U.S. public pension funds don’t have nearly enough money to pay for all their obligations to future retirees. A growing number are adopting a risky solution: investing borrowed money.
As both stock and bond markets struggle, it’s a precarious gamble.
More than 100 state, city, county and other governments borrowed for their pension funds last year, twice the highest number that did so in any prior year, according to a Municipal Market Analytics analysis of Bloomberg data. Nearly $13 billion of these pension obligation bonds were sold last year, which is more than in the prior five years combined.
The Teacher Retirement System of Texas, the U.S.’s fifth-largest public pension fund, began leveraging its investment portfolio in 2019. Next month, the largest U.S. public-worker fund, the roughly $440 billion California Public Employees’ Retirement System, known as CalPERS, will add leverage for the first time in its 90-year history.
While most pension funds still avoid investing borrowed money, the use of leverage is spreading faster than ever. Just four years ago, none of the five largest pension funds used leverage.
Investing with borrowed money can juice returns when markets are rising, but make losses more severe in a down market. This year’s steep slump in financial markets will test the funds’ strategy.
It’s too soon to tell how the magnified bets are playing out in the current market, as funds won’t report second-quarter returns until later in the summer. In the first quarter, public pension funds as a whole returned a median minus 4%, according to data from the Wilshire Trust Universe Comparison Service released last month. A portfolio of 60% stocks and 40% bonds—not what funds use—returned minus 5.55% in the quarter, Wilshire said.
While leverage could pay off if markets rebound, the losses it risks could affect not just the pension funds but also the state and local governments that stand behind them—and ordinary citizens. When public pension funds’ investment returns fall short, governments are primarily responsible for taking up the slack, pressuring them to find the money by cutting other spending or by raising revenue from steps such as increasing taxes.
Public pension funds are “operating more like hedge funds in some cases,” said Joseph Brusuelas, chief economist at accounting firm RSM. “They’re treading on very risky footing doing things like this.”
Pension funds historically invested very conservatively, favoring relatively low-yielding fixed-income investments. CalPERS had all its money in bonds until 1967.
Funds suffered significant losses in the 2000-02 dot-com bust and the 2008 financial crisis. Those setbacks, coupled with years of insufficiently funded benefit promises, left the funds as a whole well over a trillion dollars short of the asset level they ought to have. The level is dictated by a formula that includes their obligations and their targeted investment returns.
In some cases, workers’ unions have secured sizable payouts for retirees that can keep pension funds paying out full or significant benefits to their members for many years.
Public-sector retirement plans tend to carry higher and more unpredictable costs because they offer defined benefits. While private employers have generally shifted to defined-contribution plans with payouts based on market returns, state and local governments still largely offer their employees pension checks calculated based on salaries and years of service.
Even the longest equity bull market in history—a roughly 11-year run through early 2020 in which the S&P 500’s 18% annual return more than tripled its historic average—didn’t close the gap between pension funds’ obligations and assets. In 2021, public pension plans had an average of just $0.75 for every dollar they expected to owe retirees in future benefits, according to data from the nonprofit Center for Retirement Research at Boston College.
Before tackling important city issues like homelessness, public safety, and infrastructure, Huntington Beach City Council members had some fun Thursday morning.
A strategic planning workshop at Huntington Beach Central Library started with an icebreaker exercise designed to find common ground. The city leaders talked to their colleagues to discover non-work-related things they had in common with each other.
Mayor Tony Strickland found out that Councilwoman Natalie Moser is really good friends with his college girlfriend. Colleagues laughed.
"Why aren't you still with that girl?" someone asked.
"She's married," Moser quickly replied with a smile.
So is Strickland. But love—or at least consensus—has not always been common in the first six-plus months of the current City Council, which has seen a lot of 4-3 votes on key issues. Strickland, Mayor Pro Tem Gracey Van Der Mark, Casey McKeon, and Pat Burns, all elected in November, have the conservative majority.
But Thursday's workshop was about working together to find key goals and priorities for the next four years. It was facilitated by accounting and consulting firm Baker Tilly
Steve Mermell, the former city manager of Pasadena, led the council and City Manager Al Zelinka through much of the four-hour discussion. It featured brainstorming based on six general topics: fiscal stability, public engagement, housing and homelessness, infrastructure investment, fostering a high-performing organization, and public safety.
The discussion on housing and homelessness was particularly detailed. A large majority - 79% - of Surf City residents surveyed for a quality of life study, the results of which were shared at Tuesday night's City Council meeting, said that homelessness was an "extremely" or "very" serious problem.
According to last year's count. Point in Time summary-, there were 330 homeless people in Huntington Beach, including 188 unsheltered and 142 sheltered individuals.
"If we do not address the real issue, which is the mental health and the drug addiction, nothing will be changed," Van Der Mark said. "We have the state constantly on top of us, telling us, 'Build more houses and everything will be solved,' and that's not the case. I think we need to focus more on the real issue, the fundamental health services they need. The county needs to step up some more."
