Stockton, California: An Object Lesson for Investors
There are long and short-term implications to your investments because of public debt, deficits and unfunded liabilities, and you need to be aware of these policies in order to protect your capital. Stockton, California is just one example of cities, counties and states around the country that are in serious financial trouble.
“Stockton couldn’t afford this rich program (public employee salaries and pensions) even in boom times, so officials played risky investment games. In 2007, the city borrowed $125 million and put the money into Calpers, the giant California pension fund, betting that investment managers could earn more than the interest Stockton owed on the debt. When the market tanked, Calpers lost 24%-30% of the loan’s principal, according to city budget documents.
Now Stockton is stuck with interest costs on top of pension obligations that pile an additional 48% onto basic employee pay. Thus a public safety worker earning $70,000 annually costs the city another $33,000 in interest and pension-borrowing costs.
Perched precariously atop this mountain of obligations are retiree health benefits. Stockton officials awarded these to city employees in a series of votes in the 1990s but made no effort to fund them, intending simply to pay costs out of their budget as workers retired. As hundreds did just that over the years, the costs grew. Next year, the city’s fiscal documents project, retiree health costs will surpass those of the city’s regular work force. At last count the city’s unfunded liabilities for retiree health care are above $400 million.”
As the article concludes:
“The big question is whether Stockton is only the tip of an iceberg. The 50 states alone have promised their employees retirement health-care benefits amounting to a $627 billion future liability—and funded only 4% of that cost, according to a recent accounting by Bloomberg Data. Unfunded state and municipal pension liabilities range up to $4 trillion, depending on what future investment assumptions you make.
Most local governments may never reach insolvency, but the rising costs of these benefits already crowd out other spending, including on police and fire protection. Thanks to unaffordable promises made by politicians who never bothered to total up the costs, we’re in a new era of local government in America: Taxpayers can expect to pay more but get less.”
Unfortunately, Stockton is not an isolated incident. We all know about the troubles in Greece, Spain just released the “most austere” budget yet, and Detroit is another U.S. city (amongst many) that is on its way to insolvency.
At the Federal level, debt and deficits are also a problem – one look at the U.S. Debt Clock will tell you that. Sometime in the next year or two, politicians will have to start addressing our fiscal problems, and as we see with austerity in our cities, states and around the world, we believe this will not be a pleasant conversation for most Americans.
Don’t lose sight of these fiscal issues facing us, both domestically and globally. You never know when the market is going to recognize these problems and start to slow down. Higher taxes, spending cuts and slower economic growth are a drag on the markets and the economy, which creates a risky environment for investors.
(If you read this blog and enjoyed it, listen to Doug’s podcast this week for even more details on this topic, and please share this information with others who might benefit from our perspective.)