Today, the state Legislature commences hearings on a request made more than a year ago by the California State Teachers' Retirement System, CalSTRS, for a $240 billion cash injection over 30 years, starting with $4.2 billion this year, to finance an unfunded liability for teacher pensions.
No public pension problem in the United States is more consequential. That's because of the size of the problem, the stealthy manner by which it grows, the unique way CalSTRS is - or is not - funded, and the devastation for the next generation if the underfunding is not financed in advance.
The Legislature needs to act this year and in an amount and duration at least equal to CalSTRS' request. Here's why:
Journalists often report CalSTRS' unfunded liability as "$80 billion over the next 30 years," but that is not correct. $80 billion is the present value today of the next 30 years of unfunded pension payments, discounted at 7.5 percent per annum. That's why CalSTRS is asking for $240 billion, not $80 billion, over those 30 years. If provided that $240 billion and assuming an annual return of 7.5 percent, CalSTRS forecasts the liability to disappear.
Because of accounting rules adopted by the state and school districts, CalSTRS' unfunded liability grows silently. That's how that liability has been able to grow more than $25 billion without fanfare or press attention since Gov. Jerry Brown took office. If not addressed, it will grow at least another $30 billion over the next four years.
If not addressed, the unfunded liability will become $600 billion by the time CalSTRS expects to run out of money in 2043. To put $600 billion in perspective, that's two to three times the likely size of the state general fund in 2043. If Brown's $25billion of short-term debt is considered a "wall," then CalSTRS' debt is a skyscraper.
When CalSTRS runs out of money, school districts will have to spend at least $45 billion per year for costs on which they presently spend only $2 billion per year. To put $45 billion per year in perspective, that's equal to what the state will devote in total to K-12 education this year.
CalSTRS has asked for $240 billion but even that gargantuan sum is a low-ball request based on its optimistic assessment of what it will earn on that injection over that period. CalSTRS is an excellent investor but to meet its investment return assumption and thereby hold the required cash injection to only $240 billion, the stock market would have to double every decade and fixed-income yields would have to rise significantly without jeopardizing its current bond portfolio. CalSTRS' own actuary estimates that there is a greater than 50 percent chance that the system will not meet its assumed rate of return. If CalSTRS ends up earning the same return Warren Buffett expects for his pension funds, the fund will need much more than $240 billion.
CalSTRS correctly warns that it cannot earn its way out of its deficit without a cash injection. Only those with little understanding of compound interest and pension economics might believe otherwise. This explains why CalSTRS' debt more than tripled over the last 10 years even though the fund earned healthy returns during that period, which included the Great Recession.
Thirty years is roughly twice the remaining tenure of the average teacher, which means that by choosing that long period over which to pay off the debt, CalSTRS is already choosing unfairly to allocate much of the cost to the next generation. To be fairer to that generation, we should really pay off the debt in 15 years.
These facts explain why even the expensive solution requested by CalSTRS is likely to be insufficient. As a result, the Legislature must enact at least that level of support, including dedicated funding so there is no appropriation risk over the funding period. One year's funding will make little difference.
That's a tough task, but it pales in comparison with the next generation's undertaking if we don't eliminate CalSTRS' debt. Either K-12 education or, if the state covers the debt for the school districts, every other state service will come to a virtual halt. The very fabric of civil society in California will unravel.
Speaker John A. Pérez and Assemblyman Rob Bonta are due applause for pushing the CalSTRS issue onto this year's agenda. They will be due a standing ovation - especially from the next generation - when Brown signs legislation to address the problem.
David Crane is a former CalSTRS board member. He is a lecturer at Stanford University and president of Govern for California.