But housing advocates have consistently argued that the lack of affordable housing is a driving factor in homelessness. The median home price in Huntington Beach is more than $1.1 million, higher than the county average.
"We're not going to be able to raise wages to the $280,000 to $290,000 a year it takes to buy a median home in Huntington Beach," Councilman Dan Kalmick said. "[Prospective buyers won't] qualify for a loan without what I call early inheritance, which is receiving a down payment from your parents. That doesn't create a sustainable community."
At the end of the workshop, each member of the City Council was asked to identify nine specific priority items they wanted accomplished during the first two years of the strategic plan. In the category of financial stability, they included considering options for new revenues and an economic development strategy.
Five of the seven also identified implementing a 311 system to manage and track calls for municipal services as a key public engagement goal. In housing, four said they wanted to take action to maintain local control of land-use planning. Huntington Beach has a pending lawsuit against the state of California over housing issues.
In infrastructure investment, four said they wanted to provide world-class beach facilities, including the renovation and expansion of 15 beach restrooms, new lighting for Pier Plaza, security, and programming. Four also said they wanted to prioritize exploring additional sports and concert venues.
"I was thinking like a volleyball and basketball facility, or a world-class pickleball facility," Strickland said. "They can do tournaments and bring people from all over California and Nevada to our community. Right now, we have an economic study on our softball and baseball Sports Complex, and the economic study was dramatic in how positive it was for our city."
In terms of creating a high-performing organization, all seven said they wanted to establish a one-stop shop to consolidate development and frequently used services in one location. And, in the realm of public safety, five said they'd prioritize a Huntington Beach Fire Department community risk reduction program, including an engagement coordinator, opioid prevention, and targeted risk reduction campaigns.
Baker Tilly will next provide a written workshop report before city staff drafts a strategic plan for City Council approval, to be reviewed in September. A final strategic plan and implementation plan would be introduced for council adoption in October.
Former City Manager Steve Mermell bid farewell to Pasadena this week, but not before city leaders shared a kind word about the dedicated 33-year city employee who first announced his retirement back in September.
Mermell’s final week as head administrator in Pasadena concluded with a ceremony at City Hall in the company of some of his closest friends. Nearly all in attendance witnessed him climb the ranks of city government since he first began as an analyst for the Water and Power Department when he was 23 years old.
“Not every city manager gets to choose their own timing when leaving, so it’s just awesome to have the support of the employees,” Mermell said in an interview Friday, his first official day of retirement. “That really means the world to me.”
With his five-year tenure as City Manager, he led the city through a successful effort to recover money following an embezzlement scandal, navigated the coronavirus pandemic and subsequent vaccine mandates, and dealt with the ongoing fallout of a police shooting that has drawn the ire of many in the community.
Mermell said he is proud of his time in Pasadena, but he’s certainly looking forward to hitting the water with his son and an inflatable kayak.
“Running the city, making sure the streets are clean, and there’s not junk everywhere and there’s not graffiti everywhere and the lights work and the water runs — that alone is a big deal and the city employees deserve massive credit for doing all that,” Mermell said.
“I’ve been lucky, I’ve been in the right spot at the right time,” Mermell said, deflecting credit for the accomplishments. “It’s always been a team effort. I was just lucky enough to have been the quarterback.”
Mermell started with Pasadena in 1989 before working to become interim city manager in February 2016. He later permanently received the job that year after a unanimous vote by the council.
Lisa Derderian, Pasadena’s Public Information Officer, said she’s always appreciated Mermell’s humility and the fact he always took the time to help his employees succeed.
“Steve always helped people by giving them opportunities to advance in their careers and then mentor and provide leadership along the way. I’m proud to say I’m one of those employees,” Derderian said. “His calm demeanor, quick wit, and knowledge can never be replaced. He truly cares about his employees at all levels and has always put the city before his own priorities.”
During an impromptu farewell just prior to the adjournment of Monday’s City Council meeting, Councilwoman Felicia Williams said, “Many people don’t know, but Steve is probably one of the top five city managers in California.”
Describing the responsibilities of his former position as “intense,” Mermell said, “I’m confident that I’ll end up doing something else,” however, it probably won’t be leading an entire city.
For now, though, Mermell is focused on the short-term, which includes a road trip before he hits the greens for a few rounds of golf next week.
The recent retiree is teaching at California Lutheran University and is planning an overseas trip, too.
“The fact that my wife and I are going overseas, I think, is a way that I can disassociate myself without having too much of a sense of loss,” he said, “because, you’ve got to understand, I’ve been there my entire adult life.”
He added: “I started here at 23 years old in the city, so it’s not just — the city manager is a great job — it’s the city of Pasadena is a great job. And I know I’ll miss all those people and having lunch a couple of times a week with the city clerk, so it is going to feel like a sense of loss — absolutely.”
Cynthia Kurtz, who previously served as Pasadena’s City Manager from 1998 to 2008, now takes the reins while a permanent replacement is sought.
Gordo and council members are expected to complete a national search for a permanent city manager in the upcoming weeks, according to city leaders. The effort will be assisted by Kurtz and city staff.