Jerry Brown’s Pension Loan Does NOT Pay Down Pension Obligations

In an opinion piece on June 8, State Treasurer John Chiang and State Senator John Moorlach provide an invalid analogy in support of Governor Jerry Brown’s proposal to borrow money in order to boost pension contributions. They write:

“[Brown’s] proposal is just as fiscally prudent as a family deciding to use some of its discretionary cash to pay off an expensive credit card.”

No, Brown’s proposal is not like using discretionary cash to pay off debt. Just read the language from the proposed bill: “This bill would require the Controller to transfer up to $6,000,000,000 from the Surplus Money Investment Fund and other funds in the Pooled Money Investment Account … to the General Fund as a cash loan, the proceeds of which would supplement the state’s employer contributions for the 2017–18 fiscal year.” As that language makes clear, Brown does not propose to use discretionary cash to pay down pension obligations. Instead, he proposes to borrow in order to boost assets that are invested to meet pension obligations. There is a big difference.

Think about it this way: Assume Jerry Brown personally owes $100 in pension obligations but presently has set aside only $65 with an investment manager to meet the future payments due on those obligations. Brown proposes to borrow $4 from a family member and contribute that $4 to the investment manager in the hope that investment earnings on that $4 will offset some of his future pension costs. In doing so, Brown wouldn’t be paying down any portion of his $100 in pension obligations. Instead, he would be borrowing in order to boost assets from $65 to $69 in the hope that the difference between what he pays on the borrowing and what his investment manager earns will reduce his future pension costs. If instead Brown wanted to use the $4 to actually reduce pension obligations he would offer payments to pension beneficiaries in exchange for extinguishing some of their future pension payments at a discount.

As frugal as Jerry Brown is, if his own money were at risk I can’t imagine that he would not grasp the difference between (i) using his own discretionary cash to pay down his obligations and (ii) borrowing from a family member to speculate on stocks in the hope of reducing future costs relating to his obligations. Presumably he would also notice the special danger of borrowing on a floating rate basis to speculate on stock markets when interest rates are low and stock prices are high. He might also notice the unfairness of covering up unfairly low past contributions by employees, the worrisome precedent set by borrowing from a non-discretionary special fund, and the mythology of designating another special fund as the source of the repayment of the loan when the obligations already payable by that fund dwarf that fund’s assets. If he drilled down further, he would also learn that the state’s future pension payments are coming due faster than they used to, which means CalPERS is increasingly unable to invest for the long term and increasingly at risk to the consequences of market volatility.

Perhaps Moorlach, Chiang and Brown are confused by accounting, just as a number of municipal governments have been confused by pension obligation bonds. Like Brown’s proposal, POB’s allow governments to boost contributions, thereby allowing them to report smaller unfunded liabilities (ie, the difference between assets and liabilities), but that’s an accounting fiction because all the prior pension liabilities remain in place and the new debt is elsewhere on the balance sheet (see eg, Stockton’s POB). Ie, the municipality (or the state in Brown’s case) gets to report more pension assets and thereby a smaller unfunded liability (in my example above, the unfunded liability would drop from 35 to 31) and in a separate spot report the borrowing that provided the money to boost the assets. But net net, there’s no reduction in amounts owed and now there’s also interest due on the new borrowing. What Brown proposes is no different than Lehman Brothers proposed to Stockton except that, unlike Stockton, he doesn’t need an investment banker to issue bonds to the public. Instead he and the legislature would authorize the state to issue a note to a special fund.

California has already gotten into deep hot water as a result of uninformed legislation and projections involving pension economics (see eg, SB 400) and pours more hot water every day by failing to fund new promises at adequate levels. Brown’s scheme — nothing more than a leveraged boost to assets in the hope and prayer there will be a positive spread between the cost of the loan and earnings on the assets — will just add more hot water. It’s a very un-Jerry-Brown-like proposal that he should withdraw.

NB: Chiang and Moorlach also invalidly analogize Brown’s proposal to “[making] an extra mortgage payment.” It is no such thing. Mortgages are obligations secured by assets. An extra mortgage payment that reduces the principal balance of a loan secured by an asset would boost the payer’s equity in that asset. In contrast, there is no equity to be gained from an extra pension payment. Also, in both cases the extra payment would reduce total interest expense if obligations were reduced but as explained above, Brown’s proposal would not pay down pension obligations.