to pay benefits.)

      Here’s an article from 1987:

      Abstract: Illustrates how overfunding a pension plan may lead to a hostile corporate takeover in the U.S. Need for corporations to monitor the operation of their pension plans; Hands-off policy of the administration of U.S. President Ronald Reagan on plan assets reversion.

  3. John Wright

    In the mid 1970’s I had a conversation with an executive in the Insurance industry.

    He mentioned that at the rate union pension funds were buying USA company stock, they would own much of the USA equity market in the future, setting up an interesting dynamic where older retirees would want to pay lower wages to current workers to improve profits and hence improve the elders’ pensions.

    The paying of lower wages did happen, and some pressure for it was from state sponsored public employee union entities such as Calpers via their private equity positions.

    But the powerful labor unions of the 70’s and their pension funds were not as significant as this executive projected, as the unions suffered “death by a thousand cuts”.

  4. tegnost

    One of my many favorite things about NC is it’s ability to pull/present appropriate testimony from the weeds where we would otherwise be unaware of it Thanks to all for the effort in the comments section as well as from our fearless leaders…
    I’ll highlight this thought from the cunningham cook article snip…
    “The San Jose case could be precedent-setting. It is the first attempt by a municipal body to cut pensions on this scale while not in bankruptcy. And unlike in Detroit, taxpayers in the San Jose metro area aren’t struggling financially: It has the highest per-capita income in the nation, according to the Census Bureau….”

    1. flora

      +1. NC and commenters connect the dots that PE and neoliberal “economics” would prefer remain unconnected. Flying under the radar is to the looters advantage.

      1. flora

        401k plans were not designed to replace defined benefit (DB) pensions. They were created as a perk for highly paid executives. A nice add-on to an already large salary. Middle-income workers were never the designed group, unlike DB plans that were designed to benefit all workers.

        An 2012 NEA comparison of DB vs. 401k pension plans.

        PE and neoliberalism only appear to work if there are new large money pots to raid. CalPERS is a very large money pot.

  5. DorothyT

    An important avenue of investigation into CalPERS and its relationships with PE could start with Apollo, the 1990 successor to the bankrupt Drexel Burnham Lambert after Michael Milken’s incarceration. Those pesky ‘public-private’ deals that proliferated in the ’90s with California office holders and Apollo were the cornerstone that quickly spread to other PE deals and, sadly, CalPERS.

    1. Sluggeaux

      Buried in Links last Saturday was this little gem about one of Apollo’s major investments — Caesars World/Harrahs casinos — reported by Professor Rosemary Batt. It seems that CalPERS and other funds who were steered into casino LBO investments by Apollo’s hired political “fixers” are going to be left with a proverbial sh*t sandwich:


  6. Jim Haygood

    “Pension envy” is going to be a HUGE issue in the coming decade.

    For now, the fuse is lit. When the next recession and bear market strike (2017-18 is my penciled-in assumption), the public pension calamity goes off with a mighty bang, bringing the house down with it.

    One is sympathetic to the contractual (and in some cases, constitutional) argument that pensions should be paid as promised. But promises that can’t be honored (for lack of fiscal feasibility), won’t be.

    Public pension accounting is a gigantic lie. Their underfunding is twice as large as they admit, using a transparently phony and unattainable 7.5% discount rate. In the next bear market, the Big Lie will become impossible to conceal any longer.

    *switches on the grinder wheel to sharpen pitchfork tines*

    1. PlutoniumKun

      Its a huge issue everywhere – just today in the Irish Times (a supposedly liberal-ish respectable paper) there is a ridiculous article promoting envy at public servants. No mention that public servants in Ireland contribute a minimum of 12% of salary to their pensions (there is no pension fund, costs are funded entirely from current year funds). The comparative figures for the private sector seem to me to be out by several order of magnitudes, but I will let someone more competent than me interrogate in detail.

    2. laura

      It some necessary shit actually started getting built, roads, bridges, schools and the like, and all the ancillary business followed suit, 7.5 is not a moonshot, but a predictable rate of return, like it had in the past.
      Political will and policy priorities stands in the way, right next to the thieving class like Arnold and the accomodationists like Reed.

  7. Cry Shop

    Reed is a false-flag Democrat who changed his Republican registration in order to run for mayor, and he is now using his “credentials” as cover for his real paymaster, John Arnold.

    Kind of says it all about the corruption political system, that neither party has any discipline or gives two poots about it’s party platform if any monkey waving money can buy the party nomination. Both are sick, but particularly the Democratic Party — at least the Republicans are openly the party of government for sale.

  8. RUKIdding

    CalPers poised to cut retiree benefits in Loyalton, CA:
    This is an issue that will affect more retirees as time goes by. I work for a State Local District Govt (NOT for the State, itself). Should we run out of money, I could be screwed after retirement. We have pre-funded some of our retirement already with CalPers, in order to be “ahead” of what we owe. But you never what will happen. I keep telling my co-workers that they really need to save, save, save their own money because we can never be certain that our pensions will continue, or at least continue in the amounts promised now.

    Thanks for the info about CalPers. There’s loads of issues that need to be addressed.

    John Chiang was on the local radio last night, but I was so busy that I didn’t get to hear what he said. Now I can’t find the program that he was on. Don’t trust him, but he’s thrown his hat in the ring to run for Governor.

