California & Why We’re All Going Down

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We have become a society of people who refuse to forego future needs because we crave short term rewards. In the end, we will either learn to regulate ourselves or we will hit rock bottom, and then what?

There is an outstanding article in Vanity Fair, a liberal magazine, that goes on for 7 fascinating pages. The article, California and Bust, was written by Michael Lewis. Also interesting are the comments after the article, keeping in mind that they are from people living in a very liberal state. I suggest people read it for themselves, but I am summarizing it because it points to the real reason the United States is in the place it’s in and why we are all to blame.

Yes, Wall Street bundled worthless assets, lied about their value, and sold them based on the lie with the help of the Feds. Homeowners share some blame because they knew they were gambling with the equity in their homes and oftentimes failed to read mortgage agreements. Unions want to only hear the word “yes,” and people like Michael Moore say we have plenty of money, which is what we all want to hear. Colleges lie to students about the value and need for their programs, we all buy when we shouldn’t, we like to pay off 60 cents on every dollar just like our government.

Bottom line – the government we have is the government we deserve, asked for, and continue to fire up. We are the carriage horses in the park with blinders on, and we will soon head for the glue factory, unless we regulate ourselves from the smallest government entity on up.

Lewis’ Vanity Fair article can’t be given justice by my summary so please consider clicking on the link and reading the 7 page long article – it’s a great read. If not, I have a summary here.

His article begins with the prediction by Meredith Whitney in 2007, who suggested that Citigroup’s losses in U.S. subprime bonds were far bigger than anyone imagined and that the bank would have to cut its dividends. She predicted that the deficits at the state levels were far worse than imagined, but they would push their problems to the lower levels, counties and cities, where the real Americans live. Her words were self-fulfilling and the bond market dropped the next day.

Her message was taken out of context and what she was trying to convey was that rating agencies and investment advisors were complacent and not warning people of the possibility that American cities would not pay back the money they borrowed, which is the same cycle we see between Greece and the IMF.

The only reason Whitney even looked at regional economies is because she had to understand how the larger governments worked and she asked the question, “How can GDP estimates be so high when the states that outperformed the U.S. economy during the boom were now underperforming the U.S. economy – and they were 22% of that economy?”

The answer she got – “…From 2002 to 2008, the states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion.In response, perhaps, the pension money that they had set aside was invested in ever riskier assets.

In 1980 only 23 percent of state pension money had been invested in the stock market; by 2008 the number had risen to 60 percent. To top it off, these pension funds were pretty much all assuming they could earn 8 percent on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero.

Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you were looking at multi-trillion-dollar holes that could be dealt with in only one of two ways: massive cutbacks in public services or a default—or both.

Whitney thought default unlikely, at least at the state level, because the state could bleed the cities of money to pay off its bonds. The cities were where the pain would be felt most intensely.

‘The scary thing about state treasurers,’ she said, ‘is that they don’t know the financial situation in their own municipalities.’”

Whitney recognized that all states were not created equal any longer and as regional weaknesses revealed themselves, people who can afford to move will. Those without money and can’t move, and rely more on state and local assistance, end up causing a “tragedy of the commons.”

The author asked her which is the scariest state. With a two second hesitation, she answered, “California.”

Lewis went on to speak with Arnold Schwarzenegger, whose view of running the state for seven years was this, …He came to power accidentally, but not without ideas about what he wanted to do. At his core he thought government had become more problem than solution: an institution run less for the benefit of the people than for the benefit of politicians and other public employees.

He behaved pretty much as Americans seem to imagine the ideal politician should behave: he made bold decisions without looking at polls; he didn’t sell favors; he treated his opponents fairly; he was quick to acknowledge his mistakes and to learn from them; and so on. He was the rare elected official who believed, with some reason, that he had nothing to lose, and behaved accordingly.

When presented with the chance to pursue an agenda that violated his own narrow political self-interest for the sake of the public interest, he tended to leap at it. “There were a lot of times when we said, ‘You just can’t do that,’ says his former chief of staff, Susan Kennedy, a lifelong Democrat, whose hiring was one of those things a Republican governor was not supposed to do. “He was always like, ‘I don’t care.’ Ninety percent of the time it was a good thing.”

