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Springfield Goes to Wall Street


Springfield Goes to Wall Street

Fred Starkey

April 19,2012

In 2002 the Oregon Public Employees Retirement System (“PERS”) went unofficially bankrupt.  The reason was because the government promises of permanent 8% returns were impossible to keep.  Here’s why: the financial markets produce a return on investment based on a “risk/reward” ratio.  The higher the return, the higher the investor risk and accompanying volatility – meaning a concomitantly higher risk of loss as well as gain.  A well-diversified investment account can produce predictable results; some years the return may be greater than the statistical norm, but other years it may be lower – and substantially lower.  The only way to guarantee a specific return in the long run is to use a “risk-free” return rate that effectively means the pure time value of money. Logically, nobody can promise any return in the long run that exceeds the risk-free rate of return and hope to fulfill that promise.  The current investment return available in the United States with no risk is less than 1%.

However, by making such a promise to PERS recipients in their variable accounts, the public entities effectively created a gift – every year that the PERS investment account (also known as the “variable” account) failed to produce the designated return, the difference had to be made up from somewhere else.  Eventually those deficits became overwhelming.  But PERS can’t really go bankrupt, because its obligations are constitutional.  So, unlike bankrupt businesses, PERS simply sent bills to the participating public entities to make up the variable account deficit along with the 8% increases that they contractually promised to PERS members.

When PERS public entities realized that the PERS obligations would be difficult or impossible to meet, they decided to take action.  Unfortunately, what they did was to make matters worse – much worse.  According to the Oregon State Treasury, in order to finance that debt on its variable PERS account (rather than decimating their current budget), PERS sold 20-year Pension Obligation Bonds at 4.65% interest.

By selling the bonds, they immediately received the funds  necessary to meet their PERS obligation; however, now they owe that money to their bondholders.  This postponed the immediate debt, but also added interest to be paid by the taxpayer so that now taxpayers have to pay not only the 8%, but the additional 4.65% as well – for a grand total of – you figured that right – 12.65% per year.

But if that wasn’t bad enough, then the PERS managers did an even worse thing.  They had what looked to them like a big pile of money sitting in their PERS fixed account from the Pension Obligation Bond sales.  Why not take that money on which they were paying 4.65% and invest it in their variable account?   They reasoned that they could use the investment income to reduce or eliminate the amount they would have to pay out to the bondholders because it was invested in securities that had the potential of creating a higher return.   So, they “invested” the original bond sales proceeds on which they were paying 4.65% interest by moving it into their PERS variable account with an expectation of an 8% return or higher.   Unfortunately, the investment was not in fixed securities, and the PERS managers also ignored two basic rules: first, fiduciaries are never allowed to speculate with the property entrusted to them; and that is because of the second rule: stock markets are unpredictable. Instead of assessing and measuring the risk with taxpayer dollars and hedging or buffering in any way, the PERS managers simply went by the seat of their pants.  To nobody’s surprise, the stock market downturn has ravaged the values in that investment account.

The Springfield School District’s original share of the PERS losses was $60 million (along with the contractual long term growth promise of a minimum of 8%).  However, a recent independent audit now shows a loss of $30 million from the original $60 million, or ½ its value, so that the Springfield School District now owes $90 million plus the ever-accumulating interest. To nobody’s surprise, neither Springfield Superintendent Nancy Golden nor the Springfield School Board has any reasonable plan for repaying those losses.

But pay for them they must.  When those obligations come due, the Springfield School District will have to use very real tax dollars; every one of those tax dollars will represent a dollar not spent on current education. The Springfield School District will have to pay the 4.65% interest every year in addition to the principal for the bonds for the next 20 years.  That means that the interest alone exceeds $7.5 million per year. However, they only have half of the original funds available, so Springfield will have to also make up the principal as well.  That means they are on the hook for well over $10 million dollars per year – which will have to be raised in tax revenue before it can spend the very first dollar on its schools – for at least the next 20 years.

What is the lesson to be learned from the loss of millions of taxpayer dollars?  This: people who have no track record of managing money successfully in the private sector should not being managing public money.  Where else can an employee violate fundamental fiduciary rules, accumulate such losses, and keep their job?  Everybody with their hands on those PERS financing decisions should be terminated immediately.  When private Wall Street executives did this there was a national outrage and they were branded as “thieves.” However, when public employees do it in Oregon then nobody —  not even a local TV station — reports it and the employees are regarded as “valuable public servants.”

