Thursday, Oct. 30, 2008 | Recent snapshots of the city of San Diego’s pension fund have revealed staggering investment losses stemming from the world-wide stock market meltdown.
An unaudited report to the San Diego City Employees’ Retirement System’s investment committee early this month showed fund assets of $4.22 billion on Oct. 2. That is a $440 million drop from the fund’s value on June 30 and $830 million less than it was at the end of 2007, according to figures released by City Attorney Mike Aguirre.
And by Oct. 14, the fund was down to $3.92 billion — a $1.1 billion drop from the end of last year — according to notes taken during a presentation by Doug McCalla, the pension system’s chief investment officer, to the City of San Diego Retired Employees Association. Pension officials have declined this month to release updated information on its investments to the public, saying the information will be released at the proper time.
San Diego’s fund, like pension funds across the nation, has suffered deep losses in its stock portfolio as markets in the United States and throughout the world dropped by 25 percent or more just this month. The California Public Employees’ Retirement System, known as Calpers, estimated a $48 billion decline in assets from the end of June through Oct. 10.
San Diego’s pension fund receives its income from a combination of investment returns and contributions by the city and its employees. If the market does not recover, the city could have to increase its already significant annual contribution in the coming years. A share of the money would come from a general fund that is $43 million in the hole this year, and could face a deficit of between $80 and $100 million in the next fiscal year if its tax revenues continue to crater with the overall economy.
The recent losses have hit the pension system at a time year when the fund seemed to be stabilizing after years of chronic underfunding that led to one of the biggest pension scandals in American history. The system had a $1.2 billion deficit before its recent losses. Now, depending on how the markets perform on a given day, the deficit could be more than $2 billion.
City and pension system officials stressed that pension funds have very long-term investment horizons, and that the losses are paper losses (the system has not had to sell any assets). Roughly 60 percent of the fund’s portfolio is made up of domestic and international stocks. The rest is a mixture of bonds, cash and real estate investments.
David Wescoe, the pension system’s administrator/CEO, said he is confident that it will weather the current financial storm without serious ramifications. He said the system has adopted a number of policies in recent years to protect the fund’s long-term health from short-term gyrations in the stock markets.
Aguirre and other critics are accusing pension and city officials of behaving like officials did earlier in the decade when their failure to disclose the fund’s deficits led to investigations and charges from the Securities and Exchange Commission.
Aguirre has sent out press releases and held news conferences demanding that officials immediately disclose the fund’s balance and the current amount of its underfunding,
“Two years ago, the U.S. Securities and Exchange Commission nailed us for concealing the pension deficit from bond buyers,” Aguirre stated in a press release late last week. “The last thing we want to do is send the message that it’s business as usual at City Hall.”
Former mayoral candidates Pat Shea and Peter Q. Davis have echoed Aguirre’s calls for more disclosure. A widely held concern is that an increasing pension deficit will damage the city in the public bond markets, which it just gained entre back into after a four-year banishment because of the previous underfunding crisis.
Jay Goldstone, the city’s chief operating officer, said the pension fund losses, by themselves, will not hurt the city’s ability to float bonds next year. However, he acknowledged that they could be part of a basket of bad financial news that increases the city’s borrowing costs.
Wescoe said Aguirre and the other critics are misrepresenting the dangers facing the pension system.
“None of these numbers matter,” Wescoe said of the recent fund balances that have been reported, including the Oct. 14 snapshot given to the Retired Employees Association. “The only number that matters is the asset valuation on June 30 of each year. All of this hand wringing is grossly premature. That is just a fact.”
Wescoe said this because the pension fund’s balance at the end of the fiscal year is the official number used to determine the health of the pension system. That snapshot, taken on June 30 every year, is set to be released next month. Most importantly, it determines the city’s annual payment to the system, which comes in part from the city’s general fund. The city is scheduled to contribute $161 million to the pension fund in fiscal year 2009, the current fiscal year.
A drop in the fund’s assets would not hit the city’s general fund, which covers day-to-day operations such as public safety and parks, for at least budget seasons because of the lag time in reporting the assets. And Wescoe continually points to the fund’s 40-to-60 year investment horizon, which allows for many market ups and downs.
Wescoe also points to safeguards instituted in recent years that would cushion the blow of a bad year. The pension board, for example, recently lowered its expected annual rate of return to 7.75 percent from 8 percent, lowering the amount of investment gains the fund relies on each year. The returns are spread so that its gains and losses don’t cause wild fluctuations in the value of its assets from year to year.
The pension system reported a loss of 4.69 percent, not including its real estate assets, in fiscal year 2008, which ended in June; the annual contribution will not likely increase next fiscal year because the fund had strong returns from 2004 through 2007. But, according to back-of-the-napkin estimates by Goldstone and pension board member William Sheffler, the city could have to increase its annual pension contribution by more than $10 million in 2011 if the fund does not recover from the decline it has already suffered this year.
Goldstone emphasizes that the “worst-case scenario” increase in city contributions would only amount to 1 percent or so of the $1.1 billion general fund. However, it would come from a general fund that is projected to be tens of millions in the red through 2013.
Shea said the worst-case scenario is worse than Goldstone and Wescoe will acknowledge. Making up a $1 billion loss in the value of its assets is not as simple as just waiting for the market to recover, he said. The fund not only has to make up lost market value, but also lost revenue that resulted from the lower market value.
The fund’s future finances are projected on the assumption of certain market gains. Not only is the fund not registering those returns, but it now has a smaller pot of money with which to earn future returns.
“You need to have the revenue to materialize every year whether the capital is there or not,” Shea said. “Does the city have any plans to make up any of that, or not?”
Wescoe said the system came back after the 2000-2002 bear market that followed the bursting of the bubble in technology stocks. “I am in the 60-year investment business,” he said. “If you have the least bit of optimism in your life, markets will recover — they always have historically.”