“We overpromised” says the head of a pension reform group, and this may well be true. The amount being paid into the California State Teachers Retirement System (CalSTRS) by teachers, schools, and the state cannot possibly meet the amount that will be owed in the coming years. But the real problem for California is that by law CalSTRS can demand that the state make up any funding shortfall they have. That’s right, CalSTRS can legally force to state to fund them. Right now, the state is paying 23% of CalSTRS expenses. That percentage is expected to increase dramatically in the coming years and the gloomy consensus is that by 2040 the fund will be broke and will rely entirely on taxpayer money.

While CalSTRS and its sibling fund CalPERS did have a good year in 2010 primarily due to the stock market rise, they both invested heavily in risky real estate during the peak of the boom and as such have suffered losses in the billions. Certainly one question that needs to be asked is, why were they allowed to make such investments in the first place? Their first responsibility should be to protect the nest egg of retirees. But instead they did nearly the opposite, took huge risks, and lost enormous sums of money earmarked for retirees. This, quite simply, is wrong.

They both claim they need to make 7-8% a year to meet funding needs so therefore they have to take more risk. But they aren’t hedge funds (although they certainly act like it sometimes.) But a 7-8% return year after year is difficult to do. Just ask any mutual fund manager.   A few seriously down years like we’ve just seen can wipe out years of gains. So, instead of making overly optimistic forecasts of future income, perhaps they should scale it back to something more manageable like 4-5%. This means they would need to find additional money elsewhere and that pension benefits would need to be reduced too.

But there’s no easy way to reduce benefits. They are guaranteed by law. The only way around this would be a statewide initiative or constitutional amendment which would invariably be followed by years of lawsuits, should they pass. The non-partisan Legislative Analyst’s Office recommends 1) switching to something like a 401(k), which is a defined contribution plan instead of the current defined benefit plan, 2) making employees pay more, 3) no retroactive benefits, and 4) pay as you go (rather than raiding rainy day funds, borrowing, and paying as little as possible, This is what is happening now.) Other suggestions include capping the amount the state must pay (Utah just did this) and drastically reducing the amount of pension received based on salary.

Since CalSTRS and CalPERS are known for making ever-perky analyses of their portfolios and estimated future growth, are they marking their now-decimated real estate portfolios at market, at what they paid for it, or at some number of their own devising? The big banks now do not have to mark to market. They can value their real estate however they want (this due to a change in accounting rules that applies only to big banks.) How do California public pensions mark their real estate? Because it they aren’t marking to market, then their value will be on the books at much higher than what it is actually worth. Their liability then becomes much greater.

The current public pension systems cannot continue as they are because the final outcome, insolvency, is preordained. We need to find solutions.