Fred Starkey

Predicting America

  1. Pension funding is problem too large to ignore, Thomas J. Healey, assistant secretary of the Treasury under President Ronald Reagan, Senior Fellow at Harvard Kennedy School
  2. 93 and 18.6 Lunar declination Cyces and their relationship to the stock market cycles1

Swindler

  1. What is a Swindler?

Fourth Turning Regeneracy

  1. WHERE’S OUR FOURTH TURNING REGENERACY?
  2. WHERE’S OUR FOURTH TURNING  REGENERACY ? PART 2
  3. WHERE’S OUR FOURTH TURNING  REGENERACY PART 3

Understanding Pers

  1. Understanding the true cost of state and local pensions, American enterprise Institute, Andrew Biggs
  2. Can pensions be changed “going forward?” In Budget Crisis, States Take Aim at Pension Costs  By MARY WILLIAMS WALSH
  3. Public-sector pensions remain generous because taxpayers are in the dark-Dodging the Ball
  4. NASRA Issue Brief: Public Pension Plan Investment Return Assumptions
  5. Public Pension Pressures in the United States Olivia S. Mitchell, Oct
  6. Why do states assume an 8% return on public pension investments?
  7. Teamsters Find Pensions at Risk Mary Williams Walsh, November 15, 2004
  8. A Test for State’s Untouchable Pensions from New York Times Mary Williams Walsh, March 18, 2012
  9. Freedom and Understanding Pers by Fred Starkey
  10. Can States Escape Pension Obligation Through Bankruptcy?
  11. Pension funding is problem too large to ignore, Thomas J. Healey, assistant secretary of the Treasury under President Ronald Reagan, Senior Fellow at Harvard Kennedy School
  12. Analysis of California Pensions Finds Half-Trillion-Dollar Gap
  13. The Underfunding of State and Local Pension Plans; NASA
  14. What a Piece of Junk: respondingto the eonomic Policy Institute on Public employee Pay, The Enterprise Blog, Andrew Biggs
  15. Oregon’s Ever Increasing State Debt Load, Dennis Richardson
  16. A Gold-Plated Burden, Hard-pressed American states face a crushing pensions bill, The Economist, Chuck Reed
  17. PERS Rates Are Going Up, WAY UP, On July 1, 2013, Dan Re
  18. The Pension Crisis,  Ronald J Ryan, CFA
  19. State Bankruptcy: Start Worrying, Steve-Wordpress Blog
  20. On “Costless” Benefits for Public Workers, Jason Richwine

Unions

  1. The Reality of Labor Unionism in America by Brian Farmer
  2. The States With the Largest Unionized Work Force

Discount Rate

  1. Retirement Fund Discount Rate
  2. Another point of view on the pension obligation discount rate

Moodys Reports

  1. 2011 State Median Report, Moody
  2. Combining Debt and Pension Liabilities of U.S. States Enhances Comparability

Answers to the Delima

  1. Is School Like Jail? Jeffery Tucker

Recommended Books

  1. The Main Spring of Human Progress, Henry Grady Weaver , Rose Wilder Lane, and  G. Henry Weaver 
  2. The Law, Frederick Bastiette 
  3. Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics, (See Wikipedia information on author)Henry Hazlitt
  4. Freedom and Economics,
  5. The Economics of Freedom: What Your Professors Won’t Tell You, (see Wikipedia information on the author) Selected Works of  Frederic Bastiat
  6. The Road to Serfdom, Miton Friedman
  7. Common Sense, Thomas Paine (see Wikipedia information on this book)
  8. The Working Life of a Dollar ; Lee Wendelbo & Sam Shannahan
  9. The Fourth Turning: An American Prophecy – What the Cycles of History Tell Us About America’s Next Rendezvous with Destiny; by William Strauss
  10. The Millionaire Next Door, Thomas J Stanley, Ph.D. and William D Danko, Ph.D.
  11. The Fatal Conceit, The errors of Socialism,  Edited WW Bartley

Books on History  

  1. Tragedy & Hope: A History of the World in Our Time, Carroll Quigley
  2. A Monetay History of the United States, 1867-1960, Milton Friedman and Anna Jacobson Schwartz
  3. The Law of Civilazation and Decay; An essay on History; Charles A Beard
  4. Manias, Panics, and Crashes, 4th Edition; Charles P. Kindleberger
  5. Suicide of a Superpower, Will America survive to 2025? Patrick J. Buchanan

Books on Education

Cultural Literacy, Ed Hirsch, Jr.

The Harbinger, Jonathan Cahn

Books on PERS and risk

  1. Against the Gods, A remarkable story of risk, Peter L. Bernstein (See Wikipedia information on Peter)
  2. The Theory of Money and Credit, Ludwig von Mises (See Wikipedia information on this book. It is also sold at Amazon.com)
 
Books on Freedom  and Economics
  1. Economics is One Lesson,  (see Wikipedia information on this author)  Henry Hazlitt
  2. The Naked Communist,W. Cleon Skousen

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