Two years into his tenure, in mid-2005, he’d tried everything he could think of to persuade individual California state legislators to vote against the short-term desires of their constituents for the greater long-term good of all.

“To me there were shocking moments…When you want to do pension reform for the prison guards,” he says, “and all of a sudden the Republicans are all lined up against you. It was really incredible, and it happened over and over: people would say to me, ‘Yes, this is the best idea! I would love to vote for it! But if I vote for it some interest group is going to be angry with me, so I won’t do it.’ I couldn’t believe people could actually say that. You have soldiers dying in Iraq and Afghanistan, and they didn’t want to risk their political lives by doing the right thing.”

He came into office with boundless faith in the American people—after all, they had elected him—and figured he could always appeal directly to them. That was his trump card, and he played it.

In November 2005 he called a special election that sought votes on four reforms: limiting state spending, putting an end to the gerrymandering of legislative districts, limiting public-employee-union spending on elections, and lengthening the time it took for public-school teachers to get tenure.

All four propositions addressed, directly or indirectly, the state’s large and growing financial mess. All four were defeated; the votes weren’t even close. From then until the end of his time in office he was effectively gelded: the legislators now knew that the people who had elected them to behave exactly the way they were already behaving were not going to undermine them when appealed to directly.

The people of California might be irresponsible, but at least they were consistent…

Californians wanted services they couldn’t pay for and the future be damned. In the end, Schwarzenegger did accomplish a few things but left office with a 25% approval rating.

David Crane, his former economic advisor said -The pensions of state employees ate up twice as much of the budget when Schwarzenegger left office as they had when he arrived, for instance. The officially recognized gap between what the state would owe its workers and what it had on hand to pay them was roughly $105 billion, but that, thanks to accounting gimmicks, was probably only about half the real number. “This year the state will directly spend $32 billion on employee pay and benefits, up 65 percent over the past 10 years,” says Crane later. “Compare that to state spending on higher education [down 5 percent], health and human services [up just 5 percent], and parks and recreation [flat], all crowded out in large part by fast-rising employment costs.”

Crane is a lifelong Democrat with no particular hostility to government. But the more he looked into the details, the more shocking he found them to be.

In 2010, for instance, the state spent $6 billion on fewer than 30,000 guards and other prison-system employees. A prison guard who started his career at the age of 45 could retire after five years with a pension that very nearly equaled his former salary. The head parole psychiatrist for the California prison system was the state’s highest-paid public employee; in 2010 he’d made $838,706. The same fiscal year that the state spent $6 billion on prisons, it had invested just $4.7 billion in its higher education—that is, 33 campuses with 670,000 students.

Over the past 30 years the state’s share of the budget for the University of California has fallen from 30 percent to 11 percent, and it is about to fall a lot more. In 1980 a Cal student paid $776 a year in tuition; in 2011 he pays $13,218. Everywhere you turn, the long-term future of the state is being sacrificed.

Lewis then takes the example of wealthy San Jose, now drowning in a sea of debt. Lewis says you can take almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the U.S. after N.Y. and the highest credit rating in California, but its close to bankrupt. So what happened?

The Mayor, Chuck Reed, explains, The problem, he explains, pre-dates the most recent financial crisis. “Hell, I was here. I know how it started. It started in the 1990s with the Internet boom. We live near rich people, so we thought we were rich.” San Jose’s budget, like the budget of any city, turns on the pay of public-safety workers: the police and firefighters now eat 75 percent of all discretionary spending.

The Internet boom created both great expectations for public employees and tax revenues to meet them. In its negotiations with unions the city was required to submit to binding arbitration, which works for police officers and firefighters just as it does for Major League Baseball players.

Each side of any pay dispute makes its best offer, and a putatively neutral judge picks one of them. There is no meeting in the middle: the judge simply rules for one side or the other. Each side thus has an incentive to be reasonable, for the less reasonable they are, the less likely it is that the judge will favor their proposal.

The problem with binding arbitration for police officers and firefighters, says Reed, is that the judges are not neutral. “They tend to be labor lawyers who favor the unions,” he says, “and so the city does anything it can to avoid the process.” And what politician wants to spat publicly with police officers and firefighters?

