Sunday, July 26, 2009

California Pension Financing and the Risk/Return Tradeoff

Dora and I have liked the "fact" that our retirement plan at UCLA is a defined benefit. The cliche is that if we stick around that when we retire that we will receive 75% of our highest salary. How will this be financed? This NY Times article makes me nervous. Now in a growing over lapping generations set up, you can fund current obligations out of taxes on the young but if the number of new employees is shrinking and there a lot of old guys demanding their pension checks then the "smart" guys who run the program better earn some extraordinary returns on their investments to finance this. But are are there investments that are low risk and high return? I don't think so. Will the California tax payers be willing to pay higher taxes to finance the "bloated" public pension budget to a bunch of old guys who are no longer contributing to the state but are owed this money as written into their past contracts? I don't think so. --- Something bad is about to happen and it is called time inconsistency.

I hope that the Calpers portfolio managers are smarter than me but I doubt it. If they can't earn a high return , what happens next as the cumulative pension payments rise and revenue shrinks?