  9. Scrooge McDuck

    I hope that people running CalPERS, and other public pensions funds, read this article and recognize that NC is actually with them and not in opposition to them as they mistakenly believe. I agree with Ives’ point that unless pension funds begins to act strategically, they will be put down by the puppets working to promote the interests of financial firms/Wall Street, of which there are many such puppets who often take the form of politicians, lawyers, economists, professors, board members and so on.

  10. Wisdom Seeker

    Yves, I think your article inadvertently points out the Achilles’ Heel of group pension schemes generally – any large accumulation of pooled wealth is a very tempting target.

    The folks who manage pensions can be replaced or suborned, or simply fooled by those able to convince them that their approach to investing your money is “better” (at least for THEM). Those who are supposed to fund the pensions can choose not to. Or they can choose to raise benefits for cronies at the expense of everyone else.

    The pension system demonstrably does not work. The 401K system is not any better, both because of the expenses and poor outcomes, but also because it creates horrible “blank checks” for large corporations. Since 401K investors don’t get to express much choice in which enterprises they finance, we have lost most of the “shareholder pushback” which could rein in corporate abuses in the past. (Don’t tell me fund managers are doing that job…)

    Both systems should be unwound. And the broader issue is that there simply aren’t enough genuinely productive assets in the nation (much less the world) for everyone to retire and live off “investments”.

    1. flora

      Saying defined benefit pension systems do not work begs the question: What prevents them from working as designed? If what prevents them working as designed is malfeasance of the board, politicians, or theft by Wall Street companies, or any other nefarious measure, surely the problem is failure to effectively regulate according to current law. (hello, SEC)
      US Banking is/was sound when regulated according to law before laws were changed and the DoJ decided to stop effective enforcement of still existing laws.
      Saying the pension system demonstrably does not work, full stop, rather throws out the baby with the bath water.

      1. Sluggeaux

        Sunshine is the best disinfectant, and places like Naked Capitalism are the solar cells of the polity. That was Louis Brandeis, but I also keep a quote by Werner Herzog from his film Grizzly Man pinned above my desk:

        “I believe that the common character of the universe is not harmony, but hostility, chaos, and murder.”

        This notion is of course the opposite of the radical “freedom” professed by the Ayn Rand acolytes who foisted Thatcherism/Reaganism on us, ushering in the vandalization of the commons. Theodore Roosevelt and Franklin D. Roosevelt both recognized that the economic exclusion of the masses would inevitably lead to anarchy and bloody revolution — benefitting no one. Transparency, Regulation, Enforcement were the remedies that they imposed, twice saving America from collapse in the 20th Century.

        1. Yves Smith Post author

          Having a good recording of two people being eaten alive by a grizzly and watching it, as Herzog would feel compelled to do, had to be pretty traumatic.

          I think Frank Herbert, as stated by his character Liet Kynes in Dune, is closer to the mark: The most enduring principles of the universe are accident and error.

          1. Sluggeaux

            I suspect spending his childhood as the son of a Croatian refugee single mother in the ruins of the Third Reich, with Klaus Kinsky for a neighbor, had a great effect on Herzog’s world-view. Watch Into the Abyss for more of his views on human nature. Chaos is only one aspect of the universe. We humans naturally respond with hostility and murder until we learn empathy.

            Empathy is learned from transparency, regulation, and enforcement of norms. Some Boomer was trying to lecture me the other day about how I should dismiss any feelings of “guilt” — it is exactly that Boomer mentality that gives us grasping monsters like Donald Trump, Leon Black, or John Stumpf, and why they feel entitled to loot savings pools such as CalPERS.

        2. LAS

          Strong regulatory policy/law could outlast role-players – make it harder for them to practice corruption.

      2. Wisdom Seeker

        Malfeasance is not what is preventing defined benefit group pensions from working; it’s a symptom and not a cause. Ditto for underfunding, or poor returns. The deeper cause is human nature – greed, hubris and the promise of a free lunch. Malfeasance becomes part of human nature, when the incentives favor it, but human nature itself is why pensions fail, why banks fail, why regulators stop regulating, why laws are changed to favor the greedy.

        A system that is inherently corruptible will inevitably become corrupted at some point – that which can happen, will happen sooner or later. Group pensions are doomed for the same reason that communism was and remains doomed – a great idea that is unfortunately incompatible with the baser side of human nature.

        Yes, the immediate issue is failure to effectively regulate. Or maybe failure to adequately fund. Or maybe excess optimism about long-term return prospects in a low-growth world which has hit credit saturation. But once greed and zero-sum speculation have displaced prudence and positive-sum investment in the zeitgeist, regulation will always fail. Because the regulators can be captured by the same interests that prefer regulation to fail. And the lawmakers. And the law enforcers. Once the wolves of the global id have taken control of the financial henhouse, mayhem is as inevitable as the rising of the sun.

        I would argue that the banking system as currently construed is also doomed, precisely as you pointed out – the laws were changed and are no longer being enforced. But the laws were changed for precisely the same reason – human nature.

        I spent years where you appear to be now, fantasizing about and pleading online for a world in which there is effective regulation and / or enough public interest to ensure the myriad of complex laws are adequately enforced. That was a waste of time. You cannot save a people who do not want to save themselves.

        1. Sluggeaux

          You cannot save a people who are unaware that they need to be saved.

          However, the nomination of Trump proves that democracy can work, but in strange and unpredictable ways — the rank and file sent a resounding “Oh, hell no!” to the GOP establishment. Teddy and FDR twice overturned the finance establishment; Ike and LBJ overturned Jim Crow.

          Time will tell if we are effective, but you’re either part of the solution or you’re part of he problem…

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