For the last ten years, the city caved in to the demands of its public safety unions.

For instance, back in 2002, the San Jose police union cut a three-year deal that raised police officers’ pay by 18 percent over the contract. Soon afterward, the San Jose firefighters cut a better deal for themselves, including a pay raise of more than 23 percent.

The police felt robbed and complained mightily until the city council crafted a deal that handed them 5 percent more premium pay in exchange for training to fight terrorists. “We got famous for our anti-terrorist-training pay,” explains one city official. Eventually the anti-terrorist-training premium pay stopped; the police just kept the extra pay, with benefits.

“Our police and firefighters will earn more in retirement than they did when they were working,” says Reed. “There used to be an argument that you have to give us money or we can’t afford to live in the city.

Now the more you pay them the less likely they are to live in the city, because they can afford to leave. It’s staggering. When did we go from giving people sick leave to letting them accumulate it and cash it in for hundreds of thousands of dollars when they are done working?

There’s a corruption here. It’s not just a financial corruption. It’s a corruption of the attitude of public service.”

The Mayor who never thought of pensions when he took the job showed Lewis the charts.  It shows that the city’s pension costs when he first became interested in the subject were projected to run $73 million a year. This year they would be $245 million: pension and health-care costs of retired workers now are more than half the budget.

In three years’ time pension costs alone would come to $400 million, though “if you were to adjust for real life expectancy it is more like $650 million.”

Legally obliged to meet these costs, the city can respond only by cutting elsewhere. As a result, San Jose, once run by 7,450 city workers, was now being run by 5,400 city workers.

The city was back to staffing levels of 1988, when it had a quarter of a million fewer residents. The remaining workers had taken a 10 percent pay cut; yet even that was not enough to offset the increase in the city’s pension liability.

The city had closed its libraries three days a week. It had cut back servicing its parks. It had refrained from opening a brand-new community center, built before the housing bust, because it couldn’t pay to staff the place. For the first time in history it had laid off police officers and firefighters.

San Jose is now suffering from cultural bankruptcy to shore up the public unions.y 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers.

“There is no way to run a city with that level of staffing,” he said. “You start to ask: What is a city? Why do we bother to live together? But that’s just the start.” The problem was going to grow worse until, as he put it, “you get to one.” A single employee to service the entire city, presumably with a focus on paying pensions.

“I don’t know how far out you have to go until you get to one,” said Reed, “but it isn’t all that far.” At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. The only clear solution was if former city workers up and died, soon. But former city workers were, blessedly, living longer than ever.

Lewis asked the Mayor’s aides which city they pitied most. They all said in unison, “Vallejo.” The dilapidated and worn out city has real estate that plummeted 66% in four years and one in sixteen homes are in foreclosure. The city manager, Phil Batchelor, tries to explain, but the one point that rings out is he cannot come to an agreement with the unions. Some of the union members blame their unreasonable leaders for the problems, but nothing changes.

Having failed to convince its public-safety workers that it could not afford to make them rich, the city of Vallejo, California, had hit bottom: it could fall no lower.

“My approach has been I don’t care who is to blame,” Batchelor said. “We needed to change.” When I met him, a few months after he had taken the job, he was still trying to resolve a narrow financial dispute: the city had 1,013 claimants with half a billion dollars in claims but only $6 million to dole out to them. They were survivors of a shipwreck on a life raft with limited provisions. His job, as he saw it, was to convince them that the only chance of survival was to work together.

He didn’t view the city’s main problem as financial: the financial problems were the symptom. The disease was the culture. Just a few weeks earlier, he had sent a memo to the remaining city staff—the city council, the mayor, the public-safety workers.

The central message was that if you want to fix this place you need to change how you behave, each and every one of you. “It’s got to be about the people,” he said. “Teach them respect for each other, integrity and how to strive for excellence. Cultures change. But people need to want to change. People convinced against their will are of the same opinion still.”

This is a problem we see everywhere in the United States. Can we change our culture? Will we regulate ourselves or sink to rock bottom, where the enemy waits for the angry masses? Without economic freedom, we will not be free and without sacrifice, we will lose our culture.

 

 

 

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