The city of Stockton, California has been in the news lately. Stockton has declared that it is bankrupt and its fate is in the hands of the courts. In other words, the city cannot meet its financial obligations and has not only run out of cash, but has also exhausted its ability to borrow. The major reason is the incredible pensions it has been paying to municipal employees.
News reports indicate that so-called public service employees in Stockton can retire at age 50 on 90% of pay. For example, let’s assume that a police or fire chief was only earning $100000 per year. At age 50 he or she would be able to retire on $90000 per year for life. Actually, such pensions usually go up a little each year according to a cost of living factor. It’s very likely that the chief’s pension would double by age 65.
What are the consequences of this incredibly generous benefit? In the first place, the city of Stockton is paying three or four people to do one person’s job. First, there is the chief who retires and collects $90000 each year. Second, there is his replacement who is paid $100000 per year to actually do the work. Third, there is the chief who retired 15 years ago and is now at age 65 getting a pension that has probably doubled since his early retirement. Finally, there might be the 80-year-old widow of the chief who retired 30 years ago who is receiving the survivor benefit of her husband’s pension. Her monthly benefit is probably greater than the salary of the current chief.
The cost of these pensions is astronomical. It would take 2.25 million dollars earning 4% interest to provide an income of $90000 per year. Public service workers will argue that they pay into their pension plans but their contributions would never be able to provide 90% of pay at age 50. that's only for one retiree.
There are other hidden costs. Stockton has had to layoff young firefighters and policemen because of the costs of these pensions. In addition, employees retiring at age 50 quickly take other jobs in the public sector. Other towns like to hire them as contractors since they don’t need benefits. Younger employees are also blocked from advancement by the presence of these fat cats.
Stockton’s problems were compounded a few years ago by an ingenious scheme to bolster the assets of their pension funds. The town decided to borrow money by issuing bonds. It was hoped that the funds received from the bond sale could have been invested at a higher rate in order to not only pay off the bond interest but also provide more income for the pension funds.
Investors will recognize this as a very risky strategy. In effect, you are borrowing money to make an investment. Many things can go wrong and in Stockton’s case they did. The stock market tanked in 2008 and the expected high returns never materialized. Now the town can’t pay the interest on the bonds, and the investments they made have gone sour. It would appear that some are urging the bankruptcy court to allow the town to default on the bonds and screw the investors. The last thing they will give up or reform is the sacrosanct, exorbitant pensions. ###