Traditional pension plans have long been a solid vehicle for retirement, especially for government workers. But something is going on out on the West Coast.

The California Public Employee Retirement System (CalPERS) is not just big, it’s colossal. The fund manages more than $250 billion, and is known for aggressively protecting its turf. If you owe the system money, they send enforcers to your door like mobsters, threatening to break bones and torch your car if you don’t pay up.

OK, I made that last part up, but it’s not too far off.

CalPERS goes after deadbeat cities and other entities that owe it money with a vengeance, which is why recent developments are so interesting. A bankruptcy judge presiding over the bankruptcy of the city of Stockton, CA. just told CalPERS that its entire claim of omnipotence is false. Not only can Stockton change what it pays CalPERS, but the pension system holds no higher claim on assets than other creditors like bondholders.

This wasn’t an opinion written by the court, but it was the judge’s reasoning as he spoke from the bench.

CalPERS is howling because if this becomes a precedent it could undermine the entire system. It could also serve as a blueprint for other cities and states to walk on their own obligations.

Mobbish Behavior

Many if not all municipal entities (cities, counties, etc.) in California offer pensions to their employees. California’s state constitution specifically bars any public entity from reneging on a pension obligation, which means that once an employee starts accruing benefits, they cannot be reduced, period. The cities and counties tend to use CalPERS to run their pensions because the size of the organization translates into lower operational expenses.

But the combination of these two things, inviolable pension obligations and the size of CalPERS, has led to something else — an almost mafia-like relationship between the pension system and the municipalities that it serves.

When a municipality hires CalPERS to run its pension, the municipality must sign a contract stating that no matter what any court, anywhere in the world might decide, the obligations of the municipality to CalPERS cannot be diminished or discharged.  The pension system points to the constitution of the state of California for backup on this point.

When the city of Vallejo, CA went bankrupt several years ago, the town asked CalPERS to work with them on renegotiating pensions. The pension system told them to take a hike. Yes, other creditors would get much less than they were owed. And yes, in some cases that amounted to more than a 90% haircut. But pensions are protected by the state constitution, so there will be zero changes.

CalPERS told Vallejo that if the city chose to push the issue, then CalPERS would bring on the full force of its legal team. Obviously, Vallejo didn’t have any money to fight a protracted legal battle, the city was already bankrupt. In the end Vallejo caved to the demands of CalPERS, keeping their debts at 100% while crushing everyone else.

Stockton, CA is not asking the bankruptcy judge to change its obligation to CalPERS, because this city doesn’t want a fight with the pension system either. However, the judge overseeing the city’s bankruptcy must approve its plan, including how much is paid to each creditor. Stockton’s plan calls for paying CalPERS 100% of its claim.

The judge gave his view of CalPERS’ position in a statement from the bench. He noted that once an entity enters bankruptcy, it’s governed by federal law, not state law. Given that, there’s no claim in state law that can supersede the claims in bankruptcy, because that would mean that state law can supersede federal law, and that’s not the way it works.

So, no matter what agreement CalPERS made with the cities and states, once they’re accepted into bankruptcy all bets are off. It seems likely the judge won’t approve of a plan that puts CalPERS in a greatly superior position to other creditors, and that’s where the fight will start.

If CalPERS loses its “you-must-pay-us-everything” grip on municipalities, which would mean that state constitutional rights to pension benefits can be broken in bankruptcy, then a number of poorly funded California cities might try their chances in bankruptcy as well. And it wouldn’t stop there.

Cities, counties, and states around the country that are similarly positioned would all have a motivation to dive into bankruptcy. The current hole in public pensions is roughly $2 trillion. For many cities, counties, and even states, there’s no conceivable way that they’ll ever be able to pay everything that they owe.

But, as always, there’s the other side.

If Stockton, or any other city or state, is able to pay less than it owes to a pension fund, what happens to the retirees who are covered under that pension fund? That is the $64,000 question.

Years ago I wrote that eventually I think there will be a national backstop set up for public pensions, one that mirrors the Pension Benefit Guaranty Corporation (PBGC) which covers private pensions. Since such an organization would be brought to life specifically to deal with struggling pensions that are woefully underfunded, any guesses on where the money will come from to top up the funding?

Once again, American taxpayers will come to the rescue… whether they want to or not.








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Rodney Johnson
Rodney works closely with Harry to study the purchasing power of people as they move through predictable stages of life, how that purchasing power drives our economy and how readers can use this information to invest successfully in the markets. Each month Rodney Johnson works with Harry Dent to uncover the next profitable investment based on demographic and cyclical trends in their flagship newsletter Boom & Bust. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. Along with Boom & Bust, Rodney is also the executive editor of our new service, Fortune Hunter and our Dent Cornerstone Portfolio.