Letter to a State Worker

It must be tough for a California state worker to deal with the rising resentment of private sector workers. It must be easy to consider all of this some sort of plot by big business and billionaires to smack down the public sector workers, now that they’ve finished their nefarious beat-down of the private sector workers. There may be comfort in these notions, but little accuracy. Here are some thoughts for our state worker brethren to consider:

The average CalSTRS pension in 2010 for retirees leaving with 30+ years of service was $68,000 per year (ref. Government Worker Understates Average Pension). This benefit is extremely out of line with what is financially feasible. In the competitive, globalized private sector, the ability to retire before age 60 with an income of $68,000 per year requires amassing a huge amount of wealth. When savings accounts are paying interest of less than 1.0%, and the stock markets have been down for over a decade, might you not want to question the assumption that CalSTRS can earn 7.75% per year, long-term?

A self employed person in the private sector who manages to earn over $80K per year pays 53.25% tax on every extra dollar they make – 15% for employer and employee FICA and medicare, 28% federal, and 10.25% state. That doesn’t include property taxes or sales taxes, or the many taxes embedded in the typical utility and telecom bills. And, of course, if they don’t work, they don’t get paid. They are responsible for finding and paying for 100% of any benefits they enjoy including health insurance. And often, even if they are willing and able to pay the premium, they can’t find an insurance company who will cover them.

It is fine if you public sector workers need some time to accept the fact that your benefits are unsustainable. But to call those of us who have been coping with the impact of globalization and the collapse of the asset bubble for several years (if not decades) “haters,” or to encourage us to villainize big business and billionaires, does nothing to advance this discussion. Think about this:

1 – It is true that Wall Street special interests are to blame for much of our economic challenges, but your public sector pension funds are the biggest players on Wall Street.

2 – It is also true that monopolistic huge corporations are hurting the economic prospects for the rest of us, but you may not appreciate the difference between gigantic corporations who squelch competition and those emerging companies who disrupt the big corporations with faster, better and cheaper products who make our lives easier. And again, the presence of regulations tend to favor the monopolies more than the emerging companies – as do your pension funds.

3 – YOU are not bailing out Wall Street. Private sector taxpayers are footing that bill. When Wall Street conned the entire U.S. population and political leadership (it was totally bipartisan) into thinking we could drown ourselves in debt and hide that debt behind a bubble of phony, over-inflated assets as collateral, you benefited because your pension funds rode the wave of unsustainable growth that the debt created. Now the taxes paid by private sector workers pay for your pension, because Wall Street’s promises of high rates of return for your pension funds turned out to be false. And yes, you pay taxes. But for you to say that you pay taxes is sort of like the guy who stood inside a bucket and pulled on a rope hooked to the handle of the bucket, and wondered why he wasn’t able to levitate.

4 – Yes, in the old days everyone had a better pension. Are you kidding? Go back to pre-1999 payscales and pension formulas, retroactively, and you can keep your pension. It would not be insolvent.

5 – You do NOT pay for most of your retirement. If, for example, you are getting 50% of your salary after 25 years in the form of a pension, that suggests you will spend at least one year retired for every year you worked. How much was withheld from your salary for your pension? 5%? 10%? To accrue at a rate of 2.0% per year, which is what you get in this example, even at CalPERS (and CalSTRS) increasingly preposterous claim that they can earn 7.75% per year over the long term, you would have to contribute 20% of your salary (ref. What Percent of Payroll Will Keep Pensions Solvent). Did you? And if that projected rate earned by CalPERS goes down only two points, to 5.75% per year (ref. CalPERS Projected Returns vs. Reality), you would have to contribute 36% of your salary – again, to get a 50% pension for 25 years after 25 years of work. Have you made these calculations? Have you contributed 36% of your salary into your pension fund?

What you really should think about, beyond these calculations which apparently escape most everyone except the Wall Street puppeteers who are laughing their heads off that they can gamble with taxpayer’s money as long as they buy off the public employees (who set policy through their unions who control the politicians in league with Wall Street lobbyists) with pensions that exceed social security by a factor of about 5x, is that it is impossible to extend pension benefits as generous as you are getting to everyone. It is completely impossible because (1) we have an aging population where more people are going to be retired, and (2) there isn’t enough “return on investment” in the world to relieve the taxpayers of covering most of the costs for these retirees.

You can blame Wall Street all you like. But Wall Street is YOUR benefactor, not mine. Your unions are collection agents for Wall Street pension funds.

CalPERS Projected Returns vs. Reality

Whenever CalPERS, or any government worker pension fund, suggests that a long-term projected rate of return of 7.75% is realistic and prudent, one needs to consider the following: Across every major stock index in the U.S., and on most indexes in the rest of the world, publicly traded stocks have been down for the last 12 years. Here is a chart of the Dow Jones Industrial Averages staring in January 2000, and running through last week:

What is immediately clear from viewing this chart is that where the index began, nearly 12 years ago, and where it is now, are pretty much the same. To be precise, the Dow entered the week of January 4, 2000 at 11,522, and the Dow entered the week of August 8, 2011 at 11,269 (ref. Yahoo Finance – DJIA 1-2000 to 8-2011). The Dow has actually declined over the past 10.5 years.

Moreover, this loss of equity value should be measured using inflation adjusted dollars, not nominal dollars. If you review the Consumer Price Index from the U.S. Dept. of Labor, you will see that in January 2000 the index stood at 168.8, and in June 2011 (latest figures) the index stood at 225.7. This means that it would take $1.33 today to purchase what $1.00 would have purchased in 2000. From this perspective, the Dow index today would have to stand at 15,406 just to have kept up with inflation. Put another way, in real dollars, the Dow has lost 2.67% per year for the last 11.5 years.

One might argue that the Dow is not representative of the U.S. equities market, because the arcane formula that governs its calculation only incorporates a handful of blue-chip companies. Fine. Let’s take a look at the S&P 500, an index that tracks 500 of the largest publicly traded companies, most of them based in the U.S. and traded on the New York Stock Exchange:

On this chart it is obvious that even in nominal dollars, the S&P 500 is lower today than it was nearly 12 years ago. As it is, the S&P 500 entered the week of January 4, 2000 at 1,441, and the Dow entered the week of August 8, 2011 at 1,179 (ref. Yahoo Finance – S&P 500 1-2000 to 8-2011). When you take into account inflation, the S&P 500 today would have to be at 1,927 just to break even with where it was 11.5 years ago. Put another way, in real dollars, the S&P 500 has lost 4.19% per year for the last 11.5 years.

To be sure, back in 2000, these stock values were elevated because of the internet bubble, which one might argue makes 2000 an unfair choice to pick for the base year. But 2000 was the year when government worker pension benefit formulas, in one government organization after another, were increased from sustainable levels to unsustainable levels, a permanent adjustment based on this bubble. Since 2000, reality has reasserted itself with a vengeance, yet both the government pension fund managers and the union leadership who represent government workers continue to insist that 7.75% is a realistic long-term rate of return. In any event, nobody is arguing that the 2000 stock indexes were overvalued, which skews the last 11.5 years of return data. But are these stock indexes undervalued today?

One way to answer this question is to look at the aggregate price/earnings ratios for the stocks in the S&P 500. For the last half of the 20th century, the aggregate P/E for the S&P 500 was 16.48  (ref. Price to Earnings ratio of the S&P 500 well above historical average,” by Howard Spieler, written in 2002). Turning to data compiled by Robert Schiller from the Yale Dept. of Economics, S&P 500 PE Ratio by Year, one can see that in 2000 the aggregate P/E for the S&P 500 was an unsustainable 43.77. But one can also see that today that ratio is a lower, but still higher than normal 20.34. Corporate earnings are healthy. If there is a rational basis for anyone to expect U.S. equities to go up, I’d like to hear it.

It is in this context that government worker pensions, which taxpayers guarantee when Wall Street’s rosy promises greet reality, must seem a bit extreme to those of us who may only expect to receive social security at age 68. The fact is, government worker pension funds are the biggest players on Wall Street, and the unions who negotiate pension fund benefits for government workers and force taxpayers to pay tithe, are nothing more than collection agents for Wall Street.

Anyone who is just beginning to realize that government worker pension funds, who promise 7.75% returns in an environment of crippling consumer debt and asset deflation, are basically agents of Wall Street with government worker unions as their collection agents and enforcers, should read the July 25th New Yorker article “Mastering the Machine.” In this article, a spectacularly successful hedge fund manager who includes among his clients government worker pension funds, has this to say: “In order to earn more than the market return, you have to take money from somebody else.” This is absolutely true – over the past 10+ years, as Wall Street speculators have gotten spectacularly rich, government worker unions have been bought off with promises by their pension funds of over-market gains. But the indexes have been down during this period. Small investors have indeed been decimated, at the same time as taxpayers have seen increasing amounts of their taxes sent to Wall Street to sustain the solvency of government worker pension funds.

Referring to government employees who retire in their mid-fifties with pensions that average well over $60,000 per year as “working people” is more than an insult to working people who retire in their late sixties with social security benefits that average $15,000 per year, it is a crime, perpetrated by Wall Street, with government worker unions providing the political muscle. More money is paid out each year to retired government workers, who comprise barely 20% of the workforce (but 30% of retirees because they retire so much earlier), than is paid out via Social Security to the entire remaining retired population.

The way to start to reform this mess is to take any taxpayer funded retirement program – such as social security, along with any taxpayer guaranteed retirement program – such as government worker pensions, out of the hands of Wall Street speculators. This would require a pay-as-you-go system, where assessments on current workers are used to pay benefits to retired workers. In turn, this would finally expose Wall Street’s last, biggest con, the idea that somehow 7.75% rates of return can relieve taxpayers of having to pay for government workers to enjoy retirement security literally five times better (or more) than social security.

How Interest Rates Affect the Federal Budget

The relationship between stagnant economic growth and high levels of total market debt should be clear to anyone trying to manage a household where their home mortgage payment consumes 50% or more of their entire household income. Similarly, the relationship between economic growth and the ability to borrow should be clear to anyone who has enjoyed the ability to purchase anything and everything in sight right up until they reached the point where every credit card they owned was maxed, and every dime of home equity available to them was already borrowed and spent. These comparisons hold true at the macroscopic level as well.

In the case of the federal government, borrowing has been facilitated by the ability to borrow money at cheap rates of interest. According to the official website of the U.S. Treasury, the Total Outstanding Public Debt, i.e., the total amount of money currently owed by the U.S. federal government is $14.3 trillion. From the same source, the Interest Expense on the Debt Outstanding for the first 9 months of fiscal 2011 (through June 2011) is $389 billion, which equates to an annual expense of $519 billion. Does anyone see anything wrong with this picture? The U.S. federal government is only paying interest on its debt at a rate of 3.6%. What happens if this rate of interest goes up?

In the table below, the best case scenario is presented, since it excludes “Intragovernmental Holdings,” which is debt the federal government owes to other government agencies, which accounts for about a third of the total debt. If you account for payments on all 14.3 trillion of federal debt, the half-trillion that the federal government currently pays at a composite rate of 3.6% already consumes about 14% of the federal budget. And as the table indicates, for every 1.0% that the rate of interest goes up, interest payments consume an additional 3.0% of the federal budget. Back in the early 1980’s , the maximum 30 year treasury bill peaked at about 16%, so the extreme case in this table, 7.5%, is not far fetched.

A more sobering way to present this data might be to consider what percentage of government revenues (about $2.1 trillion) are consumed by interest payments on total government debt ($14.3 trillion), since currently the federal government only collects about 60% of what they’re spending. By this reasoning, at an interest rate of 3.5%, the federal government is paying 24% of every dollar it collects in taxes right back again in interest payments. That’s today, at low rates of interest. If the federal government had to pay 7.5% interest, today, then the federal government would pay just over 50% of every dollar it collects in taxes right back again in interest payments.

It is interesting to wonder if inflation can erode the principal value of the federal debt. Without presenting an avalanche of what-if spreadsheets, here are some of the problems with inflation as a panacea for debt: To the extent inflation increases government revenues to service debt, interest rates rise in parallel with the rate of inflation, meaning the amount of debt service goes up, offsetting the benefit of the diminished value of the principal. The only way these countervailing forces can end up favoring the borrower is if the real interest rates – i.e., the rate of interest less the rate of inflation – fall, but in the higher risk environment of an inflationary economy, real interest rates are likely to rise. More significantly is the fact that real interest rates are at all-time lows today. With inflation – official vs. unofficial – hovering somewhere between 2.0% and 5.0%, real interest rates on federal borrowing are arguably negative.

The problem with inflation as a cure for federal debt is also compounded by the fact that everyone’s trying it. For inflation to endure, currency must devalue, and every nation on earth – definitely including the Chinese whose debt problem is only obscured by their asset bubble – is determined to devalue their currency. Compared to the Europeans and the Chinese, the U.S. dollar remains quite durable, and is unlikely to devalue.

What could present itself in the next few years, because inflation not a very likely scenario, is that debt service becomes so burdensome for governments in the U.S., federal, state and local, that defaults begin to occur, which will require raising the risk premium in order to attract lenders, which will further add to the burden represented by payments on debt. The deflationary impact of unsustainable debt is the true boogeyman of the global economy, and is the reason they are burning up the printing presses down at the United States Mint to print more currency, and why the Federal Reserve Bank will keep interest rates as low as they can for as long as they can.

The cure for stagnant growth caused by maxed out debt is to lower the cost of living, which creates liquidity to eliminate debt and invest in new industries. This is precisely the opposite of what we are seeing stimulus money spent on. The powerful combination of environmentalist interests and government unions are blocking development of cheap energy, water storage, and abundant open land, which would lower the cost of the basic necessities of life – energy, water and shelter – and stimulate consumer spending and business expansion. Instead of building this infrastructure, they are spending stimulus money to maintain overmarket compensation and benefits for public employees, and “green jobs” whose only impact is to offer consumers products and services that cost more than existing conventional solutions. This is the path to a debt-fueled deflationary collapse, and there is an alternative.

Related posts:

The Razor’s Edge: Inflation vs. Deflation, March 15, 2010

The China Bubble, June 8, 2010

National Debt and Rates of Return, December 12, 2010

When is Debt Unsustainable, February 4, 2011

For much more, refer to “What Percent of Payroll Will Keep Pensions Solvent?,” July 23, 2011, and the couple dozen links to related posts provided below the text.